Unit 2

COMPUTATION OF TAXABLE INCOME UNDER DIFFERENT HEADS OF INCOME

2.1 Significance of Various Heads of Income under Income Tax 1961

The concept of heads of income is very important under the income-tax Act. An income which is to be properly charged under one particular head cannot be charged under any other head of income. This is because the Act contains self-contained provisions in respect of each head of income. Specific deductions are permissible under each head of income. Therefore if an income is charged under a wrong head of income, the assessee will lose the benefit of deductions available to him. For example, for the purpose of computing salary income, standard deduction, deduction towards entertainment allowance and deduction towards professional tax are available.

We have to bring various types of incomes under their specified heads and compute the same under each head. After such computation we have to add the income under various heads. This will constitute the gross total income. From the gross total income we have to allow the certain deductions permissible by the Act net figure after allowing the above deductions will constitute the total income, which is the taxable income.

2.2 Heads of Income

Income Tax Act, 1961 determines 5 heads / sources of income. These are as follows:

1. Income under the head salary.
2. Income under the head House Property.
3. Profit & Gains of Business & Profession.
4. Capital Gains.
5. Income from other sources.

Detailed discussion of the above sources is as follows:

2.3  INCOME FROM SALARY

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:

-          wages;

-          any annuity or pension;

-          any gratuity;

-          any fees, commission, perquisites or profits in lieu of or in

-          addition to any salary or wages;

-          any advance of salary;

-          any payment received by an employee in respect of any period of leave not availed by him.

-          The portion of the annual accretion in any previous year to the balance of the credit of an employee participating in a recognised provident fund to the extent it is taxable, and

-          transferred balance in a recognised provident fund to the extent it is taxable.

-          The contribution made by the central government or any other employer to the account of an employee under a notified pension scheme referred to in section 80CCD.

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:

1. Remuneration to Director of a Company, if he takes professional fees. It is taxed under Income from Business & Profession
2. Salary to Member of Parliament (MP), Member of Legislative Assembly (MLA) as they work as public servant. They are not employees of the government. It is taxed under Income from other sources
3. Salary to Partner from Partnership firm. It is taxed under Income from Business & Profession.

Basis of Charge

Under Section 15, the following income is chargeable to income-tax under the head ‘Salaries’.

• Any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not.
• 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.
• 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.

1. Dearness Allowance:

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.

1. If the employee does not live in rented accommodation, this allowance is fully taxable.
2. But if Employee lives in a rented accommodation, the deduction is as follows:

Least of-

• Actual HRA received or
• 50% of [basic salary + DA] for those living in *metro cities (40% for non-metros); or
• 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:

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:

• Actual Amount received
• 1/5th of Basic Salary
• 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

• 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.
• 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.
• 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.
• 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.
• 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:

1. Perquisites taxable for all Employees
2. Perquisites taxable for Specific Employees
3. Perquisites which are Exempt

Perquisites taxable for all Employees

The following perquisites are taxable in the hands of all employees:

1. Rent free accommodation provided by the employer to the employee. Such accommodation may be furnished or unfurnished.
2. Any concession in the matter of rent in respect of the accommodation provided or granted by the employer to the employee.
3. Any sum paid by the employer in discharging the monetary obligation of the employee which otherwise would have been payable by the employee e.g. The school fees of the children of the employee paid by the employer or the Income-tax of the employee paid by the employer.
4. Any sum payable by the employer whether directly or through a fund (other than recognized provident fund (RPF), Approved Superannuation Fund or Deposit Linked Insurance Fund) to effect an assurance on the life of the assessee or to effect a contract for an annuity.
5. The value of any other fringe benefit or amenity as may be prescribed.
6. Specified security or sweat equity shares allotted or transferred by the employer to the assessee.
7. Contribution by the employer to the approved superannuation fund in respect of assessee to the extent it exceeds Rs. 1,50,000.

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:

• 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.
• 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.
• 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.
• 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:

1. Services of a sweeper, gardener, watchman or personal attendant,
2. Free or concessional use of gas, electric energy and water for household consumption,
3. Free or concessional educational facilities,
4. Use of motor car,
5. Personal or private journey provided free of cost or at concessional rate to an employee or member of his household,
6. The value of any other benefit or amenity, service, right or privilege provided by the employer.

• 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.
• 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:

1. He is a Director of a company; or
2. He, i.e. the employee, has a substantial interest in the company. As per section 2(32), person who has a substantial interest in the company, in relation to a company means a person who is the beneficial owner of shares, not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits, carrying not less than 20% of the voting power; Here the word beneficial owner is significant. It means that even if a person is not a registered holder of shares in a company but has beneficial interest in such shares, he shall be covered by this definition and conversely, even if a person is a registered holders of shares but has no beneficial interest in such shares, he shall not be covered by this definition. Thus, the beneficial ownership is the criterion under this definition.
3. His income under the head 'Salaries' (whether due from, or paid or allowed by, one or more employers), exclusive of the value of all benefits or amenities not provided for by way of monetary payment, exceeds Rs. 50,000. Income, for this purpose, shall include all taxable monetary payments like basic salary, dearness allowance, bonus, commission, taxable allowances/perquisites but shall not include the value of any non-monetary benefits/perquisites. The following are to be deducted from salary for this purpose:
   1. Entertainment allowance (to the extent deductible under section 16(ii);
   2. Tax on employment [Section 16(iii)].

Valuation of Perquisites

1. Rent Free Accommodation:

2.       Motor Car/any other Conveyance

3.       Educational Facilities

Taxable only in the hands of specified employees

Other Educational Facilities

Bonus

Bonus Received- Taxable

Bonus Declared- Not Taxable (as it is not received)

Provident Fund

* Conditions:

1. Employee leaves the job after five years of employment; or
2. Where the service period is less than five years, the reason for termination is discontinuance of employer’s business or ill health; or
3. The balance in RPF is reassigned to RPF with the new employer on re-employment.

Public Provident Fund

Deduction under section 80C is available.

The amount received (including interest) is Fully Exempt.

Deductions under Section 16

1. Standard deduction Rs 50,000

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

2.4  INCOME FROM HOUSE PROPERTY

Introduction

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:

1. There should be a House Property.
2. Assesses is the Owner (Legal Owner or Beneficial Owner or Deemed Owner) of such House Property.
3. Such house property is not used for the purpose of Business by the owner/assessee.

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

1. Foreign Property

If house property is situated abroad, then annual value of such property shall be taxable as:

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:

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:

1. Let out property [Sec. 23(1)]
2. Self-occupied property [Sec. 23(2)(a)]
3. Deemed to be let out property [Sec. 23(4)]
4. Recovery of arrears of rent and unrealized rent [Sec. 25A]

Let out property [Sec. 23(1)]

Computation of Income from House Property

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)

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:

Working:

1. Actual Rent received/receivable= ARR-Unrealised Rent

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

1. Standard Deduction u/s 24(a): 30% of the net annual value is allowed as standard deduction in respect of all expenditures (other than interest on borrowed capital) irrespective of the actual expenditure incurred.

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:

1. Interest for Pre Construction Period
2. Interest of Previous Year (i.e can also be regarded as Post Construction)

1. Interest for Pre Construction Period

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:

Other Points

1. Interest on borrowed capital is allowed on accrual basis even if the books of account are kept on cash basis.
2. Interest paid on fresh loan, which is taken to repay the original loan (being taken for above-mentioned purpose) shall be allowed as deduction.
3. Interest on new loan, taken for paying outstanding interest on old loan, is not deductible
4. Amount paid as brokerage or commission, for arrangement of the loan, is not deductible.
5. Interest on loan taken for payment of municipal tax, etc. is not allowed as deduction.

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:

• On such interest, tax has not been deducted at source and paid as per the provision of chapter XVIIB; and
• In respect of such interest there is no person in India who may be treated as an agent u/s 163.

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:

• Is in the occupation of the owner for the purposes of his own residence;
• Is not actually let out during the whole or any part of the previous year; and
• No other benefit there from is derived by the owner.

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’.

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:

Summary of treatment of interest on loan:

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:

1. Gross Annual value: Since assessee does not let out such property & do not receive rent, therefore GAV will be determined from Step 1 only. Step 2, 3 & 4 of calculation GAV are irrelevant.

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:

• No other deduction shall be allowed from such income except standard deduction i.e. 30% of such receipt (even legal expenditure shall not be allowed as deduction)
• The income is taxable on cash basis.

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.

2.5 PROFITS AND GAINS FROM BUSINESS & PROFESSION 

Meaning of Business & Profession

Business [Sec. 2(13)]

Business includes –

• Any trade, commerce or manufacture; or
• Any adventure or concern in the nature of trade, commerce or manufacture.

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:

• Nature of Commodity
• Intention of the party
• Efforts applied in transaction
• Periodicity of transaction
• 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 -

• Profit on sale of import license or duty entitlement pass book. [Sec. 28(iiia)/(iiid)/(iiie)]
• Cash assistance received/receivable by an exporter under a scheme of the Government of India [Sec. 28(iiib)]
• 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 -

• Not carrying out any activity in relation to any business or profession; or
• 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 -

• An employee of the first mentioned person; or
• 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

1. Rent from House Property
2. Dividend on Shares
3. Winnings from Lotteries, Races etc
4. Exempted income by virtue of Sec 10, 11 or 13A
5. Sum taxable under the head ‘Capital Gains’

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:

1. Asset must be owned by the assessee.
2. Asset must be used for the purpose of business or profession during the previous year.

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:

• Assets must be of same nature;

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;

• Rate of depreciation on such asset must be same.

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:

1. Depreciation given in the Profit & Loss A/c should always be Disallowed.
2. Depreciation as per Income Tax Act will be Given in the Notes/additional information.

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-

• The General Insurance Corporation of India & approved by the Central Government
• any other insurer and approved by the Insurance Regulatory and Development Authority

- 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 unrecognised provident fund is not allowed as deduction.
• Contribution towards statutory provident fund is allowed as deduction u/s 37(1).

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:

1. Debt must be incidental to the business or profession.
2. The debt has been considered as income of the assessee of that previous year or of earlier previous years.
3. It must have been written off in the accounts of the assessee.
4. Business must be carried on during the previous year or any part of the previous year.
5. It must be of a revenue nature.

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 -

1. It must be real and not notional, fictitious or in lieu of distribution of profit.
2. It must be expended wholly & exclusively for the purpose of business or profession carried on by the assessee.
3. It must have been incurred in the previous year.
4. It must not be a personal expenditure.
5. It must not be a capital expenditure.
6. It must be lawful and not have been incurred for any purpose, which is an offence or prohibited, under any law.

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:

1. Any sum payable2 by way of tax, duty, cess, fee, by whatever name called, under any law for the time being in force.
2. Any sum payable as bonus or commission to employees for services rendered.
3. Any sum payable as interest on loan or borrowing from any
   • Public financial institutions (i.e., IFCI, LIC, etc.);
   • a State financial corporation; or
   • State industrial investment corporation.
4. Any sum payable as interest on any loans and advances from a scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank in accordance with the terms and conditions of the agreement governing such loan or advances.
5. Any sum payable by an employer in lieu of any leave at the credit of employee (i.e. leave encashment).
6. Any sum payable by an employer by way of contribution to any provident fund, superannuation fund, gratuity fund or any other fund for the welfare of employees.
7. Any sum payable by the assessee to the Indian Railways for the use of railway assets.

Computation of Profits & Gains from Business & Profession

1. When Profit & Loss A/c is given in the question

Steps to remember:

1. Start with the net profit/loss calculated in the P/L A/c
2. Add all the disallowed expenses/personal expenses according to the rules. The reason is that the assessee has claimed those expenses against the profit but as per the income tax department, these expenses cannot be deducted. Hence added. (These will be found on Dr side of P/L A/c)
3. Deduct all non business income or other incomes which are not business incomes. The reason is that assessee has shown these incomes in P/L A/c but these incomes are considered in their respective heads and hence deducted from Business income. (These will be found on Cr side of P/L A/c)
4. Add those business incomes which were not recorded while preparing P/L A/c. (These will be found in Additional information)
5. Deduct those business Expenses which were not recorded while preparing P/L A/c. (These will be found in Additional information)

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.

2.6  CAPITAL GAINS

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:

1. There should be a Capital Asset
2. Such capital asset should have been transferred during the previous year.

Capital Asset [Sec 2(14)]

Capital asset means –

• Any kind of property held by an assessee, whether or not in connection with his business or profession;
• 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

Note: Capital asset may be movable or immovable or tangible(furniture, jewellery, etc.) or intangible(goodwill, tenancy right, copy right, etc

- but does not include the following:

1. Stock in trade

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:

1. Jewellery**
2. Archaeological collections
3. Drawings
4. Paintings
5. Sculptures; or
6. Any work of art

Taxpoint:

• An immovable property and aforesaid assets held for personal use are not personal effect and hence are capital assets. E.g. a house property even though used for personal purpose cannot be treated as personal effect and shall fall within the definition of capital assets.
• Securities are not personal effect.
• Personal effect includes wearing apparel, furniture, car, cycle, scooter used by the assessee for personal purpose.
• Intangible asset do not have personal effect.

**Jewellery includes –

• Ornaments made of gold, silver, platinum, any other precious metal or any alloy containing one or more of such precious metals. It is immaterial whether or not such ornaments contain any precious or semi-precious stones and whether or not such ornaments are worked or sewn into any wearing apparel;
• Precious or semi precious stones whether or not set in any furniture utensil or other article or worked or sewn in any wearing apparel. E.g. Loose diamond shall be treated as jewellery.

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 –

1. Land which is situated within the jurisdiction of any Municipality (whether known as a municipality, municipal corporation, notified area committee, town area committee, town committee, or by any other name) or Cantonment Board having population of 10,000 or more; or
2. In any area within the distance, measured aerially-

Notes:

1. Population, according to the last preceding census of which the relevant figures have been published before the first day of the previous year, shall be considered.
2. If such land is not agricultural land, it will be treated as capital asset irrespective of its location.
3. If agricultural land is located outside India, it will be treated as capital asset.

Summary

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

1. Short Term Capital Asset [Sec. 2(42A]

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:

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 –

1. Period after liquidation: In case of shares, if company goes into liquidation, the period after the date of commencement of liquidation is to be excluded.
2. Date of transfer: For calculating the period of holding of a capital asset, the date on which the asset is transferred is to be excluded.
3. Conversion of preference shares into equity shares: In such case, period of holding includes the period for which the preference shares were held by the assessee. Similarly, period of holdings of units in the consolidated plan of the scheme of the mutual fund includes the period for which units in a consolidating plan of a mutual fund scheme were held by the assessee.

Transfer [Sec 2(47)]

Transfer in relation to a capital asset includes:

1. Sale, Exchange & Relinquishment of the asset;
2. Extinguishment of any right in an asset;
3. Compulsory acquisition of an asset under any law;
4. Conversion of asset into stock-in-trade by the owner;
5. Any transaction of immovable property u/s 53A of the Transfer of Property Act, 1882;
6. Any transaction which has the effect of transferring or enabling the enjoyment of any immovable property.
7. Maturity or redemption of a zero coupon bond

Taxpoint:

1. Above definition is indicative and not exhaustive
2. Above definition is applicable only in relation to capital assets and not otherwise
3. It also includes

• Disposing of or parting with an asset or any interest therein, or
• Creating any interest in any asset in any manner whatsoever,

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:

• Right of the assessee in the asset is given up or abandoned;
• Asset itself continues to exist after such relinquishment and becomes the property of someone else.
• There must be mutual consent of the parties. A unilateral action of writing off the claim in the books of account cannot be treated as relinquishment.

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-

1. Cancellation of licenses: Abandonment of a project and termination of industrial license, shall be treated as transfer.
2. Reduction of share capital: When a part of the share capital is paid to the shareholder by a company, such reduction of share capital shall be treated as extinguishment of proportionate right in the shares and such shareholder shall be liable to capital gain.

When there is a reduction of capital by a company and amounts are distributed to shareholder, such amount has two components –

• Distribution attributable to accumulated profits i.e. chargeable as deemed dividend u/s 2(22)(d);
• Distribution attributable to capital i.e. subject to tax u/s 45

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

• Assessee is a member of a company, co-operative society or other AOP.
• He has been allotted or leased a building on account of such membership.

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)

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

1. Expenditure must be necessary to effect the transaction and should not be vague
2. Expenditure on transfer may be incurred prior to or after completion of transfer
3. If expenditure has been allowed as deduction under any other heads of income then the same cannot be claimed as deduction u/s 48.

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–

• Sum paid for discharge of mortgage debt to clear charge over the property (created by previous owner) is a part of cost of acquisition.
• Litigation expenditure incurred by a shareholder to get the shares registered in his name will form part of cost of acquisition of shares.

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

• Any expenditure which is deductible in computing the income chargeable under any other head of income shall not be treated as cost of improvement.
• An expenditure incurred by a shareholder to file a suit to amend articles of association, which results in appreciation of value of share shall be treated as cost of improvement.

Computation of Long Term Capital Gains (LTCG)

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:

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:

1. Assets received on total or partial partition of HUF [Sec. 49(1)(i)].
2. Assets received under a gift or will [Sec. 49(1)(ii)].
3. Assets received by succession, inheritance or devolution [Sec. 49(1)(iii)(a)].
4. Assets received on dissolution of a firm, BOI or AOP [Sec. 49(1)(iii)(b)].
5. Assets received on liquidation of a company [Sec. 49(1)(iii)(c)].
6. Assets received under a trust (whether revocable or irrevocable) [Sec. 49(1)(iii)(d)].
7. Assets received under business reorganization subject to certain conditions [Sec. 49(1)(iii)(e)] e.g., assets received by a 100% Indian subsidiary company from its holding company or received by an Indian holding company from its 100% subsidiary company or received by an amalgamated Indian company from the amalgamating company, asset received on conversion of a company into LLP, etc.
8. Asset (being a self-acquired property of a member) received by an HUF from its member [Sec. 49(1)(iv)].

Deduction from Capital Gain on Sale of Residential House Property (Sec 54)

Applicable to: Individual or HUF

Conditions:

1. Assessee has transferred a long-term residential house, income of which is taxable under the head “Income from house property”.
2. Assessee must acquire one new residential house within prescribed time limit.
3. The new residential house should be in India.

Taxpoint:

• Capital asset must be a long term capital asset.
• Property must be a residential house whether let-out or self occupied.
• Income of such property must be taxable u/s 22.
• Land transferred appurtenant to a house property (assessable u/s 22) together with such house property, also qualifies for deduction u/s 54.
• The new residential house may not be taxable u/s 22. e.g. a new house acquired for the residence of employees shall be eligible for deduction.

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:

1. Legal title of the house: Holding of legal title is not necessary. It is sufficient that assessee has made the full (or substantial) payment within the time limit even though the transfer deed has not been registered and the possession is given after stipulated time.
2. Transfer of part of house: Exemption u/s 54 is available on sale of part of the house if the same is an independent unit.
3. Treatment of Land: The cost of land is integral part of the residential house.
4. Treatment in hands of legal heir: The benefit of sec. 54 is also available to the legal heir of deceased assessee provided he fulfills conditions of sec. 54.

Deduction from Capital Gain on Acquisition of Certain Bonds (Sec 54EC)

Applicable to: All Assessee

Conditions:

1. Assessee must have transferred any long-term capital asset being land or building or both.
2. Assessee acquires ‘long term specified assets’.

Long-term specified asset means any bond redeemable after 5 years, issued by

1. The National Highways Authority of India (NHAI);
2. The Rural Electrification Corporation Ltd(RECL);
3. Power Finance Corporation Limited;
4. Indian Railway Finance Corporation Limited;
5. Any other bond being notified by the Central Government.

Time limit for acquisition of new assets:

• Within 6 months after the date of transfer.
• In case of compulsory acquisition, time limit starts from the date of receipt of compensation.
• In case of conversion of capital asset into stock in trade, the time limit of 6 months for making investments in specified assets should be taken from the date of actual sale of stock in trade and not from the date when capital asset is converted into stock. [Circular No.791 dated 2/6/2000]

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

2.7  INCOME FROM OTHER SOURCES

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:

• Such receipt shall be a taxable income; and
• Such income does not specifically fall under any one of the other four heads of income (i.e. ‘Salaries’, ‘Income from house property’, ‘Profits and gains of business or profession’ or ‘Capital gains’).

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

1. Dividends [Sec. 56(2)(i)]

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

1. From any Relative

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 -

• a local authority; or
• a company; or
• a corporation established by a Central, State or Provincial Act.

Tax Treatment:

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:

• If letting of such building alone is acceptable, then income from letting of building is taxable under the head ‘Income from house property’.
• Mere knowledge of rent charged against each asset does not make it separable, unless and until the property is separately lettable.

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:

1. Any personal expenses of the assessee. [Sec. 58(1)(a)(i)]

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.