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UNIT III

Heads of Income

Q1) What are the different heads of income?

A1) The different heads of income are:

Income from salaries.

Income from House Property.

Profits and gains from Business and Profession.

Income from Capital Gains.

Income from other sources.

Q2) What is salary?

A2) 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:

a) wages;

b) any annuity or pension;

c) any gratuity;

d) any fees, commission, perquisites or profits in lieu of or in

e) addition to any salary or wages;

f) any advance of salary;

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

h) 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

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

j) 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.

Q3) What is Dearness Allowance? What is its treatment?

A3) 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

Q4: 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.
Find the HRA component that would be exempt from income tax during the FY 2019-20.

A4) 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) minus(-) 10% of {(25000p.m.12) + (2000p.m.12)} i.e.10% of Basic + DA	1,80,000	1,47,600
2		32,400	1,47,600
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, the entire HRA received from the employer is exempt from income tax.

Q5) What is the treatment of Entertainment Allowance?

A5) 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

Q6) What are perquisites?

A6) 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.

Perquisites taxable for Specific Employees.

Perquisites which are Exempt.

Q7) What is Income from House Property?

A7) 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.

Q8) How do you compute Income from House Property?

A8) Computation of Income from House Property

		LOP/DLOP		SOP
	Particulars	Rs	Rs	Rs	Rs
A	Municipal Value	XX
B	Fair Rent/Notional Rent	XX
C	Whichever is higher(higher of A and B)	XX
D	Standard Rent	XX
E	Whichever is Lower(lower of C and D)	XX
F	Actual Rent received/receivable	XX
G	Whichever is higher (higher of E and F)	XX
H	Vacancy Period	x
I	Gross Annual Value (G x No of Months of Let out/12)		XX
	Less: Municipal Tax paid by the Owner in previous year		XX
	Net Annual Value(NAV)		XX		NIL
	Less: Deductions under Section 24
	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)

	Rent received in advance/Arrears of Rent received	XX
	Less: Standard deduction @ 30%	XX
2.	Net Income		XX
	Total Income from House Property(1+2)		XX

Q9) What do you mean by capital asset?

A9) 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.

Q10) How do you compute Long Term Capital Gains?

A10) 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.

Q11) What are Income from other sources?

A11) 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.

Q12) Who is a specified employee?

A12) ** Specified Employee [Section 17(2)(iii)]:

An employee shall be a specified employee, if he falls under any of the following three categories:

he is a Director of a company; or

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.

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:

entertainment allowance (to the extent deductible under section 16(ii);
tax on employment [Section 16(iii)].

Q13) Which are the perquisites taxable for all employees?

A13) Perquisites taxable for all Employees

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

Rent free accommodation provided by the employer to the employee. Such accommodation may be furnished or unfurnished.

Any concession in the matter of rent in respect of the accommodation provided or granted by the employer to the employee.

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.

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.

The value of any other fringe benefit or amenity as may be prescribed.

Specified security or sweat equity shares allotted or transferred by the employer to the assessee.

Contribution by the employer to the approved superannuation fund in respect of assessee to the extent it exceeds Rs. 1,50,000.

Q14) Which are the perquisites taxable for specified employees?

A14) 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:

services of a sweeper, gardener, watchman or personal attendant,

free or concessional use of gas, electric energy and water for household consumption,

free or concessional educational facilities,

use of motor car,

personal or private journey provided free of cost or at concessional rate to an employee or member of his household,

the value of any other benefit or amenity, service, right or privilege provided by the employer.

e. 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.

f. 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.

Q15) How to compu Gross Annual Value of house property?

A15) 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.

Q16: 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

A16)

Particulars	Houses
Particulars	H 1	H 2	H 3
Municipal Value	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:

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.

Q17) Define Business.

A17) 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).

Q18) Define Profesion.

A18) 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.

Q19) What are the Incomes chargeable under the head Profits & Gains from Business & Profession?

A19) Income chargeable under the head Profits & Gains from Business & Profession

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.

Q20) What are the Incomes not taxable under the head Profits & Gains from Business & Profession?

A20) Incomes not taxable under the head Profits & Gains from Business & Profession

Rent from House Property

Dividend on Shares

Winnings from Lotteries, Races etc

Exempted income by virtue of Sec 10, 11 or 13A

Sum taxable under the head ‘Capital Gains’

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