UNIT II
HEADS OF INCOME
Meaning of Salary
The meaning of the term ‘salary’ for purpose of income tax is much wider than what is normally understood. Every payment made by an employer to his employee for service rendered would be chargeable to tax as income from salaries. The term ‘salary’ for the purpose of Income-tax Act will include both monetary payments as well as non-monetary facilities like housing accommodation etc.
Salary as defined u/s 17(1) of the Income Tax Act, 1961, which includes:
Employer-employee relationship
Before an income can become chargeable under the head ‘salaries’, it is vital that there should exist between the payer and the payee, the relationship of an employer and an employee.
Full - time or Part-time: It does not matter whether the employee is a full-time employee or a part-time one. Once the relationship of employer and employee exists, the income is to be charged under the head “salaries”.
Following are exclusions of an Employee-Employee Relationship:
Basis of Charge
Under Section 15, the following income is chargeable to income-tax under the head ‘Salaries’.
a) Any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not.
b) Any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, though not due or before it becomes due to him.
c) Any arrears of salary paid or allowed to him in a previous year by or on behalf of an employer or a former employer if not charged to income tax for any earlier previous year.
Thus salary has been made taxable on due basis, as well as on receipt basis whether due or not, e.g. advance of salary where any salary paid in advance is included in the total income of any person for any previous year, it shall not be included again in the total income of the person when the said salary becomes due.
The word ‘employer’ would included every type of employer - Government, a local authority, a company, any other public body or association, a foreign Government, any private employer and so on. Not only the income from present employer is taxable under the head ‘Salaries’, but all income from former employer is also similarly taxable, provided the same arises out of the former employment, e.g. pension, gratuity, arrears of salary, payment of salary in lieu of notice, retrenchment compensation etc.
Basic Salary
Gross Basic Salary is Taxable.
Note: If Net Basic Salary is given i.e TDS deducted, Profession tax deducted, employees contribution is deducted from Salary, then add back all the amounts to make it Gross Salary)
Gross Salary = Net Salary + TDS + Profession Tax + E’s Contribution, if deducted
Allowances and their taxability
Allowance is a fixed sum of money received by the employee from an employer to meet their official or personal expenses.
Allowances is defined as a fixed quantity of money or other substance given regularly in addition to salary for the purpose of meeting some particular requirement connected with the services rendered by the employee or as compensation for unusual conditions of that service. Under the Act, it is taxable under Section 15 on ‘due’ or ‘receipt’ basis, irrespective of the fact that it is paid in addition to or in lieu of salary.
In layman terms, dearness allowance is defined as the cost of living adjustment allowance which the government offers to public sector employees, as well as pensioners of the same. Dearness Allowance is a component of the salary which is applicable to employees in India.
Basically, Dearness Allowance is understood as a component of salary which is a fixed percentage of an employee’s basic salary, which aims to hedge the impact of inflation. Since, this allowance is related to the cost of living, the Dearness Allowance component differs for various employees based on their location. This implies that Dearness Allowance is different for employees working in the urban sector, semi-urban sector and the rural sector.
It is Fully Taxable
2. House Rent Allowance (HRA)
The allowance is for expenses related to rented accommodation.
Least of-
i) Actual HRA received or
ii) 50% of [basic salary + DA] for those living in *metro cities (40% for non-metros); or
iii) Actual rent paid less (10% of basic salary + DA).
*Metro Cities- Delhi, Mumbai, Chennai & Bangalore
Illustration:
Mr. Anwar, employed in Delhi, has taken up an accommodation on rent for which he pays a monthly rent of Rs 15,000 during the Financial Year (FY) 2019-20. He receives a Basic Salary of Rs 25,000 monthly along with DA of Rs 2000, which forms a part of the salary. He also receives a HRA of Rs 1 lakh from his employer during the year.
Let us understand the HRA component that would be exempt from income tax during the FY 2019-20.
Solution:
Sl No | Particulars | Amount (in Rs) | Amount (in Rs.) |
1 | Actual HRA received |
| 1,00,000 |
2 | Rent paid (15000 p.m. * 12 months) | 1,80,000 | 1,47,600 |
32,400 | |||
3 | 50% of {(25000p.m.*12) + (2000p.m.*12)} (50% is considered as the accomodation is in Delhi) |
| 1,62,000 |
4 | Exempt HRA = lowest of 1,2,& 3 |
| 1,00,000 |
Therefore, in the above example, the entire HRA received from the employer is exempt from income tax.
3. Entertainment Allowance:
It is Taxable for all employees. But Government Employees have a deduction for this allowance under section 16(ii) which is as follows:
Deduction for Govt Employees u/s 16 is least of the following:
i) Actual Amount received.
ii) 1/5th of Basic Salary.
iii) Rs 5,000.
4. Leave Travel Allowance(LTA):
Employees who receive LTA from their employers can claim exemption. An employee, here, can be an Indian or foreigner.
However, this exemption is subject to the following rules:
1. The exemption is available on 2 journeys in one block of 4 years.
2. The amount of exemption available is lower of the actual amount spent to reach the destination via shortest route or the amount received from the employer.
3. To claim exemption, the cost of reaching the destination can be taken as A/C first class (for railways) or economy class of national carrier (for air travel).
4. Exemption is allowed only if actual expenditure has been incurred for travelling anywhere in India.
5. City Compensatory Allowance:
This is one of the common components of salary structure. It is similar to DA as it is offered to employees to compensate for high cost of living in cities. Just like DA, it is also fully taxable in an employee's hands.
6. Special Allowance:
Any Allowance received by an employee which does not fall under any other allowances head, is fully taxable in his/her hands.
7. Overtime Allowance:
Some employers compensate for the overtime done by their employees. This allowance is taxable in the employee's hands.
8. Children Education Allowance & Children Hostel Allowance:
Children Education Allowance is exempt upto Rs 100 per month per child up to a maximum of 2 children.
Children Hostel Allowance is exempt upto Rs 300 per month per child up to a maximum of 2 children.
9. Conveyance Allowance/Transport Allowance/ Medical Reimbursement
a) Both these allowances were available till FY 2017-18. However, from FY 2018-19, standard deduction of Rs 40,000 has been introduced in lieu of transport allowance and medical reimbursements.
b) If employees were receiving transport allowance from their employer till FY 2017-18, as a taxpayer, they can claim up to Rs 1,600 per month or Rs 19,200 per annum as exempt from tax before arriving at gross income chargeable to tax. In case of blind, deaf, or handicapped employees, the exemption limit is Rs 3,200 per month.
c) This allowance does not require employees to submit bills to employer for claiming it. However, there is a caveat to this benefit. This exemption can only be availed if no free conveyance is provided by the employer.
d) Similarly, any reimbursement given by an employer to his/her employee for any medical expenditure incurred for himself / herself or family can be claimed as exempt from tax up to Rs 15, 000 annually till FY 2017-18. However, exemption was available only if you submit actual bills to your employer.
e) Hence these allowances are fully taxable.
10. Fixed Medical Allowance: Fully Taxable.
11. Any other allowance: Fully Taxable.
Perquisites & their Valuation-
Perquisites are facilities provided to an employee instead of money from an employer for official or personal benefits.
The word ‘Perquisites’ in the ordinary sense means any casual emolument attached to an office. Or position in addition to salary or wages. It may take various forms. It is a gain or profit which incidentally arises from employment in addition to regular salary or wages. A perquisite is something which arises by reason of a personal advantage. Under the general law, benefit which is not convertible into money is treated as a perquisite. Rent free accommodation and free educational facilities for children provided by the employer are examples of benefits not convertible into money as they are not saleable. But the income-tax law does not recognise such a distinction. For income-tax purposes, it is immaterial whether perquisites are voluntary or obligatory. Perquisites are to be discussed in 3 parts:
Perquisites taxable for all Employees
The following perquisites are taxable in the hands of all employees:
Perquisites taxable for Specified Employees
All monetary obligations of the employee discharged by the employer are perquisites which are taxable in the hands of all employees. But sometimes the employer, instead of making the payment in respect of such monetary obligations or reimbursing such amount to the employee, provides the perquisite in the form of a facility to the employee. Such facility will be a perquisite only for specified employees mentioned in section 17(2)(iii).
For example:
1) if a watchman/sweeper is engaged by the employee and his wages are reimbursed/paid by the employer, it is a perquisite for all employees because it is the duty of the employee to pay the salary of his watchman/sweeper.
2) On the other hand, if the watchman/sweeper is engaged by the employer and facility of his services is provided to the employee, it will be a perquisite only for specified employees.
3) Similarly, if a motor car is provided by the employer to the employee for his personal use it shall be taxable perquisite in case of a specified employee only. Whereas if the car belongs to employee but expenses relating to personal use of such car are paid or reimbursed by the employer, it shall be a taxable perquisites in the hands of all employees, whether specified or not.
4) Any benefit/amenity in the form of a facility (other than rent free accommodation, concession in the matter of rent or fringe benefits or amenities as may be prescribed) provided by the employer, which is not tax-free, shall be taxable only in the hands of specified employees. Some of these are:
5) If the above perquisites are provided in 'Money' (monetary terms) whether by way of reimbursement of expenses incurred by the employee for such facilities or by way of payment on behalf of employee, these perquisite shall be taxable in case of all employees e.g. if the school fees of the children of the employee is reimbursed to him or paid on his behalf to the school, such amount shall be perquisite in case of all employees. On the other hand if the children of the employee are studying in a school maintained by the employer, the education facility provided is not in money but in kind and it shall be perquisite only for specified employees.
6) Similarly, if the personal gas bills of the employee are in the name of employee and the employer reimburses the amount of such gas bills to him or pays on his behalf to the gas agency, it is in monetary terms and taxable in case of all employees; on the other hand, if such bills are in the name of employer, it will be perquisite in case of specified employee only.
Specified Employee [Section 17(2)(iii)]:
An employee shall be a specified employee, if he falls under any of the following three categories:
- entertainment allowance (to the extent deductible under section 16(ii);
- tax on employment [Section 16(iii)].
Perquisites Exempted from Tax for all Employees and Not Added in Salary Income
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The value of any medical treatment provided to an employee or any member of his family in a hospital, dispensary or a nursing home maintained by the employer shall be a tax free perquisite.
2. Recreational facilities: Any recreational facility provided to a group of employees (not being restricted to a select few employees) by the employer is not taxable.
3. Training of employees: Any expenditure incurred by the employer, for providing training to the employees or by way of payment of fees of refresher courses attended by the employees.
4. Use of health club, sports and similar facilities provided uniformly to all employees by the employer.
5. Expenses on telephone, including a mobile phone, actually incurred on behalf of the employee by the employer.
6. Employer's contribution: Employer's contribution to superannuation fund of the employee or provided such contribution does not exceed Rs1,50,000 per employee per year.
7. The premium paid by the employer on an accident policy taken out by it in respect of the employee would not be a perquisite.
8. Amount given by employer of assessee to assessee's child as scholarship is exempt under section 10(16).
9. Food and beverages provided to employees: The following shall be a tax free perquisite in the hands of the employees—
b. Any tea or snacks provided during working hours. c. Free food and non-alcoholic beverages during working hours provided in a remote area or on offshore installation.
10. Loans to employees: In the following cases the value of benefit to the assessee resulting from the provision of interest free or concessional loan shall be nil:
11. Perquisites provided outside India: Perquisites provided by the Government to its employees, who are citizens of India for rendering services outside India, are not taxable. [Section 10(7)]
12. Rent free House/Conveyance facility: Rent free official residence and conveyance facilities provided to a Judge of the Supreme Court/High Court is not a taxable perquisite.
13. Residence to officials of Parliament, etc.
14. Rent free furnished residence (including maintenance thereof) provided to an officer of the Parliament, a Union Minister or Leader of Opposition in Parliament is not a taxable perquisite.
15. Accommodation in a remote area: The accommodation provided by the employer shall be a tax free perquisite if the accommodation is provided to an employee working at mining site or an onshore oil exploration site or a project execution site, or a dam site or a power generation site or an offshore site which—
16. Educational facility for children of the employee: Where the educational institution itself is maintained and owned by the employer and free educational facilities are provided to the children of the employee or where such free educational facilities are provided in any institution by reason of his being in employment of that employer, there shall be no perquisite value if the cost of such education or the value of such benefit per child does not exceed Rs 1,000 p.m.
17. Use by the employee or any member of his household of laptops and computers belonging to the employer or hired by him.
18. Leave Travel Concession
19. Tax paid by the employer on non-monetary perquisites: Tax paid by the employer on nonmonetary perquisites of the employee shall be exempt in the hands of the employee. [Section 10(10CC)]
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Valuation of Perquisites
Given to | Valuation or taxability |
To Govt Employees | License Fees determined in accordance with rules framed by Government for allotment of houses shall be deemed to be the taxable value of perquisites. |
To Other Employees |
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| If House Property is owned by the Employer, the perquisite value shall be: i. 15% of salary, if population of city where accommodation is provided exceeds 25 lakhs as per 2001 census ii. 10% of salary, if population of city where accommodation is provided exceeds 10 lakhs but does not exceed 25 lakhs as per 2001 census iii. 7.5% of salary, if accommodation is provided in any other city If House Property is taken on lease or rent by the employer, the perquisite value shall be :
Lease rent paid or payable by the employer or 15% of the salary, whichever is lower *Salary includes: a) Basic Pay b) Dearness Allowance (only to the extent it forms part of retirement benefit salary) c) Bonus d) Commission e) All other allowances (only taxable portion) f) Any monetary payment which is chargeable to tax But does not include i. Value of any perquisite [under section 17(2)] ii. Employer’s contribution to PF iii. Benefits received at the time of retirement like gratuity, pension etc. Note: The value so determined shall be reduced by the amount of rent, if any, paid by the employee. |
B. Furnished Rent Free House | Taxable value of perquisites a) Find out taxable value of perquisite assuming accommodation to be provided to the employee is unfurnished b) Add: 10% of original cost of furniture and fixtures (if these are owned by the employer) or actual hire charges paid or payable (if these are taken on rent by the employer). Note: The value so determined shall be reduced by the amount of rent, if any, paid by the employee |
2. Motor Car/any other Conveyance
Used for à | Only Official purpose | Both Official & Personal | Only Personal purpose |
Motor car owned/leased by employer | Not Taxable | If running/ maintenance cost is reimbursed by employer Capacity<=1.6 cubic litre- Rs 1800 p.m. + Rs 900 p.m.(if driver is also provided) Capacity>1.6 cubic ltr- Rs 2400 p.m. + Rs 900 p.m.(if driver is also provided) If running/ maintenance cost is not reimbursed by employer Capacity<=1.6 cubic litre- Rs 600 p.m. + Rs 900 p.m.(if driver is also provided) Capacity>1.6 cubic ltr- Rs 900 p.m. + Rs 900 p.m.(if driver is also provided) | Fully Taxable The taxable value is as under: Actual cost of Running and Maintenance of motor car Plus: driver’s salary Plus: normal wear and tear @10% per annum of the actual cost of motor car Less: any charges recovered from the employee
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If motor car is owned by the employee but running and maintenance and driver’s salary reimbursed by employer
| Not Taxable | If running and maintenance cost is reimbursed by the employer Cubic Capacity<=1.6 litre- Actual expenses less Rs 2,700 p.m. Cubic Capacity>1.6 litre- Actual expenses less Rs 3,300 p.m. |
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If Employee owns any other automotive conveyance but running and maintenance is reimbursed by employer
| If the car is used for only official purpose, it will not be taxable in the hands of employee if cubic capacity of engine is within 1.6 litre. | If running and maintenance cost is reimbursed by the employer Cubic Capacity<=1.6 litre – Actual expenses less Rs 900 p.m. Cubic Capacity>1.6 litre – Not Applicable |
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3. Educational Facilities
Taxable only in the hands of specified employees
Facility extended to | Value of perquisite | |
Provided in the school owned by the employer | Provided in any other school | |
Children | Cost of such education in similar school less Rs. 1,000 per month per child (irrespective of numbers of children) less amount recovered from employee | Amount incurred less amount recovered from employee (an exemption of Rs. 1,000 per month per child is allowed) |
Other family member | Cost of such education in similar school less amount recovered from employee | Cost of such education incurred |
Other Educational Facilities
Particulars | Taxable Value of Perquisites |
Reimbursement of school fees of children or family member of employees | Fully taxable |
Free educational facilities/ training of employees | Fully exempt |
Bonus:
Bonus Received- Taxable
Bonus Declared- Not Taxable (as it is not received)
Provident Fund
Type of PF | Recognised PF | Unrecognised PF | Statutory PF |
Employee’s Contribution | Deduction 80C | No deduction u/s 80C | Deduction 80C |
Employer’s Contribution | Exempt up to 12% of Salary. Thus Contribution made by employer exceeding 12% shall be added to employee’s salary Income. | Not Taxable | Fully Exempt |
Interest on Provident Fund | Exempt up to 9.5%. Interest exceeding 9.5% shall be added to employee’s Salary Income | Not Taxable | Fully Exempt |
Lumpsum withdrawal | Exempt subject to certain conditions* | Contribution from employer and interest on that is taxable under the head IFS; Contribution by an employee is not taxable, and employee’s contribution interest is taxable under the head IFOS. | Fully Exempt |
Conditions:
Public Provident Fund
Deduction under section 80C is available.
The amount received (including interest) is Fully Exempt.
Deductions under Section 16
2. Entertainment allowance as discussed before(Only for Govt Employees)
3. Profession Tax
Actually paid, or
Rs 2500, whichever is lower
Statement showing calculation of Income from Salary
Particulars | Amount(Rs) |
Gross Basic Salary | XX |
Add: Fees, Commission, Bonus | XX |
Taxable Allowances | XX |
Taxable Perquisites | XX |
Retirement Benefits | XX |
Gross Salary | XX |
Less: Deductions u/s 16 |
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Standard deduction | (XX) |
Entertainment allowance | (XX) |
Profession tax paid | (XX) |
Net Taxable Salary | XX |
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Key Takeaways:
1) Every payment made by an employer to his employee for service rendered would be chargeable to tax as income from salaries.
2) Remuneration to Director of a Company, if he takes professional fees. It is taxed under Income from Business & Profession.
As per sec. 22, the annual value of property consisting of any building or land appurtenant thereto of which assesses is the owner, other than such portion of such property as he may occupy for the purposes of any business or profession carried on by him shall be chargeable to income tax under the head “ Income from house property.”
It is an exceptional feature of this head that rather than actual income from house property, earning capacity of house property is taxable. As stated u/s 22 that “annual value” of the property is taxable rather than actual income of the property.
Chargeability (Section 22)
The following three conditions should be satisfied for an income to be Income from House Property:
Letting out property for promotion of own business –vs.- Business of letting out the property
Assessee lets out the property for the promotion of its own business or profession:
If an assessee carries on business or profession in his own house property or lets out the property for smooth running of his business or profession, income from such property is taxable under the head "Profits & gains of business or profession".
Assessee is engaged in the business of letting out of the property:
If an assessee is running a business with main object of buying & developing house properties either to let out or to sell such properties, then annual value of such house properties shall be taxable under the head "Income from house property". However, profit on scale of house shall be taxable under the head Profits & gains of business or profession.
Some Special Cases
If house property is situated abroad, then annual value of such property shall be taxable as:
Assessee | Condition for taxability |
Ordinarily resident | Always taxable |
Not ordinarily resident or Non resident | Income must be received in India |
Note: The annual value of such property would be computed as if the property is situated in India.
2. Disputed Ownership
Merely, due to dispute regarding the title of property, assessment cannot be postponed. In such case, person who is in receipt of income or who enjoys the possession of the property is assessable to tax.
3. Composite Rent
Together with rent of the building, if the owner gets charges for other services or rent of other assets provided in the building (e.g. furniture, machinery, etc.), amount so received is termed as ‘composite rent’.
Composite Rent = Rent for building + Rent for assets / Charges for various services
Tax Treatment for Composite Rent
Rent including charges for amenities or services like garden facility, food, lighting, etc. or other separable assets (like machinery, plant, furniture): If the owner of house property gets composite rent for both property as well as for services rendered or other separable asset, such composite rent shall be treated as under:
Particulars | Taxable under the head |
Sum received for the use of building | ‘Income from house property’ |
Sum received for other amenities or other separable assets | ‘Profits & gains of business or profession’; or ‘Income from other sources’ |
However, if segregation of composite rent is not possible, then the whole amount will be taxed either under the head ‘Profits & gains of business or profession’ or ‘Income from other sources’.
Taxpoint: Rent from paying guest is, generally, taxable under the head ‘Income from other sources’.
Letting of building with other inseparable assets (like machinery, plant, furniture): If letting of only building is not possible or not acceptable to the other party, then sum received as rent from the properties is chargeable as business income or income from other sources even if the composite rent is segregable. E.g. Letting out of hotel rooms, auditoriums, etc.
4. Co-ownership
If two or more persons own a house property jointly, then they are known as co-owners. If individual share of each co-owner is definite and ascertainable then the share of each such person shall be taxable as his income from house property.
Tax treatment
1. Share of each co-owner in the income from the property as computed in accordance with sec. 22 to 25 shall be included in his total income.
2. Where the house property is owned by co-owners and is occupied by each of the co-owner then all of them can claim benefit u/s 23(2)(a) and interest on loan shall be allowed to all the co-owners to the extent of 30,000/2,00,000 as the case may be.
Note: Provision of Sec. 26 is mandatory and not optional.
5. Partner’s Property is used by the Firm
The business carried on by the firm should be regarded as carried on by all the partners. Thus, annual letting value of a property belonging to the assessee which is in occupation of the firm in which assessee is the partner, is not includible in income of the assessee-partner u/s 22.
Exempted Properties
Income from the following house properties are exempted from tax:
1. Any one palace or part thereof of an ex-ruler, provided the same is not let out [Sec. 10(19A)].
Tax point: If the ex-ruler has a house property and the part of which is self-occupied and remaining let out then only the self occupied part of the house property shall be exempted.
2. House property of a local authority [Sec. 10(20)].
3. House property of an approved scientific research association [Sec. 10(21)].
4. House property of an educational institution [Sec. 10(23C)].
5. House property of a hospital [Sec. 10(23C)].
6. House property of a person being resident of Ladakh [Sec. 10(26A)]
7. House property of a political party [Sec. 13A]
8. House property of a trade union [Sec. 10(24)]
9. A farm house [Sec. 10(1)]
10. House property held for charitable purpose [Sec. 11]
11. House property used for own business or profession [Sec. 22]
Computation of Income
The theory is divided into the following categories for the purpose of computation:
Let out property [Sec. 23(1)]
Computation of Income from House Property
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| LOP/DLOP | SOP | ||
| Particulars | Rs | Rs | Rs | Rs |
A | Municipal Value | XX |
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B | Fair Rent/Notional Rent | XX |
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C | Whichever is higher(higher of A and B) | XX |
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D | Standard Rent | XX |
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E | Whichever is Lower(lower of C and D) | XX |
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F | Actual Rent received/receivable | XX |
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G | Whichever is higher (higher of E and F) | XX |
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H | Vacancy Period | x |
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I | Gross Annual Value (G x No of Months of Let out/12) |
| XX |
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| Less: Municipal Tax paid by the Owner in previous year |
| XX |
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| Net Annual Value(NAV) |
| XX |
| NIL |
| Less: Deductions under Section 24 |
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| Standard deduction @ 30% on NAV |
| XX |
| - |
| Interest on Loan on House Property (paid & O/s both) |
| XX |
| XX |
1. | Income from House Property |
| XX |
| (XX) |
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| Rent received in advance/Arrears of Rent received | XX |
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| Less: Standard deduction @ 30% | XX |
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2. | Net Income |
| XX |
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| Total Income from House Property(1+2) |
| XX |
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Municipal Value
It means the annual value of the property decided by municipality on which they charge municipal tax. Such valuation may also be taken as evidence of earning capacity of a property. In metro cities (i.e. Chennai, Delhi, Kolkata, Mumbai), municipal authorities charge tax on Net Municipal Value after giving a deduction for repairs (being 10% of Gross Municipal value) and an allowance for service taxes (like sewerage tax, water tax etc. as a % of Net Municipal value).
Fair Rent or Notional Rent
Fair or notional rent of a property means rent fetched by a similar property in the same or similar locality. Though two properties might not be exactly similar still it is an indicator of rent reasonably expected from the property. An inflated or deflated rent due to emergency, relationship and such other conditions need to be adjusted to determine fair rent.
For instance: a property was let out to a friend for a monthly rent of Rs 20,000 which might be let out to another person at the rate of Rs 25,000 p.m. In such case, fair rent of the property shall be Rs 25,000 p.m.
Standard rent under the Rent Control Act
Standard rent is the maximum rent, which a person can legally recover from his tenant under the Rent Control Act prevailing in the State in which the property is situated. A landlord cannot reasonably expect to receive from a tenant any amount more than Standard Rent. Accordingly, it can be concluded that if the property is covered by the Rent Control Act then Reasonable Expected Rent (RER) cannot exceed Standard Rent.
Tax point: Reasonable Expected Rent cannot exceed Standard Rent but can be lower than Standard Rent.
Actual Rent Receivable [ARR]
Any sum receivable as rent of the house property for the previous year is an evidence for determining the earning capacity of the building. Such actual rent receivable is to be computed on accrual basis. However, where tenant pays rent, which is influenced by benefits provided by the owner of the property, such rent must be disintegrated to determine actual rent i.e. De-facto rent of the property.
De facto rent = ARR – Cost of amenities
Tax point: While computing actual rent receivable, outstanding rent shall be considered but advance rent received during the financial year is not to be considered.
Computation of Gross Annual Value
Step 1: Calculate reasonable expected rent (RER) of the property being higher of the following:
a) Gross Municipal Value.
b) Fair Rent of the property.
Note: RER cannot exceed Standard Rent.
* Reasonable Expected Rent (RER) is also known as Annual Letting Value (ALV).
Step 2: Calculate Actual Rent Received or Receivable (ARR) for the year less current year unrealised rent (UR) subject to certain conditions#.
#Unrealised Rent [Rule 4]: Unrealised Rent of current year shall be deducted in full from Actual Rent Receivable, provided the following conditions are satisfied:
i) The tenancy is bona fide;
ii) The defaulting tenant has vacated the property or steps have been taken to compel him to vacate the property;
iii) The defaulting tenant is not in occupation of any other property of the assessee;
iv) The assessee has taken all reasonable steps to institute legal proceeding for the recovery of the unpaid rent
or has satisfied the Assessing Officer that legal proceedings would be worthless.
Step 3: Compare the values calculated in step 1 and step 2 and take the higher one.
Step 4: Where there is vacancy and owing to such vacancy the ‘ARR – UR’ is less than the RER, then ‘ARR - UR’ computed in step 2 will be treated as GAV.
Illustration 1: (WHEN THERE IS NEITHER UNREALISED RENT NOR VACANCY PERIOD)
Particulars | Houses | ||||
H 1 | H 2 | H 3 | H 4 | H 5 | |
| 10,000 | 12,000 | 12,000 | 18,000 | 16,000 |
B. Fair Rent | 8,000 | 16,000 | 16,000 | 10,000 | 17,000 |
C. Whichever is higher | 10,000 | 16,000 | 16,000 | 18,000 | 17,000 |
D. Standard Rent | 10,000 | 14,000 | - | 8,000 | 20,000 |
E. Whichever is lower | 10,000 | 14,000 | 16,000 | 8,000 | 17,000 |
F. Actual Rent Received | 12,000 | 15,000 | 14,000 | 9,000 | 17,500 |
G. Whichever is higher | 12,000 | 15,000 | 16,000 | 9,000 | 17,500 |
H. Vacancy period | - | - | - | - | - |
I. Gross Annual Value | 12,000 | 15,000 | 16,000 | 9,000 | 17,500 |
Illustration 2: (WHEN THERE IS UNREALISED RENT AS WELL AS VACANCY PERIOD)
Find out the gross annual value in respect of the following properties
Particulars H1 H2 H3
Gross Municipal value 150 180 120
Fair rent 140 140 240
Standard rent 120 240 300
Actual rent if property is let out throughout the previous year 180 300 150
Unrealised rent of the previous year 25 40 20
Unrealised rent of the year prior to the previous year 30 50 60
Period when the property remains vacant (in number of months) 3 1 -
Solution:
Particulars | Houses | ||
H 1 | H 2 | H 3 | |
| 150 | 180 | 120 |
B. Fair Rent | 140 | 140 | 240 |
C. Whichever is higher | 150 | 180 | 240 |
D. Standard Rent | 120 | 240 | 300 |
E. Whichever is lower | 120 | 180 | 240 |
F. Actual Rent Received (Note 1) | 110 | 235 | 130 |
G. Whichever is higher | 110 | 235 | 130 |
H. Vacancy period | 3 | 1 | - |
I. Gross Annual Value | 110 | 235 | 240 |
Working:
H1= (180/12 x 9) – 25 = 110
H2= (300/12 x 11) – 40 = 235
H3= 150 – 20 = 130
2. In H1, till step 3 ARR is less than RER due to vacancy [otherwise ARR would have been Rs 1,55,000 (being Rs 1,80,000 – Rs 25,000). Therefore, GAV will be the ARR computed in step 2.
In H3 there is no vacancy hence step 3 gives GAV.
Municipal Tax paid by the owner
Tax levied by the municipality or local authority is deductible from Gross Annual Value (GAV). As per sec. 27(vi), taxes levied by a local authority in respect of any property shall include service taxes levied by such local authority in respect of such property. Municipal tax includes Service taxes like fire tax, water tax, etc. levied by a local authority. Such taxes shall be computed as a % of Net Municipal Value and allowed as deduction subject to the following conditions:
1. It should be actually paid during the previous year.
2. It must be paid by the assessee.
Tax point: Unpaid municipal tax or municipal tax paid by tenant shall not be allowed as deduction.
3. It must be related to the previous year or any year preceding the previous year.
Deduction under Section 24
Note: Where NAV is negative or zero, standard deduction u/s 24(a) is not available.
2. Interest on loan or borrowed capital u/s 24(b): Interest payable on amount borrowed for the purpose of purchase, construction, renovation, repairing, extension, renewal or reconstruction of house property can be claimed as deduction on accrual basis.
For the purpose of calculation, interest on loan is divided into two parts:
Pre-construction period means the period starting from the day of commencement of construction or the day of borrowing whichever is later and ending on March 31 immediately prior to the year of completion of construction.
Example: X has taken a loan on 1/4/1998 for construction of house property. started on 1/6/2000 and completed on 17/8/2011. In such case, pre construction period will be a period starting from 1/6/2000 and ending on 31/3/2011.
Treatment: Interest for pre-construction period (to the extent it is not allowed as deduction under any other provisions of the Act) will be accumulated and claimed as deduction over a period of 5 continuous years in equal installments commencing from the year of completion of construction.
b. Interest of Previous Year (i.e can also be regarded as Post Construction)
Pre-construction period means the period starting from the beginning of the year in which construction is completed and continues until the loan is repaid.
Treatment: It can be fully claimed as deduction in the respective year(s). In the given example, post-construction period will start from 01/04/2011.
In nutshell, tax treatment is as under:
Particulars | Pre-construction period | Post-construction period |
Starts from | The day of commencement of construction or the day of borrowing, whichever is later | The first day of the previous year in which construction is completed |
Ends on | March 31 immediately prior to the year of completion of construction | When loan is fully paid |
Tax treatment | The interest incurred during aforesaid period shall be accumulated and allowed as deduction in 5 equal installments from the year of completion of construction. | The interest expenses for the year (on accrual basis) shall be allowed as deduction in the respective year |
Other Points
Amount not deductible from Income from house property [Sec. 25]
Any interest chargeable under this Act which is payable outside India, is not allowed as deduction if:
Self Occupied Property [Sec 23(2)(a)]
As per sec. 23(2)(a), a house property shall be termed as self occupied property where such property or part thereof:
Treatment: The annual value of such house or part of the house shall be taken to be nil.
Note: If an assessee occupies more than one house property as self-occupied, he is allowed to treat only one house as self-occupied at his option. The remaining self-occupied house properties shall be treated as ‘Deemed to be let out’.
Combination | Treated as |
Fully self occupied | Self occupied property |
Partly self occupied & partly vacant | Self occupied property |
Partly self occupied & partly let out | Partly self occupied & partly let out |
Partly self occupied & partly use for business purpose | Self occupied to the extent used for self occupation |
Tax Treatment of Self Occupied Property (already shown in computation table above)
Net Annual Value will always be NIL because there is no rental income from such property.
Deduction of Interest on Loan u/s 24 taken for such property is available as follows:
Conditions | Maximum Interest allowed in aggregate |
Where loan is taken on or after 1/4/1999 and following conditions are satisfied - 1. Loan is utilized for construction or acquisition of house property on or after 1-4-1999; 2. Such construction or acquisition is completed within 5 years from the end of the financial year in which the capital was borrowed; and 3. The lender certifies that such interest is payable in respect of the loan used for the acquisition or construction of the house or as refinance of the earlier loan outstanding (principal amount) taken for the acquisition or construction of the house. | Rs 2,00,000 |
In any other case | Rs 30,000 |
Taxpoint: In any case, deduction in respect of interest on loan on self-occupied property cannot exceed Rs 2,00,000 in a year. |
Summary of treatment of interest on loan:
Nature of property | When loan was taken | Purpose of loan | Allowable (Maximum limit) |
Self-occupied | On or after 01/04/1999 | Construction or purchase of house property | Rs 2,00,000 |
Self-occupied | On or after 01/04/1999 | For Repairs of house property | Rs 30,000 |
Self-occupied | Before 01/04/1999 | Construction or purchase of house property | Rs 30,000 |
Self-occupied | Before 01/04/1999 | For Repairs of house property | Rs 30,000 |
Let-out | Any Time | Construction or purchase of house property | Rs 30,000 |
Deemed to be Let-Out Property [Sec 23(4)]
Where the assessee occupies more than one house property as self-occupied or has more than one unoccupied property, then for any one of them, benefit u/s 23(2) can be claimed (at the choice of the assessee) and remaining property or properties shall be treated as ‘deemed to be let out’.
Treatment:
Taxpoint: GAV of deemed to be let out property will be the ‘Reasonable expected rent (RER)’of the property.
3. Municipal taxes and deduction u/s 24(a) and 24(b) shall be available as in the case of let out house property.
Recovery of Unrealised Rent & Arrears of Rent (Sec 25A)
Applicability
The assessee has received arrears of rent received from a tenant or the unrealised rent realised subsequently from a tenant.
Tax Treatment
The amount so received shall be taxable under the head ‘Income from house property’ in the year of receipt after deducting standard deduction @ 30% of such amount.
Arithmetically, taxable amount shall be – 70% of the amount received
Taxpoint:
Note: Such receipt shall be chargeable as income from house property although the assessee is not the owner of such property in the year of receipt.
Key Takeaways:
1) “annual value” of the property is taxable rather than actual income of the property.
2) If an assessee carries on business or profession in his own house property or lets out the property for smooth running of his business or profession, income from such property is taxable under the head "Profits & gains of business or profession".
Meaning of Business & Profession
Business [Sec. 2(13)]
Business includes –
Generally, business means recurring economic activity, but for income tax purpose an isolated activity may be termed as business depending upon facts and circumstances. Following elements shall be considered to judge a transaction as business transaction:
a) Nature of Commodity.
b) Intention of the party.
c) Efforts applied in transaction.
d) Periodicity of transaction.
e) Nature of transaction(whether incidental to a business or not).
Profession [Sec. 2(36)]
Profession includes vocation. Profession requires purely intellectual skill or manual skill on the basis of some special learning and qualification gathered through past training or experience e.g. chartered accountant, doctor, lawyer etc. Professional skill can be acquired only after patient study (in a particular system either a college, university or institute) and application (i.e. experience)
Vocation implies natural ability of a person to do some particular work e.g. singing, dancing, etc. The term “vocation” is different from the term “hobby”. Vocation must have the earning feature. It can be treated as an earning means by which a man passes his life. Unlike profession, vocation does not require a degree or special learning.
Notes
1. Profit Motive: If the motive of an activity is pleasure only, it shall not be treated as business activity.
2. Business v/s Profession: An income arising out of trade, commerce, manufacture, profession or vocation shall have the same treatment in Income tax Act. However, a little segregation is required to be made between business and profession while applying sec. 44AA, sec. 44AB, sec. 40AD, sec. 44ADA, etc.
Income chargeable under the head Profits & Gains from Business & Profession (Sec 28)
Sec. 28 enlists the incomes, which are taxable under the head ‘Profits & gains of business or profession’:
1. Profits & gains of any business or profession [Sec. 28 (i)]: Any income from business or profession including income from speculative transaction shall be taxable under this head.
2. Compensation to Management agency [Sec. 28 (ii)]: Any compensation/other payment due to or received
3. Income of trade or professional association’s [Sec. 28 (iii)]: Income derived by a trade, professional or similar association from rendering specific services to its members shall be taxable under this head.
Note: This is an exception to the general principle that a surplus of mutual association cannot be taxed.
4. Export incentive [Sec. 28 (iiia) (iiib) & (iiic)]: An export incentive in form of -
a) Profit on sale of import license or duty entitlement pass book. [Sec. 28(iiia)/(iiid)/(iiie)]
b) Cash assistance received/receivable by an exporter under a scheme of the Government of India [Sec. 28(iiib)]
c) Duty draw back (received/receivable) for export e.g. Excise duty drawback, etc. [Sec. 28(iiic)]
5. Perquisite from business or profession [Sec. 28 (iv)]: The value of any benefit or perquisite, whether convertible into money or not, arising from business or profession shall be taxable under this head.
Examples: If an authorized dealer of a company receives a car (over and above his commission) from the company on achieving sale-target then market value of such car shall be taxable under the head ‘Profits & gains of business or profession’.
6. Remuneration to partner [Sec. 28 (v)]: Any interest salary, bonus, commission or remuneration received by a partner from the firm (or Limited Liability Partnership) shall be taxable as business income in the hands of the partner to the extent allowed in hands of firm (or Limited Liability Partnership) u/s 40(b).
7. Amount received or receivable for certain agreement [Sec. 28 (va)]: Any sum, whether received or receivable in cash or in kind, under an agreement for -
a) not carrying out any activity in relation to any business or profession; or
b) not sharing any know-how, patent, copyright, trade mark, license, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provisions for services.
Exceptions: The aforesaid provision is not applicable in respect of the following:
a. any sum received or receivable in cash or in kind on account of transfer of the right to manufacture, produce or process any article or thing; or right to carry on any business or profession, which is chargeable under the head Capital gains;
b. any sum received as compensation from the multilateral fund of the Montreal Protocol on Substances that Deplete the Ozone Layer under the United Nation Environment Programme, in accordance with the terms of agreement (whether or not in writing, whether or not intended to be enforceable by legal proceedings) entered into with the Government of India.
8. Keyman Insurance Policy [Sec. 28 (vi)]: Any sum received under a Keyman Insurance Policy including bonus on such policy. As per sec. 10(10D) Keyman insurance policy is a life insurance policy taken by a person on the life of another person who is or was -
a) an employee of the first mentioned person; or
b) in any manner whatsoever connected with the business of the first mentioned person.
and includes such policy which has been assigned to a person, at any time during the term of the policy, with or without any consideration
9. Conversion of stock into capital asset [Sec. 28 (via)]: The fair market value of inventory as on the date on which it is converted into, or treated as, a capital asset.
10. Recovery against certain capital assets covered u/s 35AD [Sec. 28 (vii)]: Any sum received or receivable (in cash or kind) on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital asset has been allowed as deduction u/s 35AD.
Incomes not taxable under the head Profits & Gains from Business & Profession
Expenditure allowed as Deduction
1. Capital vs Revenue expenditure: Capital expenditures are not allowed as deduction, unless & until expressly allowed whereas revenue expenditures are allowed as deduction until & unless expressly disallowed under the Income tax Act.
2. Expenditure of non-assessable business: Any expenditure of a non-assessable business is not allowed as deduction. For instance, expenditure for earning agricultural income is not allowed as deduction from income of an assessable business.
3. Expenditure must relate to the business of the assessee: Expenditure must have been incurred by the assessee for its business.
Note: In case where the assessee incurs expenditure for its own business, the mere fact that the benefit of such expenditure is enjoyed by some other person, cannot deny the admissibility of the expenditure.
4. Anticipated loss or expenditure: Subject to certain exceptions, no deductions are allowed for anticipated losses. E.g. provision for bad & doubtful debts.
5. Notional expenditure: No one can earn income from himself/herself. For instance, rent paid to a sole proprietor, salary to proprietor, interest on capital to proprietor, etc. are not income in the hands of the proprietor. Hence, it is not deductible from the income of business as expenditure.
6. Onus to proof: Onus to proof lies with the assessee. It is the responsibility of the assessee to prove that a particular expenditure is to be allowed as deduction in his case.
Specific Deductions
Rent Repairs Taxes & Insurance of Building (Sec 30)
Repairs & Insurance of Plant & Machinery and Furniture (Sec 31)
Depreciation (Sec 32)
Section 32 provided for Depreciation on Tangible & Intangible Assets.
Following conditions must be satisfied:
Method of computing depreciation (other than power units)
The method of computing depreciation as per Income tax Act is entirely different from accountancy method. For Income tax purpose, assets are categorised into Block of Assets.
Block of Assets [Sec. 2(11)]
Block of assets means a group of assets of same nature, in respect of which same rate of depreciation is charged. In other words, to fall in the same block, the following two conditions are to be satisfied:
Tangible assets being building, machinery, plant or furniture, and
Intangible assets, being know-how, patents, copy-rights, trade marks, licenses, franchises or any other business or commercial rights of similar nature acquired on or after 1-4-1998;
Method of Providing Deprecation
Depreciation shall be allowed on Written Down Value Method at the rates prescribed.
If the asset is used for less than 180 days in previous year, then only half year depreciation to be provided.
If the asset is used for 180 days or more in previous year, then full year depreciation to be provided.
Note: Number of days to be calculated from the date when asset is put to use and not from the date of purchase.
Important Notes for Students:
Sec 36(1)
Insurance premium for Stocks & Stores
Any amount paid as insurance premium against risk of damage or destruction of stocks & stores, used for the purpose of business or profession is allowable as deduction in full.
Paid means actually paid or incurred according to the method of accounting upon the basis of which the profits and gains of business are computed. [Sec. 43(2)]
Insurance premium for Life of Cattle
Any amount paid as insurance premium by a federal milk co-operative society on the lives of cattle owned by the members of a primary milk co-operative society affiliated to it, is allowed as deduction in full.
Insurance premium for Health of Employees
Any premium paid (other than by cash) by the assessee as an employer to effect or to keep in force an insurance on the health of his employees under a scheme framed in this behalf by-
- shall be allowed as deduction.
Bonus & Commission to Employees
Any bonus or commission (other than in lieu of profit or dividend) paid1 to employees shall be allowed as deduction.
Note: Such amount must have been actually paid before the due date of furnishing return [Sec. 43B]
Interest on Borrowed Capital
Amount of interest paid in respect of capital borrowed for the purposes of business or profession shall be allowed as deduction subject to following conditions:
(a) The assessee must have borrowed money.
(b) The money so borrowed must have been used for the purpose of business or profession during the previous year.
(c) The assessee must have incurred interest on the borrowed amount.
Discount on Issue of Zero Coupon Bond issued by an Infrastructure Company
Contribution towards RPF & Superannuation Fund
Any sum paid by the employer towards recognised provident fund or an approved superannuation fund as per rules specified in the fourth schedule of the Act is allowed as deduction in full.
Note: Such amount must have been actually paid before the due date of furnishing return [Sec. 43B]
Taxpoint:
Contribution towards Notified Pension Scheme u/s 80CCD
Any sum paid by the assessee, as an employer, by way of contribution towards a pension scheme, as referred to in section 80CCD, on account of an employee is allowed as deduction.
Maximum Limit: Such contribution should not exceed 10% of the salary of the employee in the previous year.
“Salary” includes dearness allowance, if the terms of employment so provide, but excludes all other allowances and perquisites.
Contribution towards Approved Gratuity Fund
Any sum paid as employer’s contribution towards an approved gratuity fund created by him exclusively for the benefit of his employees under an irrevocable trust is allowed as deduction.
Note: Such amount must have been actually paid before the due date of furnishing return [Sec. 43B]
Allowance in respect of Dead or Useless Animals
Sec. 36(1)(vi) provides for deduction in respect of animals used for the purpose of business or profession.
Conditions:
(a) Animals are used for the purpose of business or profession.
(b) Such animals are not held as stock-in-trade.
(c) Such animals have died or become permanently useless for such purpose.
Quantum of deduction
Difference between actual cost of the animals to the assessee and the amounts realised, if any, in respect of carcasses or sale of animals is allowed as deduction.
Bad Debts
Any debt or part thereof, which becomes bad, shall be allowed as deduction.
Taxpoint: It is the assessee, who decides whether a debt has became bad or not and the Assessing Officer can never insist the assessee for production of proof that the debt had became bad.
Conditions:
Recovery of Bad Debts
Treated as Income and is it taxable only if the related bad debts were allowed as deduction earlier.
Provision for Bad Debts
Not allowed as deduction.
It is allowed to banks subject to some conditions.
Expenditure on Promotion of Family Planning among Employees
Applicable to: Company only
Purpose of such expenditure: Such expenditure must have been incurred for promotion of family planning among its employees.
Quantum of Deduction
● Revenue expenditure is fully allowed as deduction.
● Capital expenditure shall be allowed in 5 equal installments commencing from the previous year in which it is incurred.
Note: Where deduction is allowed in respect of any expenditure under this section then no deduction shall be allowed u/s 32 or any other provisions of this Act.
Treatment of unabsorbed capital expenditure: As in case of unabsorbed depreciation.
Sale of assets acquired for family planning: Treated in the same manner as in case of sale of assets used for scientific research.
Securities Transaction Tax
Any amount of Securities Transaction Tax (STT) paid by the assessee during the previous year shall be allowed as deduction provided income arising from such transactions is included in the income computed under the head “Profits and gains of business or profession.’
Commodities Transaction Tax
Any amount of Commodities Transaction Tax (CTT) paid by the assessee in respect of the taxable commodities transactions entered into in the course of his business during the previous year shall be allowed as deduction provided income arising from such transactions is included in the income computed under the head “Profits and gains of business or profession.’
General Deductions u/s 37
Any expenditure which is not specifically provided in any provisions (discussed earlier) of the Act and fulfills following conditions, shall be allowed as deduction under this section -
Advertisement in Souvenir etc of a Political Party [Sec 37 (2B)]
Expenditure incurred by an assessee on advertisement in any souvenir, brochure, tract, pamphlet or like, published by a political party is disallowed.
Income Tax/Wealth Tax (Sec 40a)
Even, wealth tax and income tax paid by the assessee on income of predecessor is not deductible.
Taxpoint: Professional tax is an allowed expenditure
Payment made to Relatives in Excess of Requirement [Sec 40A (2)]
Any payment made by an assessee to a related person shall be disallowed to the extent it is excess or unreasonable as per the Assessing Officer.
Business payments exceeding Rs 10,000 otherwise than by Account payee cheque or Demand Draft [Sec 40A (3)]
Applicability: Any expenditure in respect of which payment has been made in excess of Rs 10,000 in a day otherwise than by an account payee cheque or account payee bank draft or use of electronic clearing system through a bank account [Sec. 40A(3)]
Treatment: 100% of such payment shall be disallowed.
Exception: In the case of payment made for plying, hiring or leasing goods carriages (hereinafter referred to as Road Transport), the limit of Rs 10,000 has been increased upto Rs 35,000.
Expenditures allowed on Cash Basis (Sec 43B) (i.e allowed only if it is paid before the due date of filing Returns)
Deduction in respect of following expenses are allowed only if payment is made on or before the due date for furnishing return of income u/s 139(1)1 of the previous year in which such liability is incurred:
- public financial institutions (i.e., IFCI, LIC, etc.);
- a State financial corporation; or
- State industrial investment corporation.
Computation of Profits & Gains from Business & Profession
Particulars | Amount(Rs) | Amount(Rs) |
Net Profit as per Profit & Loss Account |
| XX |
Add: Disallowed Expenses |
|
|
| XX |
|
| XX | XX |
Less: Non Business Incomes |
|
|
| XX |
|
| XX | XX |
Add: Unrecorded Business Incomes |
|
|
| XX |
|
| XX | XX |
Less: Unrecorded Business Expenses |
|
|
| XX |
|
| XX | XX |
Income from Business & Profession |
| XX |
Steps to remember:
2. When Receipts & Payment A/c is given in the Question
Add all the taxable business incomes and deduct all the business expenses to calculate Income from Business & Profession.
Key Takeaways:
1) Business means recurring economic activity, but for income tax purpose an isolated activity may be termed as business depending upon facts and circumstances.
2) Profession includes vocation. Profession requires purely intellectual skill or manual skill on the basis of some special learning and qualification gathered through past training or experience e.g. chartered accountant, doctor, lawyer etc.
Basis of Charge
Capital gain shall be taxable in the previous year in which the asset is transferred.
However, in some cases, capital gain is taxable in the previous year in which consideration is received rather than in the previous year in which transfer took place e.g. compulsory acquisition by the Government.
Following conditions must be satisfied to tax any income under this head:
Capital Asset [Sec 2(14)]
Capital asset means –
Note: Capital asset may be movable or immovable or tangible(furniture, jewelry, etc.) or intangible(goodwill, tenancy right, copy right, etc
- but does not include the following:
Stock in trade, consumable stores or raw materials held for business or profession.
However, any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 shall not be treated as stock-in-trade.
Treatment of profit on sale of stock
Such profit shall be taxable under the head “Profits & gains of business or profession”
2. Personal effect
Personal effect means any movable property held for personal use of the assessee or for any dependent member of his family but excludes the following:
Taxpoint:
Jewelry includes –
Treatment of profit on sale of personal effect
Any income on transfer of personal effect shall not be treated as capital gain. Such income is in the nature of capital receipt and hence shall not be taxed under any head.
3. Agricultural land in rural area
Agricultural land in India is not a capital asset except the following –
Population of the municipality or cantonment board | Area within the aerial distance from the local limits of such municipality or cantonment board is non-rural area |
More than 10,000 but not exceeding 1,00,000 | Upto 2 kilometres |
More than 1,00,000 but not exceeding 10,00,000 | Upto 6 kilometres |
More than 10,00,000 | Upto 8 kilometres |
Notes:
Summary
Population | Municipality or Cantonment Board | ||||
Upto 10,000 | Agro Land is not treated as Capital Asset | ||||
|
|
|
|
|
|
Within 10,001 to 1,00,000 | Agro Land treated as Capital Asset |
|
|
| |
|
|
|
|
|
|
Within 1,00,001 to 10,00,000 | Agro Land treated as Capital Asset |
|
| ||
|
|
|
|
|
|
More than 10,00,000 | Agro Land treated as Capital Asset |
| |||
Area | Local limit | 2 Km | 6 Km | 8 Km | Beyond 8 Km |
4. Gold Bonds
Following gold bonds issued by the Central Government are not capital asset:
● 6.5% Gold Bond, 1977 ● 7% Gold Bonds, 1980; and ● National Defence Gold Bond, 1980.
5. Special Bearer Bond
Special Bearer Bond, 1991 issued by the Central Government are not capital asset.
Note: It is not necessary that the assessee should be the initial subscriber.
6. Gold Deposit Bonds
Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 or deposit certificates issued under the Gold Monetisation Scheme, 2015 notified by the Central Government are not capital asset.
Note: Interest on aforesaid bonds or deposits are exempt [Sec. 10(15)].
Types of Capital Asset
It means a capital held by an assessee for not more than 36 months immediately before the date of transfer.
2. Long Term Capital Asset [Sec. 2(29A]
A capital asset, which is not a short-term capital asset, is a long-term capital asset.
Exceptions:
In the following cases, an asset shall be termed as a short-term capital asset (STCA) if it is held for not more than following period before the date of transfer:
Capital Asset | Holding Period |
Equity or preference share in a company (listed in India) | 12 Months |
Any security e.g. debenture, Government securities, etc. (listed in India) | 12 Months |
A unit of an equity oriented fund1 (whether quoted or not) | 12 Months |
Zero-Coupon Bonds (whether quoted or not) | 12 Months |
Units of UTI (whether quoted or not) | 12 Months |
|
|
Equity or preference share in an unlisted company | 24 Months |
Immovable property being land or building or both | 24 Months |
|
|
All other capital assets | 36 Months |
Period of Holding
While computing the period of holding of any capital asset, the following points are to be considered to decide the nature of asset, whether short term or long term –
Transfer [Sec 2(47)]
Transfer in relation to a capital asset includes:
Taxpoint:
directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India.
Exchange
Exchange includes barter which means mutual transfer of ownership of one thing for the ownership of another.
Notes: In case of exchange though there is only one transaction the tax liability arises on both the parties. The sale consideration shall be taken as the fair market value of assets received.
Relinquishment of the asset
Relinquish literally means 'to withdraw from' or 'to abandon' or 'to give up any thing or any right' or 'to cease to hold' or 'to surrender'. Hence, relinquishment means act of surrendering. In other words, it means interest of a person in a property is either given up, abandoned, or surrendered but the property in which right is relinquished continues to exist.
Taxpoint:
Extinguishment of any right in an asset
Extinguishment literally means ‘to put a total end to’ or ‘total destruction’ or ‘blot out of existence’ or ‘annihilation’. Extinguishment does not mean extinguishment of asset itself but to extinguishment of holder’s right to the asset and such right cannot be held by someone else.
Incidences of extinguishments-
When there is a reduction of capital by a company and amounts are distributed to shareholder, such amount has two components –
c. Forfeiture of share: Forfeiture or surrender of shares indicates extinguishment or relinquishment of right of shareholder in such shares, which have been forfeited by the company. As in CIT vs Vania Silk Mills Pvt. Ltd it was held that the term extinguishment includes all possible transactions which results in the destruction, annihilation, termination, cessation or cancellation of any right in an asset whether corporeal or incorporeal. Though there is no consideration in case of share forfeiture or surrender, still such transaction shall be treated as transfer and liable to capital gain.
Compulsory acquisition of an asset under any law
Normally, sale means a mutual will full agreement between two or more parties. But for the purpose of sec. 2(47), transfer includes compulsory acquisition of any property under any law in force.
Conversion of asset into stock in trade by the owner
Generally, a transfer requires two or more parties, but in Income tax Act even one party’s involvement may constitute transfer. As per sec. 2(47)(iv) where an asset is converted by the owner into or treated by him as ‘stock in trade’ of the business carried on by him, such conversion or treatment shall constitute transfer.
Any transaction of immovable property u/s 53A of the Transfer of Property Act
Any transaction of immovable property in which possession is allowed against part performance of the contract shall be treated as transfer [Sec. 53A of the Transfer of Property Act, 1882].
Any transaction which has enabled the enjoyment of any immovable property
Any transaction which has the effect of transferring or enabling the enjoyment of any immovable property whether by way of becoming a member of, or acquiring shares in a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner, is treated as transfer.
Property held by a member of a company, co-operative society or other association of persons to whom a building or a part thereof is allotted or leased under House Building Scheme of the company or association, is treated as deemed owner of that building or a part thereof.
Under the scheme of owning flats in co-operative housing societies, the legal ownership in the flats can be said to vest in the individual members themselves and not in the co-operative societies. Therefore, for all purposes including attachment and recovery of tax, etc. the individual member should be regarded as the legal owner.
Taxpoint
Computation of Capital Gains (Sec 48)
Short-term Capital Gain means the gain arising on transfer of short-term capital asset [Sec. 2(42B)].
Long-term Capital Gain means the gain arising on transfer of long-term capital asset [Sec. 2(29B)].
Computation of Short Term Capital Gains (STCG)
Particulars | Amount (Rs) | Amount (Rs) |
Sale consideration (Full value of consideration) |
| XX |
Less: Expenses on transfer |
| (XX) |
Net sale consideration |
| XX |
Less: Cost of acquisition | XX |
|
Less: Cost of improvement | XX | (XX) |
Short Term Capital Gain |
| XX |
Less: Exemption u/s 54B, 54D, 54G, etc. |
| (XX) |
Taxable Short Term Capital Gain |
| XX |
Note: No deduction shall be allowed in computing the income chargeable under the head “Capital gains” in respect of any sum paid on account of securities transaction tax.
The meaning of terms used in the computation:
Sale consideration (full value of consideration)
It refers to sale value of the asset (in form of money or money’s worth).
Consideration in installments: In case, consideration is receivable in installment in different years, the entire value of the consideration shall be taxable in the year of transfer.
Fair market value deemed to be full value of consideration in certain cases [Sec. 50D]: Where the consideration received or accruing as a result of the transfer of a capital asset by an assessee is not ascertainable or cannot be determined, then, for the purpose of computing income chargeable to tax as capital gains, the fair market value of the said asset on the date of transfer shall be deemed to be the full value of the consideration
received or accruing as a result of such transfer.
Expenses on transfer
It means any expenditure incurred wholly and exclusively in connection with such transfer such as, brokerage or commission incurred for securing buyer, cost of stamp and registration fee by the vendor, traveling expenses, etc. It is reduced from sale consideration to get net sale consideration.
Notes
Cost of Acquisition [Sec. 55(2)]
Cost of acquisition includes expenditure incurred for acquiring the asset or completing the title of the asset. For instance–
Cost of Improvement [Sec. 55(1)(b)]
Cost of improvement means an expenditure incurred to increase the productive quality of the asset. It includes all expenditures of a capital nature incurred in making any additions or alterations to the capital asset.
Notes
Computation of Long Term Capital Gains (LTCG)
Particulars | Amount (Rs) | Amount (Rs) |
Sale consideration (Full value of consideration) |
| XX |
Less: Expenses on transfer |
| (XX) |
Net sale consideration |
| XX |
Less: Indexed cost of acquisition | XX |
|
Less: Indexed cost of improvement | XX | (XX) |
Long Term Capital Gain |
| XX |
Less: Exemption u/s 54, 54B, 54D, 54EC, 54F, etc. |
| (XX) |
Taxable Long Term Capital Gain |
| XX |
Note: No deduction shall be allowed in computing the income chargeable under the head “Capital gains” in respect of any sum paid on account of securities transaction tax.
The meaning of terms used in the computation:
Indexed cost of acquisition
“Indexed cost of acquisition” means the ‘cost of acquisition’ (as discussed in case of short term capital gain) adjusted according to the price level of the year of sale. As per explanation to sec.48, “Indexed cost of acquisition” is an amount which bears to the ‘cost of acquisition’ the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the first year in which the asset was held by the assessee or for the year beginning on 1/4/2001, whichever is later.
Taxpoint:
Indexed cost of acquisition = Cost of acquisition × Index of the year of transfer
Index of the year of acquisition
Indexed cost of improvement
“Indexed cost of improvement” means the ‘cost of improvement’ (as discussed in case of short term capital gain) adjusted according to the price level of year of sale. As per explanation to sec. 48, “indexed cost of any improvement” is an amount, which bears to the cost of improvement the same proportion as Cost Inflation Index for the year in which the asset is transferred bears to the Cost Inflation Index for the year in which the improvement to the asset took place.
Taxpoint:
Indexed cost of improvement = Cost of acquisition × Index of the year of transfer
Index of the year of improvement
Note: Cost of Improvement incurred by assessee before 1/4/2001 shall not be considered.
Cost Inflation Index
Cost inflation index, in relation to a previous year, means such Index as the Central Government may, having regard to 75% of average rise in the Consumer Price Index (urban) for the immediately preceding previous year to such previous year, by notification in the Official Gazette, specify, in this behalf. Cost Inflation Index for different financial years is as follows:
Financial Year | Index | Financial Year | Index |
2001-02 | 100 | 2011-12 | 184 |
2002-03 | 105 | 2012-13 | 200 |
2003-04 | 109 | 2013-14 | 220 |
2004-05 | 113 | 2014-15 | 240 |
2005-06 | 117 | 2015-16 | 254 |
2006-07 | 122 | 2016-17 | 264 |
2007-08 | 129 | 2017-18 | 272 |
2008-09 | 137 | 2018-19 | 280 |
2009-10 | 148 | 2019-20 | 289 |
2010-11 | 167 |
|
|
Cost from Previous Owner
In certain cases (stated below) cost of acquisition of the previous owner1 of the property shall be deemed to be the cost of acquisition for the assessee:
Deduction from Capital Gain on Sale of Residential House Property (Sec 54)
Applicable to: Individual or HUF
Conditions:
Taxpoint:
Time limit for acquisition of new assets:
For Purchase- Within a period of ‘1 year before, or 2 years after, the date of transfer’ Example: If a property is transferred on 17/8/2018, then the new house property may be purchased at any time between 17/08/2017 to 17/8/2020.
For Construction- Within a period of 3 years after the date of transfer.
Construction may start at any time but must be completed within stipulated time.
Capital Gains Accounts Scheme, 1988
If the new asset is not acquired till the due date of submission of return of income*, then the taxpayer will have to deposit the money in ‘Capital Gains Deposit Account’ with a nationalized bank. The proof of deposit should be submitted along with the return of income. On the basis of actual investment and the amount deposited in the deposit account, exemption will be given to the taxpayer.
*Due date of filing of return being 30th September (where audit is required) & 31st July (in any other case).
Utilisation of Amount: The taxpayer is to acquire a new asset by withdrawing from the deposit account. New asset must be acquired within specified time, provided in the relevant section.
Deduction: Minimum of the following:
● Investment in the new asset; or
● Capital gain
Revocation of benefit:
If the newly acquired residential house is transferred within 3 years from the date of acquisition of new assets, then the benefit availed earlier shall be revoked. Such revoked income shall be reduced from cost of acquisition of new asset.
If the amount held in Capital Gains Deposit Account Scheme (1988) is unutilized, then such amount shall be taxable as long-term capital gain in the previous year in which the period of 3 years from the date of transfer expires.
Notes:
Deduction from Capital Gain on Acquisition of Certain Bonds (Sec 54EC)
Applicable to: All Assessee
Conditions:
Long-term specified asset means any bond redeemable after 5 years, issued by
Time limit for acquisition of new assets:
Deduction: Minimum of the following:
● Investment in the new asset; or
● Capital gain
Taxpoint: The investment made by an assessee in the long-term specified asset, from capital gains arising from transfer of one or more original assets, during the financial year
in which the original asset or assets are transferred and in the subsequent financial year does not exceed Rs 50 lakhs.
Revocation of benefit:
Earlier benefit shall be revoked if such bond is transferred or converted into money within 5 years of its acquisition or a loan is taken on security of the new asset within the said period. Tax point: In case where an assessee takes any loan or advance on the security of such specified asset, he shall be deemed to have converted such speci-fied asset into money on the date on which such loan or advance is taken.
Treatment of revoked income:
Such revoked income shall be treated as long-term capital gain in the year of transfer of new asset.
Scheme of Deposit: Not Applicable
Key Takeaways:
1) Capital gain shall be taxable in the previous year in which the asset is transferred.
However, in some cases, capital gain is taxable in the previous year in which consideration is received rather than in the previous year in which transfer took place e.g. compulsory acquisition by the Government.
2) Capital asset may be movable or immovable or tangible(furniture, jewellery, etc.) or intangible(goodwill, tenancy right, copy right, etc.
As per sec. 56(1), any income, which is not specifically exempted and not chargeable under any other heads of income, shall be chargeable under the head “Income from other sources”. This is the last and residuary head of income.
Taxpoint:
A receipt shall be taxable under this head if the following conditions are satisfied:
Sec. 56(2) lays down a list of incomes, which are taxable under this head. Such list is not exhaustive. Apart from the income stated in sec. 56(2) any other income, which is fulfilling all the above conditions, shall be taxable under this head.
Sec. 56(2) lays down the list of incomes, which are specifically taxable under this head:
Income absolutely chargeable under this head
Dividend from Shares of Indian Company- Exempt
Dividend from Mutual Funds/UTI- Exempt
Dividend from Shares of Foreign Company- Taxable
Dividend from Co OP Society- Taxable
2. Winning from lotteries, puzzles crosswords etc. [Sec. 56(2)(ib)]
Exemption/deduction [Sec. 58(4)]: Such income shall be fully taxable & no deduction shall be allowed.
Tax rate [Sec. 115BB]: Tax is charged at a flat rate of 30%.
3. Gift [Sec. 56(2)]
Cash Gift: Income from Gifts is allowed upto Rs 50,000. It means cash gifts received during the previous year the aggregate value of which does not exceed Rs 50,000 is not taxable.
If it exceeds Rs 50,000, entire amount is taxable.
Gifts in kind- Not Taxable
Immovable Property- If any immovable property is received as gift, it is taxable if the stamp duty value of the property exceeds Rs 50,000.
Taxpoint:
a) The limit of Rs 50,000/- is also for per category. In other words, one may receive cash gift of Rs 35,000 and gift in kind of Rs 36,000 without attracting any tax.
b) In case of dispute in stamp duty valuation: Refer section 50C of ‘Capital Gains’
Exceptions:
This section shall not apply to any sum of money or any property received
Relative here means—
In case of an individual
i. spouse of the individual;
ii. brother or sister of the individual;
iii. brother or sister of the spouse of the individual;
iv. brother or sister of either of the parents of the individual;
v. any lineal ascendant or descendant of the individual;
vi. any lineal ascendant or descendant of the spouse of the individual;
vii. spouse of the person referred to in clauses (ii) to (vi).
In case of HUF: Any member thereof
b. on the occasion of the Marriage of the individual (whether gift is received from relative or outsiders).
c. under a will or by way of inheritance.
d. in contemplation of death of the payer or donor.
e. from local authority
f. from or by any fund or foundation or university or other educational institutions or hospital or other medical institutions or any trust or institution referred u/s 10(23C).
g. from or by any trust or institution registered u/s 12A or 12AA.
h. from an individual by a trust created or established solely for the benefit of relative of the individual.
i. by way of distribution at the time of total or partial partition covered u/s 47(i)
j. by way of transactions in the nature of amalgamation or demerger covered u/s 47(iv) or (v) or (vi) or (via) or (viaa)or (vib) or (vic) or (vica) or (vicb) or (vid) or (vii).
k. Exemption of Compensation on account of Disaster [Sec. 10(10BC)]: Any amount received or receivable from the Central Government or a State Government or a local authority by an individual or his legal heir by way of compensation on account of any disaster, except the amount received or receivable to the extent such individual or his legal heir has been allowed a deduction under this Act on account of any loss or damage caused by such disaster.
4. Share premium in excess of fair market value of shares [Sec. 56(2)(viib)]
5. Income by way of interest received on compensation or on enhanced compensation [Sec.56(2)(viii)]
6. Sum of money received as an advance or otherwise in the course of negotiations for transfer of a capital asset, if such sum is forfeited.
7. Any sum received by the assessee from his employees as contribution to provident fund, etc. [Sec. 56(2)(ic)]
8. Interest on securities [Sec. 56(2)(id)]
As per sec. 2(28B), “interest on securities” means -
a) Interest on any security of the Central Government or a State Government;
b) Interest on debentures or other securities issued by or on behalf of -
Tax Treatment:
Case | Treatment |
When the securities are held as stock-in-trade | Interest on securities is charged to tax under the head ‘Profits & gains of business or profession’ |
When the securities are held otherwise than as stock in-trade | Interest on such securities is charged to tax under the head ‘Income from other sources’ |
Chargeability: It is taxable as per cash basis or due basis, depending on the method of accounting regularly followed by the assessee. However, where no method of accountancy is followed, then it shall always be taxable on due basis.
Expenditure allowed as deductions:
By virtue of sec. 57(i) and (iii), the following expenditure are deductible from interest income:
a) Collection expenditure
b) Interest on loan
c) Any other expenditure
Taxpoint: However, any expenses covered u/s 58 shall not be allowed
Note: If Income is given net of TDS, TDS is to be added back.
9. Income from letting/rent of machinery, plant or furniture [Sec. 56(2)(ii)]
10. Composite Rent [Sec. 56(2)(iii)]
Generally, income from letting of building is taxable under the head Income from house property; but if such letting is inseparable from letting of machinery, plant or furniture, then income from such letting is charged to tax under the head “Income from other sources” if not taxed under the head “Profits & gains of business or profession”. [Further refer the chapter “Income from house property”].
Notes:
11. Any sum (including bonus) received under a Keyman Insurance Policy [Sec. 56(2)(iv)] Keyman Insurance Policy means a life insurance policy taken by a person on the life of another person, who is either the employee or is connected in any manner with the business of the former person.
12. Any compensation or other payment, due to or received by any person, in connection with the termination of his employment or the modification of the terms and conditions relating thereto. [Sec. 56(2)(xi)]
13. Income from sub-letting of a house property.
14. Interest on bank deposits.
15. Interest on company deposits, interest on loans, etc.
16. Remuneration received from a person other than his employer for evaluation of answer scripts. However, if such remuneration is received from employer, then the same will be taxable under the head “Salaries”.
17. Rent from a vacant land.
18. Insurance commission.
19. Income from undisclosed sources.
20. Income from private tuition.
21. Interest on income tax refund.
Taxpoint: Income tax refund itself is not an income.
22. Family pension received by the family members of a deceased employee.
Meaning: Family pension means a regular monthly amount payable by the employer to a person belonging to the family of a deceased employee (e.g. widow or legal heirs of a deceased employee)
Tax Treatment: It is taxable under the head “Income from other sources” after allowing standard deduction.
Standard Deduction
Minimum of: 1/3rd of such pension; or Rs 15,000.
Relief u/s 89 on arrears of family pension
Relief is available on arrears of family pension received by the family member of a deceased employee, as in case of arrears/advance salary.
23. Directors’ sitting fee for attending Board Meetings.
24. Income from activity of owning and maintaining race-horses.
25. Stipend to trainee.
26. Interest on employee’s contribution towards unrecognized provident funds at the time of payment of lump sum amount.
Specific Disallowance [Section 58]
Following expenditures shall not be deducted from any income under this head:
2. Any interest which is payable outside India on which tax has not been deducted at source. [Sec. 58(1)(a)(ii)]
3. Any salary payable outside India on which tax has not been deducted at source. [Sec. 58(1)(a)(iii)]
4. 30% of any payment made to a resident on which TDS provision is applicable without deducting TDS as referred u/s 40(a)(ia)
5. Any amount paid as Wealth tax or Income tax. [Sec. 58(1A)]
Taxpoint: Interest paid on amounts borrowed for meeting tax liability is not deductible.
6. Any amount specified u/s 40A like -
● Payment to relative in excess of requirement; or
● Payment in excess of Rs 10,000 otherwise than an account payee cheque/draft [Sec.58(2)]
7. No deduction in respect of any expenditure shall be allowed in computing the income by way of any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or form, gambling or betting of any form or nature, etc. taxable under the head “Income from other sources”. [Sec. 58(4)]
Note: Above provision shall not apply in computing the income of an assessee, being the owner of horses maintained by him for running in horse races, from the activity of owning and maintaining such horses.
Key Takeaways:
1) As per sec. 56(1), any income, which is not specifically exempted and not chargeable under any other heads of income, shall be chargeable under the head “Income from other sources”.
2) No deduction in respect of any expenditure shall be allowed in computing the income by way of any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or form, gambling or betting of any form or nature, etc. taxable under the head “Income from other sources”.
References:
1) Income Tax Act with Gist of Supreme Court Rulings Book (Bharat Law House.)
2) Income Tax Law & Accounts For B.Com Vth Semester of Calicut University (English, Paperback, Dr. H.C. Mehrotra, Dr. S.P. Goyal)