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© With the Authors Printing and PublishingRigbts with the Publisher. Price Rs. 575/Law stated in this book is as amended by the Finance Act, 2010 applicable for Assessment Year 2011-12 and incorporates other amendments made upto October 31, 2010 Solved Paper CA Final Nov. 2010 (New & Old) - Download FREE from http;l/aadhyas.com Published by : Aadhya Prakashan Pvt. Ltd., Regd. Office: B-73, Rajendra Marg, B~pu-Nagar, Jaipur - 302015 (Raj.). Phone: 0141-2742850 Branch Office: "Kela Bhawan", 136, Vivekanand Marg, Allahabad - 211 003. (U. P.) Phone: 0532- 2564749 Mobile: 94152 67760 Visit us at : http://aadhyas.com E-mail Contacts: Allahabad Branch Jaipur Head Office Editorial Board Authors Aadhya Academy Printed by: Indian Offset Printers, 136, Vivekanand Marg, Allahabad - 211903. (U. P.) Phone: 0532- 2564749.
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PREFACE- TO THE THIRTEENTH EDITION

It is with great pride and pleasure that we place before the readers thoroughly revised, updated and enlarged 'thirteenth edition' of our book 'Students' Guide to. DIRECT TAXES' that has not only .. enjoyed great market success but has also received the appreciation of our dear students.

Uris edition, while retaining the existing features of its earlier counterpart; also incorporates new and comprehensive illustrations. illustrations and examples to explain the recent amendments have been adequately incorporated at the appropriate places. The contents of the book have been made more pre~e and logical so as to facilitate quick revision during exam days and also at the eve of the exams.
This book incorporates
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the following -

Law as applicable for the Assessment year 2011-12 ; Amendments (Amendment) by the Finance Act, 2010 (assented Act, 2010 (assented on 17-5-2010); on 8-5-2010) and Payment Circulars, of Gratuity and

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All latest developments Judicial Pronouncements

in the Direct Tax Laws, including upto October 31, 2010 ;

Notifications ;

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Special' Authors' Notes' wherever the topic needs special discussion/analysis

Topics like 'Ethics in Taxation', 'Inter-relationship between Accounting and Taxation, specifically covered in the New Syllabus prescribedfor the CA Final Exams.

etc.

This book will indubitably enable the students not only in achieving success in professional but also in acquiring clear and concrete knowledge of the subject.

exams

While thisbook covers the law along with unique illustrations that may be asked' for in me forthcoming examination, the questions asked for in past CA Final Exams .since May 1991 to May 2010 have been separately compiled along wfth their answers, as applicable for the Assessment year 2011-12, . in a book tiled 'DlREC£ TAXES - A COMPILER' by us. For students pursuing CA Final ill Hindi Medium, this book is available in Hindi, titled ~

CIrt'.

Endeavour has been made to make the edition error-free, yet mistakes might have crept in for which ,weare apologetic. We look forward to the readers for suggestions, criticism and feedback to improve the contents of the book. The readers may post their suggestions, grievances, criticism, feedback and queries by logging on to http;l/aadhyas.com Dr bye-mail to. editorialfsaadhyas.com. . ACKNOWLEDGEMENT

This book is a result of sincere efforts, persistence and perseverance of our family members, associates and students. Though words cannot express our heartfelt gratitude to them, we hereby acknowledge their co-operation.
We place on record our sincere thanks to Mrs. Mani Kela and other members of Kela family for their intense efforts in printing and publication of the book. It is due to their selfless efforts that we . have been able to present this book before the readers. ybangar@yahoo.com vandanabangar@yahoo.com sodhani.vineet@yahoo.com CA. Yogendra Bangar CA. Vandana Bangar CA. Vineet Sodhani

BIRD'S EYE VIEW

PRESENTATION OF THESUBJECT MATIER 1. TEXT (with Tax planning) : All the provisions ofthe Income-tax Act, 1961 and the . Wealth Tax Act, 1957 have been presented in simple, lucid and concise manner along with Tax planning measures so as to make reading and understanding of each topic easier. The law has been presented in topic-wise and point-wise manner. The coverage of subject-matter has,been made in thefollowing way (a) Penalties and prosecutions covered along with the respective sections to which they relate;
(b) Exempt incomes covered in respective Chapter/Head of Income to which thelj relate; the remaining covered along with Chapter on 'Deductions from Gross Total Income'.

(c) Linked 2.

01"

Inter-related Sections covered together atone place.

llIustrations and Issues: At every stage of discussion, the provisions of law have been adequately illustrated by way of examples and issues. Adequate number of numerical .'illustrations have been given at the end of major topics. So as to make the study of illustrations easier, head notes have been appended at the beginning of each illustration, which describe the objective behind each illustratiori,"

Illustrations on theoretical provisions of the Act cover various issues andj or various aspects of the law with respect to such theoretical provisions. . Questions, theoretical and numerical, and issues asked for in the past CA Final Exams have beep kept out of this book and the same have duly covered, along with the answers as per the .present law, in a separate book titled 'Direct Taxes - A Compiler' by the same authors. 3. Case laws : The landmark judgments relating to the respective topics covered in the chapter have been presented in the simplest form. The case laws study has been made - simple by use of simple and lucid language. Wherever required, the facts of the case, the question that arose and the verdict of the Court or Tribunal or Other authority have been given.

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Some case laws have been covered by way of numerical illustrations or examples, so as to make their understanding easier. Only relatively important case laws have been covered. All those case laws, which are irrelevant as per the law in force for the current assessment year, have been kept out of purview of the book. Wherever some additional content was required for understanding of case-laws, the same has been duly presented by way of 'Auihore' Notes' or otherwise.

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INDEX
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I No. !
I

Chapter Name

Pages Nos.

No. of

I i

No. of ParasI Topics

25 10

Illustrations .
Basic Concepts 1.1-1.18 2.1- 2.12 3.1- 3.28 from house property 4.1- 4.14 5.1- 5.74 6.1- 6.38 'I included in 7.1- 7.181 8.1 - 8.6

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i

1.

3
6 11 6

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I

2. Residential Status 3. I Salaries

. 4.

22
12 50 25 6 7

IIIncome
I .

I 5. I Profits and gains of business or profession

21
21 7

! 6. I Capital

Gains

II

7. Income from other sources 8.

I I

i Income

of

other

persons

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I

.1 Assessee's Total Income

I I
8

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110.
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9.

i Aggregation I Deductions
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of Income

and

Set-Off

or

9.1 - 9.16

Carry Forward of Loss from Gross Total Income

& 110.1

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I

-10.50

22

33

Exemptions from Income Tax of Various Entities Relief, Transfer

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11. Assessment
.

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! 11.1 - 11.24
Pricing 112.1 -12.18

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13 8

11

i! 12. ii Double
! : and
i

Taxation

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26

E-comm. erce of Trusts

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13.1 -13.24

18 :.-........,.~.--i

I 15. IAssessment
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14. Assessment of Non-Residents of Companies

14.1-14.8 15.1-15.22 16.1-16.10 17.1-17.18 18.1-18.52 19.1-19.6 at 20.1 - 20.30

3 10
6

7 11 13 15 33 9 8

16.. ,Tonn~ge Tax:Scheme 17. IIncome Tax:Authorities 18. IProcedure for Assessment.
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14 38
1

19.1 Liability in Special Cases

20. ITax Deduction !Source 21. Advance Refunds 22. I Settlement of Cases and Advance Rulings
I I

and

Tax: Collection

11

Tax, Recovery,

Interest

and

21.1- 21.20

19

16

I
II

22~1- 22.14 23.1-23.26

16
25 22

23. ~ Appeals and Revision

I

16

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I I
1

24.1 Miscellaneous Provisions and Penalties & 24.1 - 24.20

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i rosecution

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.1

25.1 Tax Planning, Ethics in Taxation and Inter-I [ Irelationship between Accounting· &
I Taxation
1 ! .

25.1- 25.14

12

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i 26. I\yealth ~.~. __~

Tax26.1-

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-4

I I 26.24
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604

I I
I

5 278

TOTAL

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[Solved Paper CA Final NOVEMBER, 2010 (Old & New Syllabus) : Available for FREE DOWNLOAD on htlp://aadhyas.com

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BASIC CONCEPTS
1.1 BODY OF INCOME TAX LAW:
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The Central Government has been empowered by Entry 82 of the Union List of Schedule VII of the Constitution of India to levy tax on all income other than agricultural income. The body of Income Tax Law comprises of the following(1) The Income Tax Act, 1961 (in this book, referred to as "the Act"); Extent of the Act: The Income-tax Act extends to the whole of India. "India" means the territory of India, its territorial waters, seabed and subsoil underlying such waters, continental shelf, exclusive economic zone or any other maritime zone,and the air space above its territory and territorial waters. Therefore, any income earned on account of any activities undertaken in the territorial waters, continental shelf or Exclusive Economic Zone of India is liable to be taxed in India. (2) The Income Tax Rules, 1962 (in this book, referred to as "the rules") framed by Central Government under section 295 of the Act. The rules are also known as 'subordinate or delegated legislation'; (3) Notifications issued under various provisions of the Act and the rules; (4) Circulars issued by the Central Board of Direct Taxes (CBDT) under section 119 of the Act; (5) Judicial pronouncements by the Supreme Court, High Court, National Tax Tribunal (yet to be establishe_d)and Appellate Tribunal, which explain and interpret the law. (6) Annual Finance Act: Every year a Finance Bill containing proposed amendments to be made and indirect taxes levied by Central Government, is presented in Parliament. Once Finance enacted and becomes Finance Act, amendments made by it are incorporated in the Income Generally, the amendments by the Finance Act are made applicable from the first day of financial year e.g. generally, amendments by Finance Act, 2010 areeffectiuefrom 1-4-2011. in direct Bill gets Tax Act. the next·

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First schedule to annual finance Act : The First Schedule to the annual Finance Act contains four parts, Part I provides rates for the current assessment year; Part II provides rates of TDS for the current financial year; Part III provides the rates of advance tax for the current financial year; and Part IV provides for rules for computation of net agricultural income. .

E.g. In case of First Schedule to Finance Act, 2010, Part I contains income-tax rates for assessment year 2010-11; Part II provides rates of TDS for financial year 2010-11 (i.e. assessment year 2011-12); and Part III provides rates of advance tax for financial year 2010-11 (i.e. assessment year 2011-12).
1.2 CHARGE OF INCOME TAX [Section 4] : The concept of charge of income tax is explained in the following points : (a) Income tax is charged in an assessment year at the rates specified by the Finance Act applicable on the 1st April of the relevant assessment year. It includes surcharge and additional tax.
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(b) It is charged on total income of every person for the previous year. (c) Total income is to be computed in accordance with provisions of the Act. (d) Income tax is to be deducted at source or paid in advance wherever it is required under any provisions of the Act to be so deducted or paid. .

Students' Guide to DIRECT TAXES

(e) Tax '9iffere'ntfrom penaltu, interest, etc. : Tax, penalty and interest are different concepts under the Income-tax Act. The definition of "tax" under section 2(43) does not include penalty or interest. Similarly, under section 156i it is provided that when any tax, interest, penalty, fine or any of other sum is payable in consequence of any order passed under this Act, the Assessing Officer shall serve upon the assessee a notice of demand as prescribed. The provisions for imposition of penalty and interest are distinct from the provisions for imposition of tax. - Harshad Shantilal Mehta v. Custodian [1998]231 ITR 871 (SC).

ate of effect of amendment: (a) In respect of provisions relating to levy of tax: Income Tax Act, as it stands amended on 151 April of any financial year will apply in respect of assessment of that year. For example, for assessment year 2011-12, the law as it stands amended amendments made by the Finance Act, 2010 w.e.f, 1-4-2011) 'will apply. on 1-4-2011 (i.e.

Consequently any amendment, which comes into force after 1'1 April 2011 will not apply to tile assessment year 2011-12, even if the assessment for such assessment year was actually made after the amendment, came into force. . (b) In respect of amendments for which a particular date is specified: In case of tile amendments for which a particular date is specified as its date of effect, the transactions/ events occuring on or after the said specified date shall be governed by the amended law; while the other transactions/ event shall be dealt with as per the old law. For example, section 56 has been amended 'to tax" gifts of bullion" and the said amendment is effective from 1-6-2010. Hence," gifts of bullion" received-on or after 1-6-2010 shall be liable to tax; while the said gifts received before 1-6::.2010 shall not be taxed. (c) In respect of amendments of procedural law : The amendments relating to procedural law i.e. law relating to mode of filing of returns, manner of assessment ... eriod of limitation, etc. apply to all the p proceedings pending on the date on which the amendment corne into force. (d) Retrospectiue amendments: Where a provision is brought into force retrospectively, it shall be given effect from such retrospective date even though such an amendment may have been made after 151 April of the assessment year. For example,amendment in definition of "property" in giftpr-ovisions of section 56 has been made w.r.e.f. 1-10-2009. It means that all the gift of properties, as per the amended definition, received on or after 1-10-2009 shall be taxable; those gifts which do not fall in the definition of the word "property" and received on or after 1-10-2009 shall not be taxable. Retrospectiue amendment doesn't apply to concluded proceedings : However, unless otherwise provided in the law itself, a retrospective amendment applies only to pending proceedings, not to concluded proceedings. Thus, proceedings, which have become final on account of expiry' of period of limitation or otherwise, cannot be reopened taking resort to such retrospective amendment National Agricultural Co-op. Marketing Federation of India Ltd. v. UOI [2003]260 ITR 548 (SC) 3 PERSON [Section 2(31)] : According/to section 2(31) of the Act, the term "Person" includes the following: (a) Individual:
,-

An individual covers only natural persons and a minoror a person of unsound mind.

(b) . Hindu Undivided Family (HUF) : Discussed in detail in Chapter on' Assessment of various entities'.
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:{A) Partnership firm (including a "Limited Liability Partnership" firm) : (Discussed in detail in Chapter

on 'Assessment a/various entities').

(c) Company: Discussed in detail in Chapter on' Assessment of companies'.

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(d) Association of persons (AOP) or Body of individuals (BOI), whether incorporated Discussed in detail in Chapter on ' Assessment of various entities'. **
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(e) Local authority: It means a Panchayat, Municipal Committee, District Board, Municipality and Cantonment Board or other authority legally entitled to or entrusted by the Goverrunent with the control and management of a municipal or local fund.**

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(f) Artificial

juridical person, not falling within any of the preceding categories, This category is residuary in nature. It covers Dieties, Idols, Corporation, Bar council, Guru Granth Sahib, Universities etc. **

**Profit motive not necessary to constitute person: An AOP or a BOr or a local authority or an artificial juridical person shall be deemed to be a person, whether or not they are formed or established or incorporated with the object of deriving income, profits or gains. 1.4 ASSESSMENT YEAR [Section 2(9)] :
" Assessment year" means the period of twelve months commencing on the 1 day of April every year. It st is the year Gust after previous year) in which income earned in the previous year is charged to tax.

E.g.: The assessment year 2011-12 is a period of 12 months starting from the I" April 2011 and ending on the 3rt March 2012. The total income of an assessee earned in the previous year 2010-11 is assessed in the assessment year 2011-12.

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1,5 PREVIOUS YEAR[Sedion

2(34) read with section 3] :

"Previous year" means the financial year immediately preceding the assessment year. E.g.: Thus, for the assessment year 2011-12, the previous year shall be the period from I" April, 2010 to 3rt March, 2011.
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Previous year in case of a business or profession newly set up: The period beginning with.the date of setting up of the business or profession and ending with the said financial year. . Previous year in case where a source of income newly comes into existence: The period beginning with the date
on which the source of income newly comes into existence and ending with the saidfinancial year.

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Section
68 69

Title
Unexplained Cash Credit Unexplained investment Unexplained Money Investment partly disclosed Unexplained Expenditure Amount borrowed or repaid on hundi

Year of taxability
Previous year in which credited in the books of account. Financial Year in which investment is made. Financial Year in which found. Financial Year in which investment is made. Financial Year in which such expenditure is incurred. Financial Year of borrowing or repayment.

- 69B
69C
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69A

69D

1.6 PREVIOUS YEAR RULE AND ITS EXCEPTIONS [Sections 172 to 176] : Section 4 of the Act states that income earned in a year is taxable in next year i.e. the assessment year. This is known as previous year rule. However, certain circumstances have been specified wherein accelerated . assessment is required i.e. the income earned in a year is taxable in the same year. These are as follows: (a) Non-resident engaged in shipping business. [Section 172] (b) Assessment of Persons leaving India. [Section-:L74]

1.4

Students' Guide to DIRECT TAXES

60.
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(c) Assessment of Association of Persons or Body of Individuals or artificial juridical person formed for a particular event or purpose. [Section 174A]

(d) Person likely to transfer property to avoid tax. [Section 115] (e) Discontinued business. [Section 176]
1.7 ASSESSEE [Section 2(7)] : "Assessee" means any person by whom any tax or any other sum of money is payable under this Act. The expression 'assessee' includes the following persons(a) Every person ill respect of whom any proceeding under this Act has been taken for the assessment of his income/loss/refund or for the assessment of income/loss/refund of any other person in respect of which he is assessable (b) Every person who is deemed to be an assessee under any provision of this Act.

,For instance, a representative assessee is deemed to be an assessee by virtue of Section 160(2).

(c) Every person who is deemed to be an assessee in default under any provision of this Act.

For instance, under Section 201(1), any person who does not deduct tax at source, or after deducting fails to pay such tax, is deemed to be an assessee in default. Similarly, if a person does not pay advance tax or self-assessment tax, then he shall be deemed to be an assessee in default.
1.8 iNCOME [Section 2(24)] :

c;

In common parlance income means a monetary return coming with some sort of regularity whether or , not from definite or identifiable source. It was held in Emil Webber v. CIT [1993]200 ITR 483 (Se) that the definition of "income" in clause (24) of section 2 of the Act is an inclusive definition. It adds several artificial categories to the concept of income but on that account the expression "income" does not lose its natural connotation. Anything, which can properly be .described as income, is taxable under the Act unJess it is exempted under one or the other provisions of the Act. , Some special inclusions in the definition of income tV's 2(24) : Income includes various items of
profits/ gains, etc. chargeable unde~ the five heads of income. In addition thereto, income includes (a) -Voluntary Contributions ¥whether of revenue nature or capital nature) : Voluntary contributions received by a charitable or religious trust or institution or by a scientific research association or games association or by any other notified fund or institution established for charitable or religious purposes, or, by any university or other educational institution or hospital or other medical institution referred to in section lO(23C) other than those wholly or substantially financed by the Government, or, by an electoral trust approved by the Board in this behalf (b) Income of trade, professional or similar association from specific services to its members. (e) Profits and gains of insurance business carried on by a mutual insurance company or by a cooperative society, computed in accordance with section 44 or any surplus taken to be such profits and gains by virtue of provisions contained in the First Schedule. {d] Any sum received by the assessee from his employees as contributions to any Provident Fund or 'Superannuation fund or Employee State Insurance fund or any other fund for welfare of employees. (e) Any sum received under a Keyman insurance policy including the sum allocated by way of bonus on such policy.

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(f) Any sum of money or value of property received by an individual or HUP by way of gifts as referred to in Section 56(2)(vii) and tialueof gift of shares received by a private company or a finn as-referred to in section 56(2)(viia) (inserted by Finance Act, 2010 to.e.f. 1-6-2010).

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Basic Concepts

1.5

(g) The profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members. Other concepts relating to income: The other points relating to income are (a) Income may be received in cash or in kind: In case income is received in kind, then, the same is to be valued as per the prescribed rules, or, fair market value. (b) illegal incomes are also liable to tax in the same manner as legal income. (c) Income must be real and must arise from outside sources. (d) Unless otherwise provided in law, the same income cannot be taxed twice. (e) In case of disputed title to income, the person in receipt of the income shall be liable to tax thereon. Case law CIT v. K Thangamani [20091 309 ITR 15 (Mad). Illegal Income - Encashmeni of false IDS Certificates is 'income' chargeable to tax : Where an income-tax practitioner collects refunds on false/bogus TDS certificates, such refunds shall constitute his 'income' chargeable to income-tax under the head "Income from Other Sources". The income-tax law doesn't make any distinction between legal income or illegal income, both of which are chargeable to tax. [Auth01's' Note: This judgment follows the established law on the subject. However, it must be borne in mind that in a case like this, since the income-tax practitioner had collected .wrong refunds from the Department! Central Government, hence, the Department has all rights to confiscate such money. This aspect doesn't find place in the judgment. It appears that even though the amount is liable to confiscation, the same shall be income ill. the hands of the assessee tor the year in which the refund was encashed. The confiscation shall operate as a penalty/recovery of the Ill-gotten wealth.] ,
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1.9 HEADS OF INCOME [Section 14]:

As per Section 14 of the Income Tax Act, all incomes, for the purposes of computation of total income and income tax liability, are classified under the following five heads (1) Salaries;

I (2) Income from House Property;

(3) Profits and Gains of Business or Profession;

,

(4) Capital Gains, and

(5) Income from Other Sources.

.

Nature of heads of income: The heads of income are mutually exclusive i.e, an income, which falls under one head cannot be brought to tax under any other head of income. However, income-tax levied is a single tax on total income; it, is not a collection of taxes separately levied on distinct heads of income. The Income-tax Act contains provisions describing the incomes to be included in each of the heads of income listed above. If the income from a source falls within a specific head, the fact that it may indirectly be covered by another head will not make the income taxable under the latter head. Correct classification of income under the proper head is mandatory. Incorrect classification to obtain undue incentives in the law may lead to penalties and prosecution. 1.10 EXPENDITURE IN RELATION TO EXEMPT INCOME, NOT DEDUCTIBLE [Section 14A] : While computing total income under the Act, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to exempt income (i.e. income, which does not form part oj total income). Determination of expenditure incurred for exempted income [Rule 8D of Income-tax Rules, 19621: If the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with -

1.6

Students' Guide to DIRECT TAXES

(a) the correctness of the claim of expenditure made by the assessee; or (b) the claim made by the assessee that no expenditure has been incurred, in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income as follows Amount of expenditure directly relating to income which does not form part of total income

Add: In respect of interest not directly attributable to any income/receipt, sum computed as follows . Indirect expenditure by way of interest incutred during the previous year ,. Average of value of investments, income wherefrom is exempt
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Average Value of Total assets

Add: 0.5% of average of value of investments, income wherefrom is exempt

Expenditure incurred in relation to income which doesn't form part of total income Notes: For the purposes of the above, -

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(a) Average of value of investments, income wherefrom is exempt = (Opening Value, as on 1st day of previous year, of Investment, income from which does not form part of the total income, as appearing in the balance sheet of the assessee + Closing Value, as on last day of previous year, of such investment) -;-2 (b) Average value of total assets = (Opening value, as on 1stday of previous year, of total assets appearing in the balance sheet of the assessee + Closing value of such total assets as on last day of previous year) -;-2

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(c) 'Total assets' shall mean, total assets as appearing in the balance sheet excluding the increase-on account
of revaluation of assets but including the decrease on account of revaluation of assets.

Scope of sectio1l14A [CIT v. Walfort Share and Stock Brokers P. Ltd, [201 OJ 326 ITR 1 (SC)J: (a) Objective of section 14A : The basic principle of taxation is to tax the net income, i.e., gross income minus the expenditure. On the same analogy the exemption is also in respect of net income. Expenses allowed can only be in respect of earning of taxable income. This is the purport of section 14A.
to all heads: In section 14A, the first phrase is "for the purposesof computing the total income under this Chapter" which makes it clear that various heads of income as prescribed under Chapter IV would fall within section 14A.

(b)Sectionl4Aapplies

(c) ~ectiolll4A applies to exempt incomes only & Expenses to be apportioned between exempt and nonexempt incomes: The next phrase is, "in relation to income which does not form part of total income under the Ad'. It means that if an income forms part of total income, then the related expenditure is
. outside the ambit of the applicability of section 14A. The permissible deductions enumerated in sections 15 to 59 are now to be allowed only with reference to income which is brought under one of the above heads and is chargeable to tax. The theory of apportionment of expenditure between taxable and n011-, taxable has, in principle, been now widened under section 14A.

(d) Section 1M applies to "expenditure", not "cost of acquisition" : The words "expenditure incurred"
in section 14A refers to expenditure on rent, taxes, salaries, interest, etc., in respect of which allowances are provided for u/s 15 to 59. Profits have to be computed after deducting losses and expenses incurred for business. A deduction for expenditure or loss which is not within the prohibition must be allowed if it is on the facts of the case a proper debit item to be charged against the incomings of the business in ascertaining the true profits. A return "of" investment itself or a pay-back of cost of acquisition of an asset is not such a debit item, hence, it is not" expenditure incurred" in terms of section 14A..

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. (e) Loss on sale of/asset' giving rise to exempt income - No relation to exempt income: For attracting section 14A, there has to be a proximate cause for disallowance, which is its relationship with the tax exempt income. Pay-back or a return of investment is not such proximate cause, hence, section 14A is not applicable to loss suffered on an asset giving rise to exempt income. A return" of' investment (i.e. loss on sale of capital asset generating exempt income) cannot be construed to mean "expenditure" and even if it is construed to mean" expenditure" in the sense of physical spending still the same is not such to which section 14A can apply. Section14A applies to cases where the assessee incurs expenditure to earn tax-free income; however, it doesn't apply where expenditure incurred results in acquisition of an asset. 1.11 DIVERSION OF INCOME v. APPLICATION OF INCOME : When an income, which has accrued, arisen or has been received by the assessee is applied in discharge of an obligation, it is said to be an application of income. On the other hand, when an income gets diverted at the source by an overriding title, before it has accrued, arisen or reached the assessee it would be said to be a diversion of income. Differences between Diversi on of Income and Application of Income . \
.'

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Diversion of Income (a)

Application of Income

By virtue of an obligation the income is diverted at The discharge of obligation takes place after source before it reaches the assessee. the income reaches the assessee. Obligation is on the source of income. Diversion of income takes place The income is not included assessee. Obligation is on the receipt of income. There is no over riding title in thiscase.
o

(b) (c)
(d)

by overriding title.

in the income of the Such income is included in the income of the assessee.

(e)

Income cannot be said to have accrued or arisen.

Income is said to have accrued or arisen and therefore is taxable in the hands of assessee.

Case.laui

crT v. Kama taka Urban Infrastructure Development and Finance Corporation [2009J 315 ITR 301 (Karn)

Interest earned on grants received for a particular purpose - Not income: The assesseecorporation was a nodal agency for implementation of the various schemes of the Central or' State Government, It received funds for the development of Bangalore city, which were deposited in the Bank Accounts and interest was earned thereon. The Department demanded tax on such interest contending that such interest was income of th~ assessee. Held that, the whole of the funds including interest thereon were to be applied for the purpose of the scheme entrusted to the assessee by the Government. Such sums belonged to the Government. There assessee had no right over those funds. Hence, they could not be regarded as 'income' of the assessee and were not liable to tax. [Authors' Note: Alternatively, it can be said that the.title to 'interest' was diverted by overriding title in favour of the Central/State Government, which had provided the funds. Hence/there was no question of such interest being treated as income.]

1.12 PRINCIPLE OF MUTUALITY AND COMPUTATION OF TAXABLE INCOME: The principle of mutuality is based on the principle that - "No man can make profit Gut of transaction with himself'. The mutual associations like clubs, co-operative societies etc. work on this principle.

1.8

Students' Guide to DIRECT TAXES

Conditions for recognition of mutuality: In aT v. Bankipur Club Ltd. [1997] 226 ITR 97 (SC) it was held that the law recognises 'principle of mutuality' in case following conditions are satisfied: (a) There is complete identity between the contributors and beneficiaries. (b) The association is formed with the objective of mutual benefit. (e) Any surplus resulting from the activities should either be expended for mutual benefit or should be returned to contributories .• (d) The arrangement between the members and association is of non-trading character; Fonnof Organisation : It is immaterial what particular form the association takes. Even companies may be governed by the principle of mutuality, in which case their income will not be liable to tax. Services provided only to specified members - Mutualif:!j is not affected: Where the activity is mutual, the fact that, as regards certain activities, only certain members of the association take advantage of the facility it offers, does not effect the mutuality of the enterprise. House property also exempt: Similarly in case of Chelmsford club v. CIT [2000] 243 ITR 89 (SC), where the business of the assessee was governed by mutuality, the annual value of the clubhouse was not taxable. Exceptions: The following incomes though arising out of mutual activities are taxable: (a) Profits and gains of any insurance business carried on by a mutual insurance company, or, a cooperative society (even if it is a mutual concern). [Section 2(24)(vii)] (b) Income of a trade, professional or similar association (Tom specific services performed for its members. [Section 28(iii)] . (e) The profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members. [Section 2(24)] AllUpa111. Trading firm - Not mutual concern : The assessee-finn was created to carry on the business

Enterprises of money-lending and trading of garments. During a year, it had only advanced loans to the v. ITO partners and earned interests thereon. It filed its return of income claiming exemption from
[2010] lTR
(Kam)

322 income-tax on the doctrine of mutuality on the ground that it had not entered into any 230 business activity other than lending to partners. The benefit of mutuality was not allowed. Held that, the firm was created notonly for the benefit of its partners for lending money to them but it was created to do other businesses like money-lending to all third parties and to do garment business. In any particular year, if the firm has not done any business and has extended loans only to its partners, for a particular assessment year, it cannot be said that the firm was established or created for the benefit of its partners by applying the principles of mutuality. Even while lending loans to partners, it was carrying out its business of lending. Hence, principle of mutuality couldn't be applied.

Illustration 1 -Total income of mutual association: A social club furnishes the following details -Rs.

(a)

Receipts by way of entrance fees and Annual Membership fees from members Expenditure on members Bank Interest

3,60,000 60,000 70,000 2,10,000 1,70,000 5,40,000 [.}.:~.:.

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(b)
(c)
(d) (e) (f) (g)

IExpenditure IExpenditure

Receipts [rom members for specific services incurred on providing specific services to members . .

I Collection from non-members

on non-members

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1.9

Compute the taxable income of the social dub. What will be your answer if, instead of the social club, the assessee is a trade association.

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Solution: The taxable income of the social club shall be computed as follows Profits andGains from Business or Profession:
Collection from non-members Less: Expenditure on Non-members

(amounts in Rs.)

5,40,000 3,77,000 1,63,000 70,000 2,33,000

Income from other Sources: Bank Interest

Total Income Notes:

(a) Net Receipts from members by way of entrance and membership fees i.e. Rs, 3,00,000/-'(3,60,000 - 60,000) is income from mutual 'activity and is therefore exempt from tax. . . (b) Net income from specific services to members i.e. Rs. 40,000/- (2,10,000 -1,70,000) is also income from mutual activity and is therefore exempt from tax. (c) Net Receiptsfrom non-members i.e. Rs. 1,63,000/- (5,40,000 - 3~77,000) is taxable income as it is tainted with commerciality as it has been received from outside.

If the assessee is a trade association: If the assessee is a trade association, the income earned by it from specific services rendered to its members i.e. Rs. 40,000/- (2,10,000 -1,70,000) will be taxable. Therefore, its total income shall be Rs. 2,33,000 + 40,000 = 2,73,000.
1.13 CAPITAL RECEIPTS AND REVENUE RECEIPT~ : ~ .. Capital is a fund while Revenue is a flow. Revenue receipts are like fruits of a tree while tree being the source is the capital receipt. No conclusive rule can be laid down and the nature of the receipt varies according to the circumstances of each case. However, following. broad propositions can be laid down Capital Receipts Revenue Receipts

~ ..

Capital receipt is generally referable to fixed Revenue receipt is referable to circulating capital or {:apita1.E.g.: Sale of assets, which the assessee uses stock in trade. E.g.: Sale of stock-in-trade or any as a fixed capital to enable him to carry on his trading asset results in revenue receipts. business, is capital receipt. for Payment made to compensate a person towards loss of Payment received towards compensation extinction wholly or partly of a profit earning profits or earnings, is a revenue receipt. source is a capital receipt. . A receipt in lieu of source of income is a capital A receipt in lieu of income is revenue receipt. receipt. E.g.: Compensation for loss of employment is a capital receipt. Capital receipts are exempt from tax unless they Revenue receipts are taxable unless expressly exempt from tax like in case of income exempt u] s 10 to 13A. are expressly taxable like in case of capital gains. Compensation received for relinquishing interest, Compensation received for relinquishing interest in whether wholly or partly, in a capital asset of the stock-in-trade of the business is a revenue receipt. business is a capital receipt.
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1.10 Case law

Students' Guide to DIRECT TAXES

(a) Payment for requisition/use of capital assets is revenue receipt, while payment received for acquisition of capital asset is capital receipt, though it is taxable under Capital Gains. (b) Earnest rnoney and Advance: If earnest or advance money forfeited in respect of contract of trading goods is revenue receipt, however, if the same is forfeited in respect of capital assets it will be a capital receipt Ttaoancore Rubber and Tea Co. Ltd. v. CIT [20001243 ITR 158 (SC). (c) Subsidy: It was held in Sahney Steel & Press Works Ltd. v. CIT [1997J 228 ITR 253 (SC) that nature of subsidy in hands of recipient is determined having regard to purpose for which subsidy is given. . Subsidy is Revenue receipt if it is given -+ as assistance to carry on business already commenced; or .. to meet any specific revenue expenditure or by way of its reimbursement E.g.: The subsidy given by way of refund of sales taxsubsidy on power consumed and exemptions from payment of water charges etc. is revenue in nature and, hence, taxable accordingly. Subsidy is Capital receipt if it is given - .. as assistance to set up new business; or • to complete a project; or .. to acquire an asset CIT v. Saurashtra CemelltDelay in supply of machinenj - Compensation irrespective of loss actually Ltd. [2010]325 ITR 422 (SC) suffered - Not relates to loss of profits - Capital Receipt
Facts }>

'The assessee was engaged in the manufacture of cement. It entered into arragreement with M/ s. WIL, the supplier, for the purchase of an additional cement plant -_'The agreement provided that in the event of delay caused in the delivery of machinery, the assessee was to be compensated at 0.5% per month of the price of the respective machinery; without proof of actual loss, but the total amount of damages was not to exceed 5% of the total price of the machinery. The supplier failed to supply the machinery within the stipulated time and the assessee received Rs. 8,SO,000from the supplier by way of liquidated damages . The Deparbnent sought to assess the amount as revenue receipt liable to income-tax; while the assessee claimed the same to be capital receipt.

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Nature of receipt: The determination of damages was not based upon the calculation made in respect of loss of profit on account of supply of a particular part of the plant. The damages to the assessee was directly and intimately linked with the procurement of a capital asset, i.e., the cement plant, which would obviously lead to delay in coming into existence of the profit-making apparatus, rather than a receipt in the course of profit earning process. Conclusion: Compensation paid for the delay in procurement of capital asset amounted to sterilization of the capital asset of the assessee as supplier had failed to supply the plant within time as stipulated in the agreement. The said amount received by the assessee towards compensation for sterilization of the profit earning source, not in the ordinary course of their business, was a capital receipt in the hands of the assessee. Therefore, the same was not includible in the total income.

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[Authors' Note: The question whether damages could be deducted in computing the 'actual cost' of plant was not raised before the court. Section 43(1) provides that the actual cost shall be reduced "by that portion ' of the cost thereof if any, as has been met directIy or indirectIy by any other person or authority". Explanation 10 thereto applies to "subsidy or grant or reimbursement (by whatever name called)", which are to be deducted in computing the cost of tile asset. In this case, payment of damages cannot be regarded as cost "met" by any other person. The damages have not been provided to "meet" the cost of asset; they are penalty for delay in supply. Hence, this cannot be deducted in computing cost of the machinery.]

Kailasli

Nath. Cancellation of Development Contract - Revenue receipt for the contractor: The assessee, a firm engaged in tile business of construction and development of immovable properties, entered into a contract for development and construction on land owned by Mis. DCM. While the work was in progress, ut« DCM cancelled tile contract and paid a compensation to the assessee therefor. The assessee used to follow 'Project Completion Method' in respect of such contracts for tax purposes. Held that, since the development and construction on land was "business of tile assessee", the receipt on cancellation of business agreement was a revenue receipt liable to tax. As the assessee used to follow project completion method, tile project got completed on its termination/ cancellation; hence, such receipt was taxable in the year of cancellation.

and Associates v. ITO [2.010J 1 ITR ~Trtb) 77 (Delhi) [SBJ

CIT v. Penni Subsidy to be utilized for repayment of loans taken on capital account - Capital Receipt:

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St~gar~ I L ~ The charaeter of the receipt of subsidy has to be determined with respect to the purpose for. which it is,.granted. If ~e. subsidy is received to r~pay.loans ~en !9t set-up of ner 392 (SC) " unit ~r expansion of an existing one, then, th~ same IS Ile1th~r received III the course of - trade; nor to enable the assessee to run the business more profitably. Therefore, the same is not a revenue receipt; it is a capital receipt. 1.14 REAL INCOME: Real income' refers to actual income arising out of tile transaction made by the assessee. Unless otherwise specifically provided by law, only real income is taxable. The real income theory states that where there is neither accrual nor receipt of income, income cannot be said to have resulted even if in bookkeeping, an entry is made about a 'hypothetical income', which doesn't materialise. However where income has, in fact, been accrued or received and is subsequentIy given up or waived, it remains the income of the recipient and is chargeable to tax.
.-'.' .

Exceptions to Real Income Theory: In respect of the following items though the income may not actually accrue or arise to the assessee but itis taxable - (a) Annual value of House property; (b) Value of perquisites received by an employee from the employer. Case law CIT v. Sarabhai Holdings [2009] 307 ITR 89 (SC) Facts P. Ltd. Foregoing after accrual - Taxable; while foregoing accrual, not taxable before

>

Vide agreement dated 31-3-2006, the assessee sold its undertaking as a going concern to E, its own subsidiary, for a total consideration of Rs. 11.5 crores. The agreement contained terms for payment of the consideration in instalments along with interest@ 11 % w.e.f. 1-4-2006.

12

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, Students' Guide to DIRECT TAXES

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On 15th March, 2007 E wrote to the assessee proposing modification in terms of payment and deferment of charge of interest. Vide resolution dated 31 st March, 2007, terms were revised and interest was to be ~ClJ~ed from 1 t. April, 2010; not earlier.
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The assessee didn't include the interest on sale consideration in its total income for the assessment years 2007-08 and 2008-09; as all interests had been waived. The Department included .the interest in the total income of the two assessment years and imposed interest/penalty for failure to pay advance tax.

Question Whether the interest was includible in the total income of two assessment years?

Decision The interest for the financial year 2006-07 (assessment year 2007~08) had already accrued to the . assessee. The charge of income-tax on such already accrued interest couldn't be wiped out later on by passing resolution on ~1s1March, 2007. The interest for the financial year 2007-08 was deferred by way of resolution dated 31'1 March; 2007. Such deferment came into force before accrual of the interest. The assessee had all rights to change the terms of the agreement and defer the interest, before the accrual. Therefore, no interest accrued to the assessee during the financial year 2007-08 (assessment year 2008-09) and, accordingly,no addition could be made to the income of the assessee on that account. No interest/penalty could be charged for the assessment year 2008-09, there being no income. chargeable to tax. However, the penalty imposed for assessment year 2007-08 could be waived in peculiar facts and circumstances of the case; there being genuine belief on the part of the assessee.

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~ [l1le dates/years stated herein are not 'actuals'; they are as revised by the Authors. Authors' Note: When the amount of accrued interest has been foregone, it appears that the same would be eligible as bad debts or otherwise in computing the total income of the assessee. The accrued interest shall never be realised in view of foregoing of the same and, on account of commercial expediency involved herein, the non-recovery / non-realisation ought to be allowed as deduction.} .15 "KEYMANINSURANCE POLICY" AND ITS TAXABILITY:
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Section 2(24) treats any sum received under Keyman insurance policy, including sum received as bonus iereon, as income for the purposes of Income Tax Act. Keyman insurance policy means a life insurance policy taken by a person on the life of another person rho is/was the employee of first mentioned person or is/was connected in any manner whatsoever with ie business of first mentioned person. axability : (1) In case the Keyman insurance policy is assigned to an employee, any sum (including bonus) received on its maturity is taxable as "profits in lieu of salary" under Section 17(3). "(2) In case of a person carrying on business or profession in whose hands the policy matures, the sum (including bonus) so received is chargeable under head "Profits and Gains of Business or Profession". (3) In case the policy is taken in name of any other person or assigned to any other person (other than employee), the sum received thereunder shall be taxable under head 'Income from other sources'.
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1.16 MAXIMUM MARGINAL RATE (MMR) [Section 2(29C)] :

1.13

It is tit! rate of income tax (including surcharge, if any) applicable in relation to the highest slab of income, specified in the Finance Act for the relevant year, in the case of the following persons: - (a) an individual or (b) an Association of person or body of individuals. E.g.: MMR for Assessment year 2011-12 is 30.9% (being Tax@30% + 3% EC and SHEC on income tax). 1.17 AVERAGE RATE OF TAX [SECTION 2(10)] : Amount of income tax calculated on the total income x 100 Average Rate of tax
=

Total Income The total income, referred to in this clause, is as defined by Section 2(45). Thus, it also includes income on which special rates of tax are applicable. E.g.: Long-term capital gains. Amount of Income Tax' is the income tax computed on total income taking into account the rebates and relief available under different provisions of the Act.
I

1.18 METHOD OF ACCOUNTING

& ITS ROLE IN COMPUTING INCOME [SECTION 145] :

Method of Income chargeable under the head Accounting is (i) Profits and Gains of Business and Profession; and relevant for (ii) Income from other sources. Method accounting be adopted of Either - (a) Cashsystem of accounting; or (b) Mercantile system of accounting, regularly to employed by the assessee.
--The accounts should be prepared in accordance with the following accounting standards notified by the Central Government in case the assessee is following Mercantile system of accounting (a) Accounting Standard I: Disclosure of accounting policies. (b) Accounting Standard II: Disclosure of prior period and extraordinary items and changes in accounting policies. .

Rejection books account [Sec. 145(3)]

of (1). Where the Assessing Officer is not satisfied about the correctI].ess or completeness of

of the accounts of the assessee; or

(2) Where the assessee has not regularly followed the proper method of accounting; or (3) Where assessee has not regularly followed the notified accounting standards; or then, Assessing Officer can make an assessment in the manner provided in section 144.

Change method accounting

in (a) It is open to the assessee to change his method of accounting but the change should of be bona fide and not a casual departure from the regular method which has been
accepted by him for a number of years. (b) It is also open to the assessee to follow one system of accounting in respect of oner source and another system in respect of another source.

Effect of method of accounting adopted: The method of accounting adopted determines the amount of income chargeable to tax. If cash basis of accounting is adopted, then, all incomes not received in cash will not be chargeable to tax and all unpaid expenses will not be allowed as deduction. However, if accr-ual

1.14

Students' Guide to DIRECT TAXES

basis of accounting is adopted, then, the outstanding incomes and expenses will be taken into account while determining the amount of income chargeable to tax. Taxabilitsj of incomes under other heads: The method of accounting is not relevant for incomes chargeable under other heads of income, as the Act provides for specific mode of their chargeability. The incomes under other heads are chargeable to tax as follows Head of income Salaries Income from House Property Capital Gains Case Laws CIT v. Standard Radiators P. Ltd. [2006] In c~se of change of method of accounting from cash system to mercantile system, not only the provision of expenditure for current year in accordance with the mercantile system will be allowed, but also the expenditure relatable to earlier years, which couldn't be allowed being not paid in cash, will be allowed in current year on cash basis.
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Chargeable on due or receipt basis, whichever is earlier Chargeable on accrual basis Chargeable in the year in which the capital asset is transferred

286 ITR 207 ror ex.: In case 0f . (Guj.] assessee ch'an~~ fr om cas I system t~ mercan tile svstem i fin an~a I 1 e system m J year 2010-11,he will be allowed provision for expenses during the year 2010-11 along WIth the expenses pertaining to 2009-10 or earlier years, which couldn't be allowed in those years but is paid during the financial year 2010-11.
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K K. Khullar v. DCIT [2008] 304 ITR (AT) 295 {Delhi)

Even if assessee-advocate follows cash system of accounting, advance money received by lum' for services to be rendered in future cannot be brought to tax. Since the same is refundable in case service is not act'ltally rendered, the same is not incoine. Since section 4 creates charge of income-tax only on income, therefore, what is taxable under the Act is only the income to the extent of service rendered recognised on cash-basis. [Note: The same view should be applicable in respect of expenses as well.]

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1.19 CHART SHOWING MODE OF COMPUTATION OF TOTAL INCOME AND TAX :

I Name
Istatus:

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of ass~ssee:
0

Assessment Year:

Previous Year:

11.
j2.
13.

Income from Salaries [Section 15 - 17] Incomes from House Property [Section 22 - 27] Profits and gains of business or Profession [Section 28 - 44DBJ

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14. Capital Gains [Section 45 - 55A]

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15. Income from Other Sources [Section 56 - 59J

Total [(1) + (2) + (3) -+- (4) + (5)] Add: Income of other persons included in assessee's total income (i.e. Deemed incomes to be aggregated with appropriate heads of income) [Section 60- 69DJ. Less: Adjustment on account of set off or carry forward of losses [Section 70 - 80J

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xxx x xxxx xxxx xxxx

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. Basic Concepts
Gross Total Income Less: Deductions under Sections 80C to 80U Total Income [rounded off to Rs. 10] Computation Taxon net income Add: Surcharge .(in case of company-assessees only) Tax and Surcharge Add: Education Cess
@

1.15
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of Tax Liability:
XXXX

xxxx xxxx

2% and secondary and higher education cess

@ 1%

xxxx xxx x xxxx xxxx xxxx xxxx

xxxx

Tax and Surcharge and education cess Less: Relief under sections 86, 89, 90 and 91 Tax Less: Pre-paid Taxes Tax paid on self assessment Tax deducted or collected at source Tax paid in advance Tax liability (Rounded off to nearest Rs. 10) Add: Interests under sections 234A 234B and 234C Total amount payable (Rounded off to nearest Rs.l0) I; 1.20 GENERAL AND SPEGAL RATES OF TAX

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xxxx

xxxx
xxxx

xxxx

As per section 4 of the Income-tax Act, income-tax is to be charged at the rates prescribed by the annual . I Finance Act. The rates prescribed by the annual Finance Act can be termed as "general' rates" of taxation. However, the Income-tax Act itself contains certain "special rates" of income-tax to be charged on certain specified category of incomes. For example, lottery winnings are chargeable to tax at a flat rate of30%.
. ::.;

Accordingly, wherever any special rate of tax has been specified in the Act in respect of any income, the concerned income will be taxed at such special rate. Further, unless specified otherwise, the basic exemption limit is not available from incomes chargeable to tax at special rates. The other incomes will be charged to tax at the general rates of income-tax. Surcharge, if any, and education cesses, being in addition to income-tax, are leviable on the amount of income-tax calculated as per the general and special rates of income-tax. . ,1.21 MANUFACTURE [Section 2(29BA)] : "Manufacture", with its grammatical variations, means a change in a non-living physical object or article orthing,(1) resulting in transformation of the object or article or thing into a new and distinct object or article or thing having a different name, character and use; or (2) bringing into existence of a new and distinct object or article or thing with a different chemical composition or integral structure.

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1.16

Students' Guide to DIRECT TAXES

1.22 GENERAL RATES OF INCOME TAX FOR INDIVIDUAL FOR ASSESSMENT YEAR 2011-12 (I) In case of every individual, (II)In case of resident women (11,1) In case of resident individual, artificial below the age of 65 years at who is of 65 years or more at any HUF, AOP/BOI, juridical person any time during previous year time during the previous year Income Upto Rs, 1,60,000** Next Rs. 3,40,000 Next Rs. 3,00,000 Balance Rate Nil 10% 20% 30% Income Upto Rs. 1,90,000** Next Rs. 3,10,000 Next Rs. 3,00,000 Balance Rate Income Upto Rs. 2,40,000** Next Rs. 2,60,000 Next Rs. 3,00,000 Balance Rate Nil 10% 20% 30..00%

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10% 20% 30%

~'*Maximum amount not chargeable to tax, 01~ Basic Exemption limit - Meaning of: The aforesaid amount of Rs. 1,60,000 or Rs. 1,90,000 or Rs. 2,40,000 is called "maximum amount not chargeable to tax" or
"basic exemption limit" applicable to the assessee. 1.23 TAX RATES IN CASE OF ASSESSEES OTHER THAN INDIVIDUALS (1) In the case of every co-operative society Upto -Rs.10,000' Next Rs. 10,000 Balance (2) In case of every local authority - 30% (3) In case of other assessees 10% 20% 30%
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30% NIL

Domestic . company

Foreign company

30% 7.5%

40% 2.5%

**Marginal Relief: In this case, marginal relief will be provided, which wil1.be = Tax on total income (plus surcharge) - [Tax on total income of Rs. 1 crore + (Total Income - Rs. 1 crore)], if positive.

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Note: Thus, no surcharge on income-tax shall be levied for the Assessment Year 2011-12, except in the
case of an assessee being a company (domestic company or a foreign company). Hence, there is no question of any marginal relief of surcharge except in the case of company assessees.

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Basic Concepts
1.24 CESSES . I1~ case of every assessee, the amount of tax shall be increased by cesses as follows 1. Education Cess (BC) 2. Secondary and Higher Education Cess (SHEC) Thus, TOTAL CESSES (EC + SHEq 2% of income-tax 1% of income-tax 3% of Income-tax=
@

1.17

**Nate: In the case of company assessees, the EC and SHEC Surcharge - Marginal Relief, if any).
1.25 ROUNDING OFF OF INCOME AND TAX:

3% shall be imposed on (Income-tax +

(1) Total income will be rounded off to nearest multiple of Rs. 10. - Section 288A
(2)

Tax (including tax deductible at source or advance tax), interest, penalty, fine or any other sum payable, and the refund due under the Act shall be rounded off to the nearest multiple of Rs. 10. Section 288B.

Illustration 2 -Tax liability of a company: A company has earned an income of Rs. 1,00,35,000. Compute
the income-tax payable by it if: (a) it is domestic company; (b) it is foreign company. / Ans: Computation of tax liability is given below Particulars Total Income:
0

..

(a) Domestic Company 1,01,70,000 30,51,000 2,28,825 32,79,825 1,09,825 31,70,000 95,100 32,65,100

(b) F«!~ign Company; 1,01,70,000 40,68,000 1,01,700 41,69,700 0 41,69,700 1,25,091 42,94,790

Tax on total income @30%, 01",40%

Add: Surcharge

7.5%, or, 2.5%

Tax inclusive of Surcharge Less: Marginal Relief (See Note) . Net tax including surcharge Add :ECandSHEC@3%
..

Total Taxpayable (rounded off to nearest Rs. 10)

.-.--.

Note : Marginal Relief has been computed as follows:

(A) Tax inclusive of surcharge (as computed above) (B)Tax on total income of Rs. 100 Iakh (C) Total income in excess ofRs. 100 lakhs
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32,79,825 30,00,000 1,70,000 1,09,825

41,69,700 40,00,000 1,70,000 -300 i.e. NIL

Marginal Relief (A - B - C)

LIB

I.

Students' Guide to DIRECT TAXES

Rlustration3 -Computaiion of Tax Liability: Compute the tax liabiliiy ill the following cases Assessee -/
t

Stains Resident Individual Non-resident Individual of 67 years Resident Individual of 70 years Resident Individual of 23 years Non-resident individual of 58 years

Total income [in. Rs.) 10,29,000 10,49,550 10,28,200 10,25,600

(a) Mr.Ram
(b) Mrs. Rohlni (e) Mr. Shyam (d) Mrs. Preen (e) Mrs. Srivastava

u,oo,ooo
Total Tax 1,67,581 1..73,931 1,59,125 1,63,440 2,20,420 Total Tax (rounded off) 1,67,580 1,73,930 1,59,130 1,63~440 2,20,420

Solution: TIle computation of tax liability is given below Assessee (a) . Mr. Ram (b) Mrs. Roillni (e) Mr. Shyam Cd) .Mrs.Preeti
(e) Mrs. Srivastava Total income [in Rs.] 10,29.. 00 0 10,49..550 10,28,,300 10,25,600 12,00,000 Income-tax 1.62,700 1,68,865 1~490 1,58,680 414,000 EC&SHEC@ 3% 4,881 5,066 4,635 4,760 6A20

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2
RESIDENTIAL STATUS
2.1 DETERMINATION OF RESIDENTIAL SfATUS OF INDIVIDUAL: The three different kinds of residential status applicable to various assessees are - (1) Resident (R); (2) Not Ordinarily Resident (NOR); (3) Non-Resident (NR). The residential status of individual will be determined as under )
I

Assessee Resident

Basic Condition

Additional Conditions

'1)
jl

He must satisfy at least one of the Not required. basic conditions {as given below}.

Ordinarily He must satisfy at least one of the He must satisfy either one or both of the Not Resident basic conditions (as given below). additional conditions gwen in section 6(6). Non-Resident
}i> Basic Conditions

Should not satisfy any of the basic Not required. conditions. as given under section 6(1) :

(a) He must be in India for a period of 182 days or more during the previous year;

or

(b) He must be in India for a period of sixty days or more during tile previous year and 365 days or - more during the four years Pr.~c~ding previous year.* the

_**Under the fallowiHg circumstances, the period of 50 days, gwen ill (b) above, is exteJlded to 182days
1. 3.

Indian citizen who leaves India during previous year for the purpose of employment outside India; An Indian citizen or a person of Indian origin (who is abroad) who comes to India on a visit during the previous year.

2. Indian citizen who leaves India during the previous year ctsa member of the crew of an Indian Ship;

Note: A person is deemed to be of Indian origin; if he, or either of his parents or any of his grand parents was born in undivided India.
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Additional conditions as given under section 6(6) ~

1. He must be a non-resident in India in 9 out of the 10 previous years preceding that year; or 2. He must be in India during 7 preceding previous years for an aggregate period of 729 days or less.
~--

Important points to be kept in mind in determining the residential status (1) In computing the period of stay in India, it is not necessary that the stay should be for a continuous .period. What is to be seen is the total number of days' stay in India during the relevant previous year. (2) It is not necessary that the sta y should be at one place; total stay in ~?ia is considered. (3) vVhere a person is in India only for a part of a day, the calculation of physical presence in India in respect of such broken period should be made on an hourly basis. A total of 24 hours of stay spread over a number of days is to be counted as being equivalent to the stay of one day. (4) If no data is available to calculate period of stay in terms of hours, then the day on which he enters India as well as the day on which he leaves India shall be taken into account as his stay in India. (5) India: As per section 2(25A) "India" includes its territorial waters, seabed and subsoil underlying such waters, continental shelf, exclusive economic zone or any other maritime zone and the air space above its territory and territorial waters. Thus, if any person is present in any of the aforesaid places, then, he will be regarded as present in "India".

. 2.2

Students' Guide to DIRECT TAXES

Altematipe approach- A critique:

Some expertspresent the aforesaid two additional conditions in a positive manner and create two different classes viz. Resident and Ordinarily Resident and Resident, but not ordinarily resident. According to them, an individual is regarded as 'Resident and Ordinarily Resident' in India if he satisfies at least one basic condition and also fulfils both of the following additional conditions 1. He must be a resident in India in at least 2 out of the 10 previous years preceding that year; and 2. He must be in India during 7 preceding previous years for an aggregate period

0!..30 days or more. 7

Further, an individual is regarded as 'Resident, but not Ordinarily Resident' in India if he satisfies at least one basic condition and alsofulfils either one or none (not both) of the additional conditions. 'While the solution doesn't generally change when this approach is followed, but, this approach is faulty and misconceived on account of the following reasons (A) Income-tax Act doesn't contemplate any status like 'Resident and Ordinarily Resident'. The status is that of 'Not Ordinarily Resident', which is granted on fulfillment of additional conditions. (B) The status of not ordinarily resident is granted so as to ensure that foreign incomes of occasionally resident do not form part of Indian income. The burden cast is on the assessee to prove that he is eligible for the benefit of status of 'not ordinarily resident', Therefore, requiring' fulfillment of additional conditions for the grant of imaginary status of 'Resident and Ordinarily Resident' is totally misconceived. All residents are so-called 'Resident" and Ordinarily Resident' by default and thus, fulfillment of conditions is required only for the grant of status of 'Not ordinarily resident' . (C) In the alternative approach, the first additional condition uses the word 'resident'. However, resident may be further classified into 'Resident and Ordinarily Resident' .and 'Not ordinarily resident'. Which of these is to be-used ? If it is said that' resident' is another status, now we have fourth status-with us! Thus, for the reasons aforementioned, the so-called alternative approach is totally misconceived.
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Illustration l-Residential status of Individual : Determine the residentiai status in the following cases(a) Shri Kamal came to India for first time on 15u1 December 2010 for a period of just 200 days in India. (b) Mr. Y was sponsored by his employer in India for training in USA. He left India on 03.06.2010. He came backto India on 05.04.2011. He did not go out of India previously. (c) Mr. Samuel, a foreign citizen (not being a person of India origin) comes to India for first time in last 12 years on March 01, 2010. On 5th September 2010 he leaves India for Singapore on a business trip. He comes back on March 2, 2011.

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Solution: The residential status is determined as follows (a) SinceShri Kamal is in India for a period of 107 days (17 days of Dec. + 31 days of Jan. + 28 days of Feb. + 31 days of March) during the previous year ending 3151 March 2011, hence, he is a non-resident. (b) Since Mr. Y is inIndia for a period of 64 days (30 + 31 + 3) during the previous year and was in India for all the preceding 4 years (Le..365 days or more), therefore, he satisfies second basic condition-and is, therefore, resident in India. (c) Since Mr. Samuel is in India for a period of 188 days (30 + 31 + 30 + 31 + 31 + 5 + 30) during the previous year ending 3rl March 2011, he is a resident. He satisfies additional conditions as follows - . (i) He was non resident in India in all of the last 10 preceding years; (ii) He resided in India only for 31 days (March, 2010) during the 7 preceding previous years. Hence, he is a not ordinarily Resident in India.
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Illustration 2 -Residential Status of Individual: The applicant, an Indian comparty, deputes its employee
'M' to UK for two years from 1-7-2010. Decide whether 'M' is resident for the previous year 2010-11. The

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Residential Status

2.3

income-tax authorities contend that since M was not previously unemployed, hence, the provisions relating to extension of 60 days stay 10.182days is not applicable and, therefore, M is resident is India. Solution: In case of an Indian citizen who leaves India for employment outside India, minimum period of residence for being treated as resident in India is extended to 182 days. The expression' employment outside India' would indicate that leaving India should be for the purpose of 'employment outside India' and not inerely 'employment'. Therefore, there is no necessity that the Individual who leaves India should be an unemployed person. - British Gas India P. Ltd., In re [2006] 155 TaX111an 26 (AAR). 3 Since during the financial year 2010-11'M' stayed in India for less than 182 days, therefore, 'M'was nonresident during the financial year 2010-11.
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2.2 DETERMINATION

OF RESIDENTIAL STATUS OF OTHER PERSONS:

(A) Residential Status of HUF :

(a) Resident HUF [Section 6(2)] : If the control and management of the affairs of HUF is situated wholly or partly in India then HUF is said to be Resident in India. (b) Non-Resident HUF : If the control and management of the affairs of HUF is situated wholly outside India, then HUF is said to be Non-Resident in India. (c) Not-ordinarily Resident HUF [Section 6(6)] : A resident HUF is said to be 'not ordinarily resident' in India if Karta or manager thereof satisfies any one or both the following additional conditions : ~ He has been non-resident in India in nine out of the ten years immediately preceding the relevant previous year; or He has been present in India for 729 days or less during the seven years immediately preceding the previous~year.·
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Place of situation Qf control and management: Control and management is situated -afa place where the head, theseat and the directing power are situated. (B) Residential status of compamj [Sec. 6(3)1: An Indian company is always resident in India. A &oreign company will be resident in India if control and management of its affairs is wholly situated in India.

(C) Residential status of a finn or an Association of persons or other person [Section 6(4)]:
(1) Resident Firm or Association of persons OJ; other person - If the control and management of the affairs of Firm or Association of persons. or other person is situated wholly or partly in India, then the Firm or AOP or such other person is said to be resident in India.
1.:.-.

(2) Non-Resident Firm or AOPor other person: If the control and management of the affairs of Firm or AOP or other person is situated outside India then Firm or Association of persons or such other person is said to be Non-resident in India. [A Firm/ AOP or other person cannot be 'not ordinarily' resident. The residential status of the partners/ members of the firm/ association is not relevant in determining the status of the firm/ association.] 2.3 IMPACT OF RESIDENTIAL STATUS ON TAX INCIDENCE [Section 5J : The following chart indicates the tax incidence in case of different residential status Particulars (1) Income received in India by him or on his behalf (whether accrued in India or outside India).
I

Tax Incidence R Yes Yes NOR Yes Yes NR Yes Yes

(2) Income deemed to be received in India by him or on his behalf (whether accrued in India or outside India).

2.4

Students' Guide to DIRECT TAXES

Yes Yes Yes
..

(3) Income accruing or arising in India (whether received in India or

outside India).

(4) Income deemed to accrue or arise in India (whether received in

India or outside India).

Yes

Yes

Yes

(5) Income which accrues or arises outside India (other than that covered in cases (1) to (4) above)

Yes

No*""

No

**Exception: In case of a person not ordinarily resident in India, the income, which accrues or arises outside India, shall form part of the total income in India only if it is derived from a business controlled in or profession set-up in India. Thus, out of the income, which accrues or arises outside India, only the income derived from a business controlled in or profession set-up in India will be taxable in India. Note: Foreign income not taxable even if included in Indian accounts: Income accruing or arising outside India shall not be deemed to be received in India by reason only of the fact that it is taken into account in a Balance Sheet prepared in India. become taxed on accrual basis not taxable again on receipt basis: Income included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received in India. E.g.: In case salary is taxed on due basis, then, the same shall not be charged to tax again when it is actually received. Resident in respect of one source - Resident in respect of all other sources [Section 6(5)] : If a person is . resident in India in a previous year relevant to an assessment year in respect of any source oCincome, he shall be deemed to be resident in India in the previous year relevant to the assessment year in respect of each of his other sources of income. 2.4 RECEIPT v. REMITIANCE OF INCOME :

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Receipt of income refers to the first occasion when recipient gets money under his control. Subsequent transmission of income to another place is remittance of income. WIUle the receipt of income is liable tax, subsequent remittance thereof will not be taxed again. In case the person bringing money from outside India acts as agent of payer, income will be said to be received in India. However, if such person acts as agent of payee income will be said to be received outside India and subsequently remitted to India. .

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2.5 INCOME DEEMED TO BE RECEIVED IN INDIA [Section 7] : The following shall be deemed to be received in the previous year: (1) Employer's annual contribution to the recognised provident fund in excess of 12% of salary and interest credited to the recognised providerit fund account in excess of 8.5% p.«. (amended to.ef. 1-92010; earlier the rate was 9.5% p.a.) (2) In case of transferred balance from Unrecognised Provident Fund. to newly recognised. Provident Fund, the amount to the extent of employer's contribution and interest thereon. (3) The contribution made by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme referred to in Section. 8OCCD. (4) Cash Credit, Unexplained- invesbnent, Unex-plained Money, Unexplained Expenditure, Affiount borrowed or repaid on Hundi. (5) Tax deducted at source in the hands of payee. (6) Deemed profits chargeable to tax under the Act Investment partly disclosed,

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2.6 "INCOME ACCRUING AND ARISING" V. "INCOME DUE"

2.5

Accrue refers to the right to receive income, whereas due refers to the right to enforce payment of the same. For example, salary for work done in December will accrue throughout the month, day to day, but will become due on the salary bill being passed on 31st December or 1st January. Similarly, on Government securities, interest payable on specified due dates accrues/arises period of holding, day to day, but will become due for payment on the specified due dates. 2.7 INCOME DEEMED TO ACCRUE OR ARISE IN INDIA [SECTION 9] : According to.Section Sec. Income • • • any business connection in India or property or asset or source of income in India, or through transfer of capital asset situated in India, during the

9 the following incomes are deemed to accrue or arise in India -

9(1) (i) Income through or from -

9(1)
(li)

Income that falls under the head "Salaries", if it is earned in India. Salary shall be treated as earned in India if (1) it is payable for service rendered in India; or (2) it is paid for the rest period or leave period which is preceded and succeeded by services rendered in India and forms part of the service contract of employment Income chargeable under the head "Salaries" payable by the Government to_a citizen of India for service rendered outside Iridia':ilowever, allowances and perquisites in this case are exempt-il/s 10(7). A dividend paid by an Indian company outside India. Income by way of interest payable by (1) Government; (2) A resident, except where it is payable in respect of any debt incurred, or moneys borrowed and used(a] For the purpose of business or profession carried on by such person outside India; or (b) For the purposes-of making or earning any income from any source outside India; (3) A non-resident, where it is payable in respect of any debt incurred, or moneys borrowed and used for the purposes of a business or profession carried on by such person in India. Income by way of royalty payable by (I) Government; (2) A resident, except where it is payable in respect of any right, property or information used or services utilised (a) for the purpose of business or profession carried on by such person outside India; or (b) for the purposes of making or earning any income from any source outside India ; (3) A non-resident, where it is payable in respect of any right, property or information used or services utilised for the purposes of a business or profession carried on by such person in India or for the purposes of making orearningany income from any source in India. .

_ 9(1)
(ill)

! 9(1)
(iv)

9(1) (v)'"

9(1) (vi)"

9(1) (Vll ii]"

Income by way of fees for technical services payable by (1) Goverrunent;

2.6

Students' Guide to DIRECT TAXES

(2) A resident, except where it is payable in respect of services utilised (a) in a business or profession carried on by such person outside India; or (b) for the purposes of making or earning any income from any source outside India; (3) A non-resident, where it is payable in respect of any services utilised in a business or .profession carried on by such person in India or for the purposes of making or earning any income from any source in India. :

"Interest, Royalty and Fees for technical services taxable even if tLO territorial connection of non-resident 'with India or even if services not actualbjrendered in India [Explanation] : For the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under section 9(1)(v)/(vi)/(vii) and shall be included in the total income of the non-resident, whether or not,(i) the non-resident has a residence
01'

place of business

01' business

connection

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India; or w.r.ef.1-6-19761

(ii) the non-resident has rendered services in India, [Substituted

by FinanceAct,2010

ANALYSIS: Thus, eoen if the services haoe Hot actually been prouided in India and the non-resident doesn't have territorial connection with India, the aforesaid income deemed to accrue 01' arise ill India shall continue to be taxable. For example, interest payable by the Government of India or the Government of the States of India shall be deemed to accrue or arise in India even ifthe non-resident recipient has no connection (residence/place of business/business connection) with India. Similarly fees for technical services payable by the Government shall be deemed to accrue or arise India even if such services are rendered abroad and the non-recipient has not territorial connection with India.
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2.8 Royalty [Explanation to Section 9(1)(vi)J : The term 'royalty'means consideration including any lump sum consideration for (1) Transfer of all or any rights (including granting of a licence) in respect of any patent, invention, model, design, secret formula or process, trademark or similar property; (2) ,Use or right to use any industrial, commercial or scientific equipment

but not including the amount

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referred to in section 44BB;

(3) Imparting of any information concerning the working of or the use of a patent, invention, model, design, secret formula or process, trade mark or similar property; concerning teclmical, industrial, commercial or scientific knowledge,

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(4) Imparting of any information experience or skill. (5)

Use of any patent, invention, model, design, secret formula or process, trademark or similar property.

(6) Rendering of any service in connection with activities referred in (1) to (5) above.
(7) Transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or videotapes for use in connection with radio broadcasting but not including consideration for the sale; distribution or exhibition of cinematographic films. Exclusions: The following shall not be treated as royalty (a) Any consideration, which would be chargeable as income of recipient under head 'Capital Gains'; (b) Any consideration for the sale, distribution or exhibition of cinematographic films. 2.9 FEES FOR TECHNICAL SERVICE~ [EXPLANATION TO SECTION 9(1)(VII)J : 'Fees for technical services' means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel).

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Residential Status

2.7

Exclusions : Consideration .for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries", shall not be treated as 'fees for technical services'. Illustration B - Interest whether deemed to accrue or arise in India: Mr.A, a citizen of India, left for USA for the purpos,es of employment on 1.5.2009.He has not visited India thereafter, Mr. A borrows money from his friend Mr. B, who left India one week before Mr. Ns departure, to the extent of Rs.10 lakhs and buys shares in X Ltd., an Indian company. Discuss the taxability of the interest charged @10%in B's hands where the same has been received in New York. Solution: In this case, Mr. A and Mr. B are non-resident in India during the previous year 2010-11; and the purpose of borrowal by Mr. A is not 'carrying on of any business of profession in India'. He has borrowed for the purpose of investment in India. Hence, the provisions relating to deemed accrual under section 9(1)(v) are not applicable in this case. Accordingly the interest does not accrue or arise in India and is, therefore, not taxable in India. 2.10 CONCEPT OF 'BUSINESS CONNECTION' [EXPLANATIONS TO SECTION 9(1)(1)]: According to Section 9(1)(i), income arising out of a 'business connection' in India shall be deemed to accrue or arise in India. The concept of business connection is envisaged in the following points (1) Business Connection: Business connection involves relation between a business carried on by a nonresident, which yields profits and some activity in India, which contributes directly or indirectly to the earning of those profits. It predicates an element of continuity between business of the non-residentand the activity in India. It includes professional connection e.g. when foreign lawyer is called upon in India to plead the case in Indian courts - Barendra Prasad Roy v. ITO [1981J 129 ITR 295 ($9 , (2) Business Connection - Definition of [Expl. 2]: Business activity carried through following agents of non-resident is covered (a) Concluding agent who concludes contracts on behalf of the non-resident. only purchase goods/merchandise for the non-resident are not covered, or

Houeoer, agents who

(b) Stocking agent who maintains stock of goods in India from which he regularly delivers goods on behalf of the non-resident.

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(c) Indenting agent who secures orders in India mainly/wholly for non-resident or, that non-resident and other non-residents who exercise control over one-another or are under common control. Exceptions: (i) Business activity carried out through an agent having an independent status and acting in ordinary course of business, is not regarded as business connection. However, an agent working mainly / wholly for non-resident or, that non-resident and other non-residents who exercise control over one-another or are under common control is not regarded as having an independent status. (ii) In cases falling under (a) or (b) or (c) above, only the income attributable to the operations carried out in India shall be deemed to accrue or arise in India. [Explanation 3] (3) Income not to be treated as arising from or through Business Connection [Explanation 1] : (a) _In case all the operations of a business are not carried out in India, only the income reasonably attributable to the operations carried out in India will be deemed to accrue or arise in India. (b) In case of a non-resident, income in respect of operations confined to purchase of goods in India for the purpose of export shall not be deemed to accrue or arise in India. (c) In case of a non-resident, engaged in business of running a news agency/publishing newspapers, magazines, journals, income arising through and' from activities confined to collection of news and views in India for transmission out ofIndia shall not be deemed to accrue or arise in India.

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2.8
\,'.

Students' Guide to DIRECT TAXES

(d) In case of a non-resident being(A) an individual who is not a citizen of India; (B) a firm not having a partner who is either a citizen of India or resident in India; and

(C) a company not having any shareholder who is either ci~l12f

India or resident in India, film in

income arising through or from operations confined to shooting of any cinematograph India shall not be deemed to accrue or arise in India.

(4) Apportionment

of profit where operations not fully carried on in India: In case all the operations of a business are not carried out in India, only the income reasonably attributable to the operations carried out in India will be deemed to accrue or arise in India. If the income from Indian operations cannot be definitely ascertained, then, the same may be computed by apportionment (a) at such percentage of Indian turnover as determined by the Assessing Officer; (b) Taxable profits

= Total profits

Receipts accruing/ arising in India

Total receipts of Business; or

(c) in any other manner as considered suitable by Assessing officer. Case law Kanchanganga . Sea Part of fish caught handed over to non-resident against charter fee due Foods Ltd. v. CIT Apportionment of fish done after valuation in India at the Indian port - Amounts [2010] 325 ITR 540 (SC) to 'receipt in India' by non-resident - Taxable in India & IDS u/e 195 required Facts

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The assessee-company was engaged, in sale and export of sea food (fish, etc.) and obtained fishing rights in the Exclusive Economic Zohe of India. To exploit fishing rights, it entered into an..agreement with M/ s. ESC_~,Hong Kong, a non-resident company, chartering two fishing vessels. M/ s. ESCL was to catch the fish and pay US$ 75,000 per month or 15% of.the gross value of the fishes catched, whichever is more, to the assessee. Thus, 85% of the gross value of the fishes was retained by (or paid to) M/ s. ESCL towards hire charges of the vessels. The catch was brought to the Indian port, where Fishery Department used to assess their value and collect local taxes leviable thereon, Thereafter, the fish was exported out of India,

} . The assessee didn't deduct any tax on payments made to/retained by M/s. ESCL. It was argued that: M/s. ESCL didn't carry out any operations in India; even if such operations were carried out in India, they were merely for purchase of goods; the payment to M/ s. ESCL was also made outside India; therefore, no part of the income of M/s. ESCL could be said to accrue or arise in India. Hence, there was no obligation to deduct tax at source u/ s 195 of the Act. } The Department contended that the amount paid to/retained by M/s. ESCL was 'charter fee' of the vessels and was liable to tax in India, as accrued in India u/ s 5(2). Hence, IDS was to be made.

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Question } Whether the assessee was liable to make TDS is] s 195 of the Act?

Relevant Statutory Provisions } Section 5(2), Section 195 and Sectio~ 201 of the Income-tax Act, 1961

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, Decision } Scope of total income: As per section 5(2), total income of M/ s. ESCL shall include all income from whatever source derived received or deemed to be received in India. It also includes such income which either accrues, arises or deemed to accrue or arise to M/ s. ESCLTn India.

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Residential Status

»
~.

..

2.9

Income received in India: In this case, first of all, the chartered vessels with the entire catch were brought to the Indian Port, the catch were certified for human consumption, valued, and after customs and port clearance, Mis. ESCL received 85% of the catch. So long the catch was not apportioned the entire catch was the property of the assessee and not of MI s. ESCL as Mis. ESCL did not have any control over the catch. It is after Mis. ESCL was given share of its 85% of the catch it did come within its control. To constitute receipt of income the recipient must have control over it Thus, Mis. ESCL effectively received the charter fee in India. Therefore, the receipt of 85% of the catch was in India and this being the first receipt in the eye of law and being in India would be chargeable to tax. Sale outside India: The fact of the sale of fish and realization of the sale consideration of fish by MI s. ESCL outside India shall not mean that there was no receipt in India. Since 85% of the catch was received after valuation by MI s. ESCL in India, in sum and substance, it amounted to receipt of value of money in India. Hence, the said receipt was liable to income-tax in India. The assessee was liable to deduct tax u] s 195 on the value of catch paid to MI s. ESCL and since it had not made TDS, it was assessee-in-default u] s 201 of the Act.

» .Conclusion:

[Authors' Note: This judgment shows that payments in kind are 'income' of the recipient and liable ·to liable to TDS. The TDS may be made by the assessee by less payment-in-kind of 'fish catch' and paying such TDS in cash with the Government The 'valuation' of fish-catch may also pose problem, for which, in this case, the valuation for the purposes of imposition of 'local taxes' in India may be taken.]

CIT v. EstelCommunications P. Ltd. [20t)9J 318 ITR Payment to non-residents for provisiQtL.of internet 185 (Del.) - SLP dismissed by Supreme Court in bandwidth - Not fees for technical services, not [2009J 310 ITR (SL) 2 taxable in India Facts )))The assessee was providing internet access of a certain bandwidth assessee collected a charge from such subscribers. to its subscribers for which the

The main server, on the basis of which the internet services were provided, was located in the USA, and the assessee used to pay certain sum to the US party 'Teleglobe'. . The Assessing Officer contended liable to TDS ul s 195 of the Act. that the amount paid to Teleglobe was taxable in India and was .

Question )Whether the Department was right in demanding TDS from the assessee?

Decision )There was no privity of contract between the customers of the assessee and the Teleglobe. The assessee was merely paying for an internet bandwidth to Teleglobe and then selling it to subscribers in India. The use of internet facility might have required sophisticated equipment but 'that didn't mean that technical services were rendered by Teleglobe to the assessee. It was a simple case of purchase of internetbandwidth by the assessee from Teleglobe. There were no technical services provided by the Teleglobe to till' assessee and, thus, provisions of' section 9(1)(vii) providing for deemed accrual of fees for technical services were not applicable Therefore, no part of the income of Teleglobe could be said to have accrued or arisen in India and there was no liability on the part of the assessee to deduct TDS from amount paid to Teleglobe.

).)-

2.10

Students' Guide to DIRECT TAXES

CIT. v. Toshuko Ltd. [1980J 125 ITR Commission paid outside India to non-resident agent located 525 (SC) outside India on sales made outside India not taxable in India Pacts

The Indian exporter appointed a non-resident sales agent outside India who was entitled to 3% commission on invoice amount of sales made outside India. . The full sale price was, at first, remitted to India and the commission due to the agent was credited to the ledger account of the agent by the Indian exporter. Later, the account of agent was settled by remitting the amount outside India.

» »
>

Question Wheth~r the commission earned by the non-resident sales agent could be taxed in India?

Decision It could not be said that the making of the entries in the books of Indian exporter amounted to receipt, actual or constructive, by the non-resident sales agents as the amounts so credited in their favour were not at their disposal or control: they could not, therefore, be charged to tax on the basis of receipt of income, actual or constructive, in India. The non-resident agent did not carry on any business operation in India; it acted as selling agent outside India. The receipt in India of the sale proceeds of exported goods remitted by the purchasers from abroad did not amount to an operation carried' out by the non-resident agent in India; the same could not be regarded as 'business connection' u] s 9(1)(i) of the Act. Further, the conunission amounts which were earned by the non-residentagent for services rendered outside India could not be.deemed to be income which had either accrued or arisen in India. Hence, the said commission was not taxable in India. Accordingly, there is source from such income u] s 195.
0

>

110

liability to deduct tax at

Illustration 4 -Tax Incidence and Scope of Total Income : Compute the gross total income of Mr. B, an Indian citizen, who is in receipt of the following during the previous year if he is - (a) Resident; (b) Not ordinarily resident, or (c) Non-resident (all sums in Rs.) (a) Income from property situated in India received in UK (b) Interest from saving bank deposit in SBI (c) Income from business in UK controlled from India (d) Income from business in India controlled from UK (e) Income from business in USA controlled from USA (f) Income from property in UK received in India (g) Income from property in Indonesia received there but Rs. 10,000remitted to India (h) Past untaxed profits from business in Germany remitted to India (i) Income from agriculture in Pakistan (half of which received in India) Solution: Computation of gross total income of Mr. B in the above three cases '.

75,000 55,000 40,000 60,000 2,00,000 20,000 30,000 2,00,000 25,000

••••
!,::.:'.~.

Resident 75,000

NOR 75,000

NR 75,000

(a) Income from property situated in India received in UK

~~0~l~ii:t~~~~~'i1il~l~t(ilirll'1'{§I!l~il~~ill'i~§II_! ,

Residential Status
(b) Interest from saving bank deposit inSBI (c) Income from business in UK controlled from India (d) Income from business in India controlled from UK : (e) Income from business in USA controlled from USA
I

2.11
55,000 40,000 60,000 2,00,000 20,000 30,000 0 25,000 5,05,000 0 12,500 2,62,500 0 12,500 2,22,500 55,000 40,000 60,000 0 20,000 0 55,000 0 60,000
,

0 20,000 0

i (f) Income from property in UK received in India

(g) Income from property in Indonesia remitted to India received there but Rs. 10,000

(h) Past untaxed profits from business in Germany remitted to India (not liable to tax, as it is not the income of current year) (i) Income from agriculture in Pakistan (lh of which received in India) Gross Total Income

Illustration 5 -Tax Incidence and Scope of Total Income: Compute the gross total income of Mr. B, an Indian citizen, who isin receipt of the following during the previous year if he is - (a) Resident; (b) Not ordinarily resident, or (c) Non-resident (all sums in Rs.)(a) Income from agriculture in India (b) Income from artwork in USA and spent for medical treatment in France (c) Income from activity of purchasing goods in India and exporting them to USA (d) Income from business of publishing magazine in UK by collecting news and views in India (80% attributable to operations in India) (e) Income from shooting of cinematograph carried out in India) • films in India (40% attributable to the operations 5,00,000 60,000 1,00,000 80,000 20,000 3,00,000 15,000 90,,000 50,000

(f) Income from transfer of residential-house situated in India (g) Salaries from XiZ Ltd. (50% of which relate to services rendered outside India) (h) Arrears of salary from Government includes Rs. 20,000 worth of allowances) of India for services rendered outside India (This

(i) Dividends from Indian company received in UK Solution : Computation of gross total income of Mr. B in the above three cases -

Resident
(a) Income from agriculture in India (exempt under section 10(1)) (b) Income from artwork in USA, spent for medical treatment in France
.' ..
'

NOR
0 0 0 90,000 40,000

NR
0 0 0 0

15,000 90,000 50,000

(c) Income from activity of purchasing goods in India and exporting to USA (not a business connection in case of non-resident only) (d) Income from business of publishing magazine in UK by collecting news and views in India (80% attributable to operations in India) (nota business connection in caseof non-resident only) . (e) Income from shooting of cinematograph films (40% attributable to operations in India) (it is _a business connection as Mr. K is an Indian citizen) (f) Income from transfer of residential house situated in India

5,00,000
.,

2,00,000 60,000
"

'2,00,000 60,000

60,000

2.12

Students' Guide to DIRECT TAXES

l,OO,OO~.i/. 50,OOO!

I (g) Salaries from XYZ Ltd. (50% relates to services rendered outside India) I
(h) Arrears of salary from Government of India for services rendered outside India (This includes Rs. 20,000 worth of allowances) - allowances
I

. -,--

60,000

I
I

50,000 ! 60,000 !
11~

60,OOO!

.0.'.
I·.~.~ ".::

'are exempt under section 10(7)

(i) Dividend from Indian company received in UK (exempt u/ s10(34» Gross Total Income 8,75,000

i
5,00,000 3,70,000

o -----f------.--.-. o 0
()

Illustration

6 -Tax Incidence and Scope of Total Income: Compute the gross total income of Mr. C, an Indian' citizen, who is in receipt of the following during the previous year if he is - (a) Resident; (b) Not ordinarily resident, or (c) Non-resident (all sums in Rs.) (a) Dividends from foreign company received in India (b) Dividends from foreign company received outside India but remitted into India (c) Interest on debentures issued by Goverrunent of India (d) Interest on loan taken by Mr. P, a resident, for his business outside India (e) Interest on loan taken by Mr. G, a non-resident, for his business in India (f) Interest on loan taken by L, a not ordinarily resident for treatment of his father (g) Interest on deposits with an Indian company received in UK (h) Interest on last year's recognised provident fund balance
@ 12%

10,000 5,000 70,000 60,000 35,000 45,000 30,000 ___12,000 20,000

f;·:. ...

(i) iInterest on loan taken by Mr. M, a non-resident for investing in bonds in India.
Solution : Computation of gross total income of Mr. C in the above three cases -

••••
·1:.-.
;

Resident
(a) Dividends from foreign company received in India (b) Dividends from foreign company received outside India but remitted into India (c).Interest on debentures issued by Goverrunent of India (d) Intere~t on loan taken by P(resident) for his business outside India (e) Interest on loan taken by G (non-resident) for his business in India
---_

NOR
10,000 01 70,000 I 0 35,000 45,000 30,OOQ

NR
10,000

•.. ~

10,000 5,000 70,000 60,000 35,000 45,000 30,000

°1
i

70,000 0 35,000 45,000 30,000

ill
[:~:,C:::'.:::·
... -.

(f) Interest on loan taken by L, a not ordinarily resident for treatment of his father is deemed to accrue or arise in India (g) Interest on deposits with an Indian company received in UK (h) Interest on last year's recognised provident fund balance @ 12% (Deemed to be received in India but interest in excess of 8.5% taxable)

r:X'f

(assumed that interest credited on or after 1-9-2010)

(i) Interest on loan taken by Mr. M, a non-resident lor the purpose of investing in bonds in India. (Not deemed to accrue or arise in India since the

3,500

3,500 0

3,500 0

loan was not used by the Non-resident for his Business or profession in India.)
Gross Total Income

20,000 2,78,500 1,93,500 1,93,500

I.

3
SALARIES
SALARY - CHARGE AND MEANING 3.1 INCOMES CHARGEABLE TO TAX UNDER THE HEAD 'SALARIES~ [Section lS} ~ The following incomes shall be chargeable to tax under the head "Salaries": (a) Any salary due from an employer or former employer, whether paid or not. (b) Any advance of salary paid by or on behalf of an employer or former employer before it became due. (c) Any arrears of salary paid or allowed by or on behalf of an employer or former employer, if not charged to income tax for any earlier previous year. Notes: (l) Arrears of salary are chargeable to tax on receipt basis only. - CIT v. Sardar Arju11:Singh Ahluwalia (Deed.) [1999] 240 ITR 693 (SC). (2) Any advance of salary already taxed shall not again be taxed when it becomes due. (3) Any salary, bonus, commission or remuneration due to, or received by, a partner of a firm from the firm shall not be regarded as "salary". It is taxable as profits and gains of business or profession. (4) Thus, salary is chargeableori'<due basis" or "receipt basis", whichever is earlier. However, income once taxed on one basis-cannot again be taxed on the other. basis, i.e. income once taxed on due basis cannot again be taxed on receipt basis or vice-versa. (5) While advance salary and arrears of salary are taxable in the year of receipt, the assessee can claim relief under section 89 in respect of the same. 3.2 CHARGE UNDER 'SALARIES' AND EMPLOYER-EMPLOYEE RELATIONSHIP: Income is taxable under the head "Salaries", only if there exists employer-employee relationship between the payer and the payee. The following are some important features of employer-employee reiationship -

I' ,

~j

(1) Employer-employee relationship is "Contract of Service" (where employee is bound to work for his employer) as against "Contract For Service" (where a person offers his services for charges). (2) Employer-employee relationship is similar to master-servant relationship wherein the master (i.e. employer) has a control over the work and working mechanism of the servant (i.e. employee). It is distinct from principal-agent relationship, as the agent is generally free to carry out his principal's instructions according to his own discretion without direct control and supervision of the principal.

~.

Instances where employer-employee

relationship exists/does not exist -

)-

(1) Paper-setters/Examiners: Where a teacher receives remuneration for setting question paper for -/; examination or works as an invigilator then the remuneration received by him will not be taxable under the head 'Salaries' but will be taxable under the head 'Income from other sources'. (2) MLl\s/MPs: Salary received by the Members of Parliament or Members of Legislative Assemblies will not be taxable under the head 'Salaries' as they are not Government employees. Salary received by them will be taxable under the head 'Income from other sources'.

3.2
(3)

Students' Guide to DIRECT TAXES

Director of a company: A director of the company, where he acts as an agent of the company and receives the remuneration in such capacity, cannot be said to employee of the company and such remuneration will not be taxable as Salaries.

'%,:;1

(4) Judges: Remuneration received by judges is Salaries, as though judges have no employer, but there is employment created by Constitution.-Justice Deoki Nandan Agarwala v. UOI [19991237 ITR 872 (SC) (5) Pay and allowances to Chief Minister is 'salarf : In view of Article 164(5) of the Constitution of India, which provides for payment of salary to the Ministers, the pay and allowances received by the Chid Minister from. the State Government is chargeable to tax as 'Income from Salaries'. - Lalu Prasad v. CIT [20091316 ITR 186 (Patna).

,(:.'<\

(6) Advocate General: Retainer fee received by an Advocate-General is not 'Salaries' because he gives advices to the govemment in his professional capacity; not as an employee of the Govemment. - CIT v. Govindaswaminathan [19981233 ITR 264 (Mad) 3.3 SALARY [Section 17(1)] : Salary has been defined in an inclusive manner. Accordingly, "Salary" includes (a) Wages; (b) Any annuity or pension (c) Any gratuity (d) Any advance of salary

(e) Any fees, commissions, perquisites or profits in lieu of or in addition to any salary or wages;

(fJ Any payment received by an employee in respect of any period of leave not availed by him; (g) Employer's annual contribution to recognised provident fund in excess of 12% of salary and Interest credited to such fund in excess of 8.5% p:~. (amended w.e.f. 1-9-2010; earlier the rate was 9.5% p.a.) fSalanj = Basic SalaD} + Dearness Allowance (to the extent it forms the part of retirement benefits 'I: percentagewise fixed commission on turnover J
balance from Unrecognised Provident Fund to newly recognised Provident Fund, the amount to the extent of employer's contribution and interest thereon.
(i) Contribution made by Central Government or any other employer in previous year, to the account of an-employee under a pension scheme referred u/s 80CCD. (h) In case of transferred
I

Case Law: Fixed percentage-wise [1979J 117 ITR 1 (SC).

commission on turnover is 'salary' - Gesietner Duplicator Pvt. Ltd. v. CIT .

3.4 VARIOUS CONCEPTS REGARDING TAXABILITY OF SALARIES: (1) Fixed pay scale and graded pay scale: In case of fixed pay scale, a fixed amount of salary is received for a specified period. In case of graded pay scale, there is an annual increment depending upon the grade in which the employee is placed. E.g., Mr. Xjoins the service in the grade ofRs. 14,000-300-15,800-400-19,800 on 1/6/2000. This means(a) Salary w.e.f. 1-6-2000 Rs. 14,000. (b) Six yearly increments of Rs. 300 w.e.f. 1-6-2001 will last on 1-6-2006 and salary w.e.f. 1-6-2006 would be Rs. 15,800. (c) Salary w.e.f. 1-6-2009 _= Rs. 15,800 + 400
x
:.' ::.~-' .
";"

3 = Rs. 17,000.

j{:~:

(d) Salary w.e.f. 1-6-2010 = Rs. 17,000 + 400 = Rs. 17,400. _ Therefore, his basic salary for the financial year 2010-11 (assessment year 2011-12) shall be-

f)'Q':
i:"

~17~'

Salaries
·IFoI the month of April, 2010 and May, 2010 (Rs. 17,000 x2) IFor the months of June 2010 to
7

3.3
34 0001 x 10)

3r

March 2011 Total

(Rs. 17,400

'1

1.74)JOO1
. 2708)}OO

(2) Salary from more than one source: H salary is received from more than one employer during' the same previous year, salary from each source is taxable under the head "Salaries", (3) Salary Due ·_;GoverP.ment Employee v, Private Employee: Since salary is taxed on "due" or "receipt" basis, whichever is earlier, therefore, the date when salary becomes due decides 'whether the same is taxable in the previous year or not Generallysalary becomes due on the last day of each month. However, in some cases, as per the terms of the employment, salary may become due on 15t day of the next month. Therefore, in that case, salary from March 2010 to Feb 2011 shall be taxable for the assessment year 2011-12. (4) Tax-free salary: In case the salary is paid tax free, the amount of tax paid is included under the head salaries. E.g.: H the employer pays Rs. 90,000 tax-free salary and pays Rs. 10,ODOas income-tax on behalf of employee, then, the taxable salary of employee will be Rs. 90,000 + Rs. 10,000 = Rs. 1,00,'000. (5) Any deductions made by the employer from the employee's salary like the PF deduction, Taxdeduction at source etc. shall also be included in the salary. (6) Advance Salary v. Loan or Advance Against Salary : As per section 15, salary received before it becomes due i.e. advance salary is charged to tax in the year in which it is received.

Loan or advance against salary : Loan or advance taken by an employee against salary, which is to become due to him subsequently, cannot be regarded as receipt of salary itself, as loan is not income. The loan! advance so takenjs-repayable in instalments to the employer and such instalments may be deducted out of.salary of the employee due in subsequent months. .
TIlUSI

while advance salary is taxable; loan or advance against salary is not so taxable.

(7)

Foregoing of salary v. Surrender of salary: Foregoing of salary: Salary is taxable on "due basis" even if it is not received. Hence, if an employee foregoes his salary after it has accrued to him, then, such subsequent waiver does not make it exempt from tax liability. Surrender of salary: Though forgone salary is includible in "Salaries", the surrender of salary to the Central Government under Section 2 of the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961 will be excluded while computing the taxable income.

(8) Place of accrual of salary income: Income under the head salary is deemed to accrue or arise in India if the same is payable for services rendered in India. Further, salary paid by Government to.an Indian citizen for services rendered outside India is also deemed to accrue or arise in India. The provisions of Section 9(1)(ii) and (iii) are summarized below: -

(It has been assumed thai the salary is paid at the place where seroice is rendered)
EmployeeCase 1: Indian citizen (resident or non-resident) i lease 2: Non-resident or resident Not ordinarily I(other than cas: 1) EmployerGovernment of India Any Where service is rendered Outside India Outside India In India Whether taxable in India Salary YES NO YES Perquisite! allowance NO (exemptujs NO 10(7))

YES

3.4
Case' 3: Resident than case 1and 2)

Students' Guide to DIRECT TAXES

(other Any Anywhere

YES

YES

(9) Salary from UNO - Exempt: Salary, emoluments and pension received from the UNO is exempt from tax under Section 2 of the United Nations (privileges and Immunities) Act, 1947. 3.5 DEDUcrIONS ADMISSIBLE IN COMPUTING INCOME UNDER HEAD 'SALARIES' [Sec: 1~] :

111eincome chargeable under head "Salaries" shall be computed after making the following deductions (1)

Entertainment allowance granted by tIre employer [Sec. 16(ii)): This deduction is available in case of Government employees only. The deduction is allowed to the extent of least of the following (a) Actual amount received; or (b) Rs. 5,000; or (c) 20% of basic salary

(2) Employment Tax [Sec. 16(iii)): Any sum paid by assessee on account of a tax on employment within the
meaning of Article 276(2). Under the said article, employment tax cannot exceed Rs. 2,500 p.a. PROFITS IN LIEU OF SALARY, COMPENSATIONS AND ALLOWANCES 3.6 PROFITS IN LIEU OF SALARY [Section 17(3)] : In general "Profits in lieu of salary" means receipt of an amount that would be gain or advantage in addition to salary though not named as salary. As per section 17(3) "Profits in lieu of salary" includes(1) Any compensation due or received from employer or former employer at or in connection with the termination of his employment or modification of the terms and conditions relating to employment, provident fund or other fund to the.extent of

(2) (a) Any payment due or received.from unrecognized employer's contribution and interest thereon.

(~; h,.j~ 1:.

r·~::·:~
,:il

(b) Any sum (including bonus) received under a Keyman insurance policy .: (c) Any other payment dueor received from an employer or a former employer. (3) Any amount due or received, whether in lump sum or otherwise, from any person before joining employ~eitt with that person or after cessation of emplqyment with that person. Case law CIT v. The assessee, a Japanese organisation, paid salary its employees expatriated to (located in) NHK India. The letter of employment to employees provided : Japan "Your emoluments shall be subject to deduction of taxes as per applicable laws and tax liability in Broadhost countrf (India) shall be borne by the NHK Japan Broadcasting Corporation". casting The Japanese Government levied citizen tax on its citizens under "Individual Inhabitant C01POTax Act". It was contended that such tax constituted overriding charge on the salary ration income and was, therefore, to be excluded in computing the salary/taxable income. The [2010J 322 Assessing Officer argued that the whole of the salary was includible in taxable income and ITR 628 no deduction on account of the citizens tax-was available.· . (SC) Held that, -

;'_>-::

(i) under the letter of employment, the emoluments paid by the assessee were subject to deduction of tax as per applicable laws.
therefore, if the levy of citizens tax was an overriding charge, then, it would not be includible in income; . (iii) accordingly, the matter was remanded to consider afresh whether the said levy of citizens tax amounted to overriding charge.

"3lt

":.:.

>:

(ii)

Salaries

3.5

CITv. Smt . Amount received as compensation for denial of job on gender discrimination basis - Not Rani . 'Sala1Y' - Not taxable : The assessee, a woman, was not offered a job in a US-bilsed Shankar broadcasting agency even after she had cleared the competitive test on the ground of her Mishra being a "woman". On a suit filed by the assessee and other women against the US-based [2010] 320 agency for the said gender discrimination, the assessee received compensation. ITR 542 The assessee didn't offer such compensation as 'income' (contending that the same is (bellti) revenue receipt); while the Department sought to tax the same as 'profits in lieu of salary' under section 17(3)(iii) of the Act . Held that, charge as profits in lieu of salary" u] s 17(3) arises only if there is charge of 'salary' u/s 15 of the Act. Section 17(3)(iii) provides that the amount due or received whether in lump sum or otherwise by an assessee from any person before joining or after cessation of employment with that person is 'profits in lieu of salary'; thus, the said amount must be in connection with the employment with that person. There was no employer-employee relationship, as the assessee was never offered any job. The very basis of the compensation was that the assessee had not been given the job for which she had applied on the ground of discrimination based on their sex. The assessee never performed any service as sh~ was never given the job. .'
11

Hence, the compensation could not be regarded as 'profits in lieu of salary'. The said compensation was a capital receipt, not chargeable to tax. 3.7 EXEMPTION FOR LEAVE TaA VEL CONCESSION IN INDIA [Section 10(5)] : (1) An exemption is available to.au.employee in respect of value of travel concession or a~~?tance due or received from his employer or former employer for himself and his family, in connection with his leave to anyplace in India before or after retirement/termination from service. (2) Amount of Exemption : Situations Journey by air Exemption upto the amount not exceeding** Economy fare of national carrier by shortest route

In case places are connected by rail and I" Class AC rail fare by the shortest route journey is performed other than by air If places are not connected by rail and (a)recognised transport system exists (b)no recognised transport carrier exists

rtf deluxe

class fare on such transport by shortest route

I" Class AC rail fare by the shortest route (as if the journey had been performed by rail)

**T1-ze amount of exemption shall not exceed the amount actually incurred for such travel.
(3) Availability of Exemption: (a) Exemption will be for any 2 journeys in a block of 4 years, current block being Seventh 2010-2013. (b) In case exemption is not availed of in a block, whether for both or for one journey, the exemption in respect of only one journey can be carried forward to the first year of next succeeding block. (c) Exemption will be only in respect of two surviving children after 1-10-98. However, exemption shall be available in respect of children born before 1-10-98 and also in respect of multiple births after one child.

3.6

Students'

Guide to DIRECT TAXES

PENSION AND (TIl) LEAVE .r":'·:-· \~ ~'.~.' '.

3.8 EXEMPTIONS IN RESPECf OF - (I) GRATUITY, (II) COMMUrED ENCASHMENT:

(I) GRA"TUITY [Sec.lO{IO}]: Exemption in respect of gratuity is as follows: (I) In case e[Gooemment (2) In case

employees (other than employees of statuwry corporations): Wholly Exempt caoered by Payment of Gratuity Ad, 1972: 'The least of the following is exempt ::(b) Actual gratuity received; or
.

of Employees

(a) Rs. 10 lakl!**, being the specified limit; or

.

(c) (15 + 26) x Salary last drawn x Completed years of service or part thereof in excess of 6 months.
[**Limit increased from Rs. 350000 to Rs, 10 Iakh, TheIimit of Rs.10 lakh is applicable in relation to the employees who retire or become incapacitated prior to such retirement or die on or after 24-5-2010 or whose employment is terminated on or after 24-5-2010. For retirement, etc. taldng place before 24-5-2010, the old limit of Rs. 350000 shall apply.] Notes: (1) Salary

= Basic pay

+ Dearness Allowance (always included).

(2) Part of a year in excess of 6 months is considered a completed year e.g. Service of 15 years 6 months 1 day = 16 completed years of actual service. (3) In case of any other employee: The least of the following is exempt -

(a) Rs. 10 lakhr being the specified limit; or (Limit ums RE. 350000 before 24-5-2010, as above)
(b) Gratuity actually received.

(c) ¥2 x Average Salary x Completed years of service rendered by employee (ignore fraction of year)
Notes: (A) Average Salary == AVerag~9£ salary drawn during 10 months immediately preceding the month of retir~.!Ilent E.g. If retirement takes place on 16th March 2011, average salary for 10 months period ending February 28, 2p11(Le. from 1st May 2010 to 28th Feb. 2011) is the ave~age salary. (B) Salary = Basic pay + Dearness Allowance (if it forms the part of retirement benefits) + Percentage-s ... fixed commission on turnover. rise (C) Completed years of service include the period of service by the employee under his former employens) provided the empioyee did not receive any gratuity by such former employer. - CIT v. PN Mehra [19931201 ITR ~30 (Born.) (II) Commuted Pension [Sec. 10(10A)]: Exemption in respect of commuted pension is as follows: (1) In case

CD

,.,

::i,~

of enipurfees of Central/State GOvernment or local authority or statuion] corporation: Fully Exempt

=

(2) In case of any other employee: The exemption shall be available as follows: -

;;. )-

Case 1 - Where emplouee is in receipt of gratuity: Exemption

'value of the pension which he is entitled to receive'*;

Commuted value of 1/3rd of the

Case 2 - In any other case: Exemption = Commuted value of lh of the 'value of the pension
which he is entitled to receive'*. .

*Value of pension employee is entitled to receive

= Commuted Pension -;-% of pension commuted

(3) Commuted Pension received from pension fund established by LIe or any other insurer approved u] s 10(23AAB) is fully exempt from tax in case of all assessees. (III) Leave Encashment [Sec. 10(lOAA)J: Exemption in respect of leave encashment being cash equivalent of earned leave at employee's credit at his retirement, whether 011 superannuation or othenoise, is as follows: (1) In case of Central or State Gouemment employees: ·Wholly exempt;

;.:. .:

\/:~

tl

Salaries
. following is exempt (a) Amount actually received; or
(c) 10 months x Average salary;

3.7

(2) In case of other employees (including employees aflocal autlw1ihJ or statutonJ corporation): The least of the
~ ~ iJ
J

(b) Rs. 3,00,000 being specified amount;

(d) Earned leave to the credit of employee x Average salary

\ ?

Notes: (1) Average Salary = Average of salary drawn during the period of 10 months immediately ·preceding the date of retirement, E.g. J1 a person retires on March 16, 2011, then 10 months average salary shall be computed from May 16,2010 to March 15, 2011.

(2) Salary

Basic pay + Dearness Allowance (if it forms the part of the retirement benefits) + Percentage-wise fixed commission on turnover. .
=

(3) Earned leave to the credit of the employee = [Annual Leave Entitlement (not exceeding 30 days) x completed years of actual service rendered} - Leave availed. WIille computing the completed years of service, the fraction of year is to be ignored i.e. 15 years and 9 months are to be reckoned as 15 completed years. Case Laws CIT v. D.P. Malhotra [1998} Leave encashment on retirement by way of resignation, shall also be 229 ITR 394 (Bant.) eligible for exemption under Section 10(lOAA}. aT v, Vijay Pal Singh Leave encashment received during continuity of employment [2005] 144 Taxman504 (All.) cannot fall within the expression 'otherwise'. So, it is not exempt under Section 10(lOAA}.
i (IV) General Notes in relation to gratuity, commuted pension and earned leave encashment-:':'

(1) Leave encashment or gratuity during continuity of employment and any uncommuted pension received shall be taxable for all employees. However, reliefu/s 89 is available for leaoe encashmeni. (2) Aggregate amount of exemption in respect of gratuity/leave encaslunent from all employers shall not exceed the specified limits viz. Rs. 3,50,000 or Rs, 3,00,000 respectively. Further, if an employee had claimed exemption in respect of gratuity/leave encashment in earlier years and again claims exemption in respect of such sum received in subsequent years, the specified limit of Rs. 3,50,000 or Rs, 3,00,000 'shall be reduced by the amount or the aggregate amount of exemption already claimed. ~. (3} . Any gratuitous payment or leave encashment to widow / oilier legal heir of an employee who dies while in active service will not be taxable. Further, ex-gratia payment received upon injury/death " of the person, while on duty, will not be liable to income tax. Illustration 1 -Gratuity exemption under various cases: Mr. X is an employee of AB Co. Ltd. He received Rs. 9,43,200 as gratuity. He is covered by the Payment of Gratuity Act, 1972. He retired on 15th November 2010 after rendering 38 years and 6 months and 15 days service. His basic salary w.eJ. 1-10-2010 was Rs. 23,600 per month (prior to that Rs. 23,000 p.m.). His dearness allowance was Rs. 12,800 p.m. (50% of which forms part of salary for retirement benefits). Calculate the amount of gratuity exempt from tax. Vvhatwould be your answer in the following independent cases '/

(a} if Mr. X is not covered by the Payment of Gratuity Act, 1972 ; or (b) if Mr. X is a government employee.

Solution;

(1) If Mr. X is covered by the Payment of Gratuity Act: The amount of gratuity exempt from tax

shall be least of the following amounts (amounts in Rs.) -

3.8
(1) Amount received (2) 15/26 x Salary last drawn
x

Students' Guide to DIRECT TAXES

9,43,200 Completed years of service (rounded off) (i.e. 15/26 x 36400 x 39) . 8,19,000 10,00,000

('!:.2

(3) Amount notified by the Central government Hence, exempted gratuity

= Rs. 819000;and taxable amount of gratuity = 9,43,200 - 819000 = Rs.124200. Note: Salary last drawn = Basic + DA (fully included) = Rs. 23,600 + 12,800 = Rs. 36400.

.(II) If Mr. X is not covered by the Payment of Gratuity Act: The amount of gratuity exempt from tax shall be least of the following amounts (amounts in Rs.) (1) Amount received (2) 1/2 x Average Salary
x

943200 Completed yrs. of service (ignore fraction of year) . (i.e. V2 x 29,460 x 38) 559740 1000000 9+

(3) Amount notified by the Central government Hence, exempted gratuity

= Rs. 559,740;and taxable amount of gratuity = 9,43,200~ 559,740 = Rs. 383460.

x

Note: Average Salary = Salary drawn during 1st January 2010 to 31st October, 2010 -;-10 = (23,000
23,600 + 50% of 12,800 x 10) -;-10 = 29460.

(III) If Mr. X is a Government Employee: The whole of the amount of gratuity shall be exempt from tax. Therefore, the taxable amountofgratuity = ~IL.

NpTE : If the retirement had taken place before 24-5-2010, then, the maximum exemption limit would have
been Rs. 350000 and accordingly, the balance would have been liable to tax. Illustration 2 -Commuied pension: Rani is entitled to get a pension of Rs. 1,500 p.m. from Raja Ltd. She gets three-fifth of the pension commuted and receives Rs. 90,000. Compute the taxable portion of commuted value of pension when - (i) she does not receive gratuity; (ii) receives Rs. 50,000 as gratuity. Solution: (a) (1) When Rani doesn't receive gratuity:
= 3/5 = 60%.
-i-

% of pension commuted
= 1/2 x

(b) Exemption

(Commuted pension

% of pension commuted)

1/2 X

(90,000-;-60%) = Rs. 75000 (90,000-;-60%»

=

(c) Taxable portion of commuted pension (II) Whett Rani receives gratuity:

90,000 - 75,000 = Rs. 15000.

Taxable commuted pension

= 90,000 - (1/3

Rs. 40000.

Illustration 3 -Conunuted pension: )( retires from a Private service on 31st May 2010. At the time of his retirement after 15 years and 6 months of service, he was getting the salary of Rs. 4,000 per month. He gets pensionofRs.900 per month upto 30th November 2010. With effect from 1st December 2010 he gets 4/5th of his pension commuted for Rs. 2,00,000.Determine the amount of gross salary. Solution: Salary
@

Computation of gross salary (Amounts in Rs.) Rs. 4,000 per month

x

8,000 6 months) + (Rs. 180* x 4) (*Pension to.e]. 1-12-10

Uncommuted pension (Rs. 900

= 900 -;-5)

6,120 75,000 89,120

Taxable portion of commuted value of pension [200000 Gross salary

Ph of (200000 x 5 -;-4)}]

Salaries
Illustration

3.9

4 -Leaoe EncasTtment : Mr. Mukesh was a sales manager in ABC Ltd. After completing 24 years and 7 months of service he retired on 31st October 2010. From the following information, compute the amount of leave salary chargeable to tax (1)" Salary at the time of retirement - Rs. 6,900 p.m. (2) Average monthly salary for 10 months ending on 31st October 2010 - Rs. 6,850

(3) Leave entitlement- 1112 months for each completed year of service.
(4) Leave encashment received on the basis of salary at the time of retirement - Rs. 1,44,900

Solution : The least of the follow~g amounts will be exempt from tax (all amounts in Rs.) (1) Actual earned leave salary received 1,44,900 68,500
x

(2) 10 months' Average salary (3) Earned leave to the credit

Average Salary (9 x 6850) (SeeNote)

61,650 3,00,000

(4) Amount notified by the Central Government

Note: (1) Leave taken by Mr. Mukesh (3) Earned leave at the credit

= (24 x 1.5) -

(1,44,900 + 6,900) = 15 months.

(2) Leave Entitlement as per Income-tax law = 30 days x Completed year of service = 24 months

= Leave entitlement - Leave taken = 24 - 15 = 9 months. Hence, the taxable earned leave salary = Amount received - Exemption =1,44,900 - 61,650 = Rs. 83250.
3.9 EXEMPTION FOR RETRENQ:l:~ENT (a) Amount actually received; COMPENSATION [SECTION 10(lOB)] : (b) Rs. 5,OO,OOOi Amount of Exemption; Least of the following is exempt from tax (e) An amount calculated in accordance with Section 25F(b) of the Industrial Disputes Act, 1947 i.e. 15 days' average pay x Every completed year of service or part thereof in excess of 6 months. 3.10 EXEMP110N IN RESPECT OF COMPENSATION RECEIVED VOLUNTARY RETIREMENT/SEPARAtION [Sectionl0(10C)] : BY AN EMPLOYEE ON

(1) Applicability: This section applies to compensation on Voluntary Retirement/Separation received or receivable by an employee of - (i) A public sector company, (ii) Any other company, (iii) A Statutory authority, (iv) A local authority, (v) A co-operative society, (vi) A University, (vii) An Indian Institute of Technology, (viii) Central or State Government, (ix) Notified institution, or (x) Notified institute of management, on his voluntary retirement or termination of his service. ' It is not necessary that whole amount of compensation must be received at the time of voluntary retirement.

Where the compensation is receivablein instalments, the same will also be exempt.
(2) Quantum:
-

Least of the following is exempt - (a) Amount actually received; (b) Rs. 5,00,000

(3) Conditions to befulfilled for claiming exemption [Rule 2BA]: Exemption applies only if compensation
is received under any Voluntary Retirement/Separation Scheme fraI?ed as per/following guidelines (a) the scheme applies to an employee who has completed 10 years of service or completed 40 years of ageexcept in case of employees of public sector company; (b) it applies to all employees induding workers and executives except directors of a company or cooperative society; .
i . .

'.

(c}scheme

has been drawn to result in overall reduction in the existing strength of the employees;

3.10

Students'

Guide to DIRECT TAXES

(d) the vacancy caused by the voluntary retirement or voluntary separation is not to be filled up.

(e) retiring employee is not employed in another company I concern belonging to same management;
(f) Amount of compensation does not exceed - (i) 3 months x salary last drawn x completed year of service; or (ii) Salary last drawn x Balance of months left before retirement or superannuation.

Salary = Basic pay + DA (forming part of retirement benefits) + %-wise fixed commission on iumooer. Higher of the two limits specified in Rule 2BA s110uld be taken : If the amount receivable under Scheme exceeds both limits specified in Rule 2BA, then no exemption can be claimed u] s lO(lOq.
Rule 2BA doesn't use 'whichever isIower'. Hence, out the two limits, the higher of the two will be taken. - Arun Kumar T. Makwardl v. ITO [2006]286 ITR 502 (Guj.) (4) Exemption only once: If exemption has been allowrd to an employee under this section in any assessment year, no exemption shall be allowed to himin relation to any other assessment year. (5) No exemption if relief availed 11/5 89 : Where any relief has been allowed to an assessee under section 89 for any assessment year in respect of any amount received or receivable on his voluntary retirement or termination of service ot: voluntary separation, no exemption under this section shall be allowed to him in relation to such, or any ether, assessment year. -:: Thus, relief under section 89 and exemption under this section cannot be availed of simultaneously. Further, once relief is claimed ujs 89, the right to claim exemption in respect ofVRS compensation is lost forever. (6) VRS received under Optional Early Retirement Scheme of RBI - Exempt U/S 10(10C) : In view of the CBDT letter en the subject,. it was held that the amounts received by the employees of RBI under Optional Early Retirement Scheme of the RBI shall be exempt upto the limit specified in section 10(10q of the Act, - Chandra Rpnganathan v. CIT [2010]326lTR 49 (SC).

@)"
(':''''

,=~7'

€ij &)

al~)

C)

[Authors' Note: TIle optional early retirement scheme of RBI 'Wasgenerally in conformity with Rule 2BA of the Income-tax Rules, 1962, however, it was not intended at staff reduction; it was merely a soft-exit scheme for those who intended to retire early. Hence, the Madras High Court had denied the exemption: The CEDT/Department agreed to allow exemption u/s lO(lOC) to employees of RBI, hence, the appeal 'Wasallowed by the Supreme Court. This judgment is, therefore, restricted to the empuqees of RBI.]
Illustration 5 -Computation of taxable Voluntary Retirement Compensation : R is employed in a public c-ompany and is paid a _sum of Rs. 6,00,000 on Voluntary Retirement from service. TI1e normal age of retirement in the company is 60 years and R who was 45 years at the time of retirement had completed 20 years of service. His monthly salary at the time of retirement was as follows (amounts in Rs.) : Basic Pay Dearness Allowance (50% is includible for pension) 10,000 6,000 3,000 800

BRA
Conveyance Allowance

What is" the amount of compensation taxable under the Income-tax Act? What will be your answer if the compensation received by R is - (a) Rs. 8,00,000; or (b) Rs. 24,00,000. Solution: As per section 10(10C) read with rule 2BA the exemption is available only if the amount received as compensation does not exceed - ?}>

3 months

salary last drawn

completed year of service i.e. 3 (50% ofDA ofRs. 6000)

= Rs.

13000

20 = Rs. 7,80,000

Salary last drawn

= 10000 + 3000

13;000

Salary last drawn

x No, of months of service left for retirement i.e. 13000 x 15 x 12 = Rs. 23-40,000

Since the amount received is less than the aforesaid limits, R will be eligible for exemption in respect the compensation. Consequently, the amount exempt is the lower of specified 1.i_mit s. 5,00,000 or amount R received Rs. 6,00,000. Therefore, Rs. 5,00,000 1'.111e exempt and the balance Rs. 1,00,000 will be taxable. b

Salaries
Other cases -

3.11

" ;
I

(a) In this case, the amount received on retirement exceeds the first limit of 7,80,000 but is within the ·limit of Rs. 23,40,000. Therefore, the exemption under section 10(10C) will be available. The amount taxable at the time of retirement = Rs. 8,00,000- Rs.5,OO,OOO = Rs. 3,00,000. (b) In this case, the amount received on voluntary retirement exceeds both the limits ie. first limit of 7,80,000 and second limit of 23,40,000. This payment is not in accordance with rule 2BA and hence, no exemption will be available ix] s 10(10C). Therefore, the taxable compensation will be Rs, 24,00,000. 3.11 EXEMPTION IN RESPECf. OF TAX ON NON-MONETARY EMPWYER ON BEHALF OF EMPLOYEE [Section lO(lOCc)l : PERQUISITES . BORNE BY

If, in case of an employee earning income in the nature of a perquisite being non-monetary payments, the employer pays tax on such income on behalf of such employee, the tax so paid shall be exempt. Tax implication in hands of employer: Section 40(a)(v) expressly disallows such expenditure in hands of the employer. Therefore, the tax so paid by the employer will not be deductible expenditure in his hands. 3.12 TAX IMPLICATIONS IN RESPECf OF VARIOUS PROVIDENT FUNDS : The various provident funds are Statutory Provident Fund (SPF) established under Provident Fund Act, 1925, Recognised Provident Fund (RPF), Unrecognised Provident Fund (URPF) and PublicProvident Fund notified by Central Government (PPF). . The following table summarizes the various issues relating to tax incidence of contributions made and payment Feceived out of various provident funds Tax incidence of (1) Employer's contribution SPF Exempt

RPF/
'~.,

-,-

URPF

PPF

Exempt upto 12% of salary (Salary employment so provide + percentage-wise fixed commission on turnover)

Not taxable when the N,A.

= Basic + DA, if the terms of contribution is made,

(2)Employee's contribution
:.

Deduction Deduction u] s 80C available 80C available

uls

No deduction Deduction available ul s 80C ss] s . 80C available

~
',

(3)Interest toPF

credited

Exempt

Exempt upto interest calculated @ 8.5% (before 1-9-2010, rate was 9.5% p.a.)

p.a. Not

taxable when Exempt interest is credited ~ Employer's Exe1l1:pt contribution & interest under thereon: Taxable as section al I' f be s ary. Re ie can 10(11) I· d 9 . c anne u] s 8 .

f'
)-,
~) ...

(4)Lump sum Exempt payment at the time under Of retirement or section termination of 10(11) service

Fully exempt from tax if .. . (a) 5ervice IS te rmma ted d ue t 0 ill h ea Ith 0 f .. f I ex' employee or discontinuance 0 emp oy s . b usmess or any 0 ther reason b eyon d hi IS I con tr 0; or

(b) If, on cessation of employment,-hetakes t 'b ii E t employment with another· employer, con n Ldl lOn: . xemp I li , . exemption IS all owe d to· th e ex ttl sue 1 as taxe ear er. en accumulated balance is transferred to his RPF AI c maintained by other employer; or . . (c) The employee has rendered continuous . service WIith his emp Iover for a perlO d 0 f 5 oyer or a peri years or more. ** )-.

..

',

~ Employee's

own

'Income from S r ources,

~lnterest on employee's contribution: Taxable as

Other

1-

3~12
Note:

Students' Guide to DIRECT TAXES

(1) **If RPF balance with previous employer is transferred to RPF AI c maintained by new employer, then, the period for which service was rendered to previous employer will be included in computing the limit of 5 years. _

(2) Transferred Balance from URPF to a RPF : When a URPF gets converted into RPF, then, _th~ income that would have been taxed had the fund been recognised from the date of its institution would be
taxed as the income of the employee during previous year in which the fund gets such recognition. The amount not transferred to RPF and paid out of URPF will be taxable in the same manner as the lumpsum payment from URPF is taxed. 3.1:? TAX INCIDENCE OF APPROVED SUPERANNUATION FUNDS:

(1) Employer's contribution to approved superannuation fund: Contribution to approved SUperalillUation fund is exempt up to Rs. 1lakh. Any excess above Rs. 1lakh is taxable in the hands of employee. (2) Employee's contribution: (3) Employee's contribution is eligible for deduction under section 80C.

Interest credited to the employee's account: It is also exempt from tax in the hands of the employee.

(4) Payment from Approved Superannuation fund [Section 10(13)]: Such payment is fund is exempt onlyif it is made on death of beneficiary, or to an employee in lieu of or in commutation of an annuity
on his retirement at a specific age o'r on his becoming incapacitated prior to such retirement.

'

3.14 EXEMP'fIPN IN RESPECT OF HbUSE RENT ALLOWANCE (HRA) [Sec.10(13A) and Rule 2A] : HRA is granted to an employee by his .fmployer to meet expenditure actually incurred on payment of rent. It is exempt to the extent of Ieastofthe following: (a) Actual HRA received (for the period for which rented accommodation was occupied by employee); (b) Rent paid less 10% of salary for the relevant period; (e) 40% of salary (50% of salary if the accommodation is situated in Mumbai, Kolkata, Chennai or Delhi). Notes: (1) Salary
=:

:--; ..\8'
=: ~

Basic pay + DA (if it enters into retirement benefits) + %-wise fixed commission on turnover

(2) Computation of exempted HRA depends on - (a)' HRA actually received, (b) Amount of rent paid, (e) 'salary' of employee and (d) place of situation of rented house. If there is change in any of the factors during the previous year, the exemption should be worked out on 'monthly basis'. 3.15 LIST OF DIFFERENT ALLOWANCES AND THEIR TAXABILITY :

(1) Fully taxable allowances: Dearness allowance, City Compensatory allowance, Medical allowance, Tiffin
allowance, Servant allowance, Project allowance, Overtime allowance etc.

(2) Allowances exempt to the extent actually expended for the official purposes [Section 10(14)0)]:
(a) Travelling Allowance to meet cost of travel on tour or on transfer (including any sum paid in connection with transfer, packing and transportation of personal effects on such transfer) (b) Conveyance Allowance to meet expenditure incurred on conveyance in performance of official duties if free conveyance is not provided by the employer. (e) Uniform Allowance to meet expenditure incurred on purchase or maintenance of uniform or , . wears during the performance of the duties of an office or employment of profit. (d) Daily Allowance granted on tour or for the period of journey in connection with transfer, to meet ordinary daily charges incurred on account of absence from his normal place of duty. (e) Research allowance for encouraging the academic, research and training pursuits in educational and research institutions.

[&1
.. ~
.

IJ"1~lili~flll~*t{JI,ti!!~!lf$~I"~lt~\~~II~§I~lt~~fjt¥111If~
.

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;

~
)

Salaries
(f) (3)
...

3.13

~,

Helper Allowance to meet expenditure incurred on a helper where such helper is engaged for performance of official duties or employment of profit

Other allowances exempt to the extent notified by rules [10(14)(ii)]: Allowance Extent of exemption

r
:'I.

(
~
?

-(1) 'Allowance granted to the employees of transport system to Lower of: .ineet persOrmlexpenditure during his duty, provided he is not (a) 70% of such allowance or in receipt of daily allowance. . (b) Rs. 6,000 per month

~ ~ ~ ~ ~ :I ~~
Y 1

(2) Tribal Area Allowance [in states of MP, Tamil Nadu, UP, Rs.200p.m. Karnataka, Tripura, Assam, West Bengal, Bihar, Orissa]
(3) (a) Transport Allowance to meet costof commuting between Rs.800p.m. place of residence and place of duty (b) Transport Allowance in case of blind or orthopaedically Rs. 1,600 p.m. handica pped . (4) Underground allowance granted to an employee working in Rs.800p.m. uncongenial/unnatural climate in underground mines (5) Children Education Allowance Rs. 100 pm per child for 2 children Rs. 300 pm per child for 2 children PERQUISITES

"

(6) Hostel Expenditure Allowance

.
,;.-.

I
3.16 PERQUISITES [Section 17(2)] :

In general parlance, "perquisites" means any benefit or an amenity provided to the employee by the employer, directly or indirectly, whether in cash or in kind, in addition to salary and wages. According to Section 17(2) perquisite includes (i) Rent-free accommodation: Value of rent-free accommodation provided to assessee by his employer; [ii] Concessional accommodation: The value of any concession in the matter of rent in respect of any accommodation provided to the assessee by his employer;

(Iii) Benefit or amenity taxable only in the case of specified employees : The value of any benefit or
amenity granted or provided free of cost or at concessional rate. Note1: Specified Employee means (1) An employee who is the director of the company; or (2) An employee having a substantial interest in the company i.e. who is the beneficial owner of equity shares carrying 20% or more of the voting rights in the company; or . (3) Any other employee whose income chargeable 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~~. 50,000.
-'

'In other ~ords, while computing limit of Rs, 50,000, following shall be deducted/ excluded: -

(if All non-monetary

benefits; . (ii) All monetary payments exempt under section 10;

(iii) Deductions under section 16 [i.e. Ent~rtainment allowance and professional tax]:

'-3.14

Students' Guide to DIRECT TAxEs

Note 2 :.Conyeyanc~ from office to residence and vice-versa is exempt: The use of any vehicle provided _l>y a' company or an employer for journey by the assessee from his residence to his office or other place of work, or from such office or place to his residence shall 110tbe regarded as perquisite. Note 3 : 5 Benefits covered: Car Facility; Provision for sweeper, domestic servant, etc.; Facility for gas, electricity, or water etc.; Education facility; and Transport Facility are taxable only in the case of specified employees. The same have been discussed in detail later.

(iv) Employees' obligation met by employer: Any sum paid by the employer in respect of alLY obligation which, but for such payment, would have been payable by the assessee [other than tax on non-monetary

perquisiteswhich is exempt under section 10(10CC)}.

(v) Employees' life insurance or annuitu : Any sum payable by the employer, whether directly or through a fund (other than RPF, approved Superannuation fund and Deposit-linked Insurance Fund), to effect an assurance on thelife of the assessee or to effect a contract for an annuity. (vi) Employee Stock Dpti()1{Plall/Scheme (ESOP) or Sweat Equitsj : The value of any security (including securities offered under employee stock option) or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee. Fair market value (determined as per prescribed method) of the security or sweat equity shares on the date on which the option is exercised by the assessee/ employee
x

®
. .

Less: Amount actually paid. by, or recovered from, assessee in respect of such security or shares
Value of such security or sweat equity shares

x x

Sweat Equity Shares means equityshares

issued by a company to its employees or directors at a discount or for .consideration other than cash for providing know-how or making available rights in the nature of intellectual property rights or value additions.

Option means a right but not an obligation granted to an employee to apply for the specified security
or sweat equity shares at a predetermined price. (vii) Contribution to approved' superannuation fund : The amount of any conb:ibution to an approved superannuation fund by the employer in respect of the assessee, to the extent it exceeds Rs. 1 lakh. Thus, contribution to approved super-annuation fund is exempt to the extent of Rs. Llakh. Any excess above Rs. 1lakh is taxable. [viii) Other prescribed fringe benefits ; The value of any other prescribed fringe benefit or amenity. 9 Benefits covered: Interest-free or concessionalloan; Travelling, touring, etc. for holiday; Food and beverage facility; Gifts; Credit card facility; Club facility; Use of movable asset; Sale of movable assets at concessional rates; and Other facilities'. 3.17 VALUATION OF MEDICAL FACILITIES PROVIDED BY EMPLOYER [PROVISO TO SEC. 17(2)] : (1) Treatment itt employers' hospital: Any medical treatment provided to an employee or any member of his family in any hospital maintained by the employer - EXEMPT ; (2)

!~~j~
,"

.·tI ...
.
- ,-.'

;.:

Treatment in government hospital

or treatment of' prescribed disease ill approuedhoepital

~~!t~
r;;::~
:.::'.".:.
'~'.'

[~/(Jj

.•

~~

Reimbursement of expenditure incurred on medical treatment of employee or his family member- (a) in any hospital of Govemment/Iocal authority or any other hospital approved by Government; or (b) in respect of diseases or ailments prescribed in Rule 3Ain an approved hospital - EXEtvlPI' ; (3) Payment of health insurance premium: Health insurance premium paid by an employer in relatiori to .an employee under any scheme approved by the Central Government or Insurance Regulatory and Development Authority (IRDA) for the purposes of Sec. 36(1)(ib) - EXEMPT ;

:>~
"."_' t:'::,::-'.·:::

~::!.

!!riltltll~!tlli'\I~I~I~IIIW~\I~!{!~11ttl$i~i~'!I';It<Ilii~

Salaries

3~15

(4) Reimbursement

of health insurance premium: Reimbursement of heaIthinsurance premium paid by employee on his health or health of his family member under scheme approved by Central Government or IRDA under section BOD - EXEMPT ;

(5) Reimbursement

of other medical expenses: Reimbursement of expenditure incurred by employee on medical treatment of himself or his family member [except treatment referred in (1) & (2)] - EXEMPT UPTO Rs. 15,000. (Only amount in excess ofRs. 15,000 will be taxable).

As per CBDT Circular No.1 of 2010, dated 11th January, 2010 on lIDS on Income from Salaries', medical reimbursement referred to be above will always be exempt upto Rs. 15,000. (6) Medical treatment abroad: Expenditure incurred or reimbursed by the employer for, (a) Medical treatment of employee or his family member outside India; or Stay -abroad of such employee or family member and one attendant who accompanies the patient in connection with such treatment - EXEMPT TO THE EXTENT PERMITTED BYRBI; (b) Travel of such employee or family member and one attendant who accompanies the patient in connection with such treatment outside India - EXEMPT ONLY IF gross total income of such employee, as computed before including this expenditure, does not exceed Rs. 21akh. ~ Hospital includes a dispensary or a clinic or a nursing home;

Note:

~ Family means (i) spouse and children of that individual; and (ii) the parents, brothers and sisters of the
individual or any of them wholly or mainly dependent on the individual 3.18 VALUATION OF PERQUISITE IN RESPECT OF FREE OR CONCESSIONAL ACCOMMODATION [Explanations to Section 17(2) read with Rule 3] :
II

RESIDENTIAL

ABper Ru1e 3, accommodation"'~~ludes a house, flat, farmhouse or part thereof, or accommodation in. a hotel, motel, service apartment, guesthouse, caravan, mobile home, ship or other floating-structure. The value of residential accommodation provided by the employer to his emyloyee or to any member of his household during the previous year shall be determined as follows: Circumstances Value of Residential Accommodation

(I) Central or State Govt. employees Licence fee determined by the Union or State Government. holding office/post in connection (This doesn't apply to employees sent on deputation. For details, with affairs of Govt. SEENOTE 6)
»,

(II)"Other employees: (a) Where accommodation is owned by employer (including

Cities having population as per 2001 census:

employees sent on deputation by Not Exceeding 10 lacs: to Central/State Govt. -undertaking controlled by it)
.'

Exceeding 10 lacs but not exceeding 25 lacs:

·10% of salary

Exceeding 25 lacs:
~ 15% of salary

7.5% of salary (b) Where accommodation taken on lease or rent employer

is Lower of thefollowing: by (1) Actual amount of lease rental paid or payable by employer; or

(2) 15% of salary.

for the period during which such accommodation is provided.

(S-·, 3.16 Students' Guide to DIRECT TAXES

.f.':-_
t'.-;·-

accommodation m nature of motel, ... . '. . '. . service apartment or guest house] for the penod durmg which such accommodation IS provided.'
Notes: (1) Salary
= Basic pay + Dearness allowance/ pay (if enters in computation of superannuation or retirement benefits) + Bo~us + Commission + Fees + All taxable allowances + All monetary payments chargeable to tax; from one or more employers (wlrether such sums are payable monthly or otherwise)
t:}

(c) Accommodation provided in Lower of the following: hotel by any employer (Gaut. or (1) 24% of the salary paid or payable; or other), ["Hotel" . includes licensed (2) A c tu a I char ges patid or paya bl e t0 su ch h 0teI .

{:'> ....

Salary does not include or

(a) dearness allowance or dearness pay unless it enters into the computation of superannuation retirement benefits of the employee concerned; (b) employer's contribution to the provident fund account of the employee; (c) allowances which are exempted from payment of tax; (d) the value of perquisites specified uj s 17(2) ;

(e) any payment or expenditure specifically excluded under proviso to section 17(2)(iii) or proviso to section 17(2); (f) lump sum payments received at the time of termination of service or superannuation or voluntary retirement, like gratuity, severance pay, leave encashment, voluntary retrenchment benefits, commutation of peru;ioMlri'd similar payments. ..__ ~ Salan) on due basis only: For perquisite valuation, salary is to be calculated on due basis only and for the period during which the accommodation was occupied by the employee during previous year. (2) Value of furnished accommodation: The value of unfurnished accommodation as computed above
.

Jt
)" :'.:.:- ....
',

(except in case of hotel accommodation) shall be increased by the value of furniture as under:

If furniture t:} If furniture

t:}

is owned by employer: 10% p.a. ofcost of furniture. is hired by employer: Actual hire charges paid or payable by the employer.
appliances, air-

:'>D

-'.:."

'Furniture' includes television sets, radio sets, refrigerators, other household conditioning plant or equipment or other similar appliances or gadgets.

~~~/

(3) Rent or charges paid or recovered from the employee shall be deducted from the value of perquisite. (4) Exempt Perquisites: The accommodation perquisite shall be exempt in the following cases(A) Where the employee is provided hotel accommodation for a period not exceeding in aggregate 15 days on his transfer from one place to another, the value of perquisite shall be nil. (B) Accommodation provided to employee working at mining site or an onshore oil exploration site, or a project execution site or a dam site or a power generation site or an offshore site which, (a) being of temporary nature and having plinth area not exceeding 800 sq. feet, is located not less than 8 kms. away from the local limits of any municipality or a cantonment board; or (b) is located in a remote area. [,Remote area' means an area that is located at least 40kilometl'es away

.~;~;.
,-"

from a town having a population not exceeding 20,000 based on latest published all-India census] .
(5) Double Accommodation on transfer: Where on account of his transfer from one place to another, the employee is provided with accommodation at the new place of posting while retaining the accommodation at the other place, the value of perquisite shall be determined as follows -

Li..o
j ••..•

::_:.-: :.:_ .. .....

_

··..0··

.Salaries
For First days After 90 days

3.17

90 Perquisite shall be valued with reference to only one such accommodation which has the lower value as computed as per the rules given above Perquisite will be valued for both such accommodations as per rules given above.

(6) Employees sent on deputation by Government - Valuation under point (II)(a) of the Table: Where the accommodation is provided 'by the Central Government or any State Government to an employee who is serving on deputation with any body or undertaking under the control of such Government,- .
t

(i) the employer of such an employee shall be deemed to be that body or undertaking where the employee is servin~ ()11 deputation: and

(ii) the value of perquisite of such an accommodation shall be the amount calculated in accordance withS!. No. (II)(a) of the Table, as if the accommodation is owned by the employer. Illustration 6 - Value of rent-free accommodation in various cases: Compute the value of perquisite in respect of rent-free furnished house, if Ashok stays in a city with a population of-

(i) not exceeding 10 lakh ; (ii) exceeding 10 lakh but not exceeding 25lakh i and (iii) exceeding 251akh.
Ashok is in receipt of the following amounts from his employer during the previous year - Basic pay: Rs. 1,80,000; Dearness allowance: 25% of basic pay; Commission: 5% of basic pay; and Bonus: Rs. 8,000. His employer has paid income tax of Rs. 5,000 and professional tax of Rs. 1,500 on his behalf. 'Besides, his employer provided refrigerator and television costing Rs. 24,000 and paid Rs. 500 per month towards rent of other furniture provided. Solution: Step 1:Salary for the purp.Q§,eof valuation of rent-free accommodation Basic Pay Dearness Allowance & Commission (25% + 5% = 30% of basic pay) Bonus Income-tax.and professional tax paid by employer (not includible in salary, as they are 'perquisites) Total Salary Step 2 : Computation (i) ValueofRFA of taxable value of Rent free accommodation in various cases'
=

' 1,80,000 54,000 8,000 0 2,42,000

7.5% of salary +12

500 +10% of 24,000

26,550 32,600 44,700

[ii]' Value of RF A = 10% of salary +12 x 500 +10% of 24,000

(iii)Value ofRFA
= 15% of

salary +12

500 +10% of 24,000

3.19 VALUATION OF PERQUISITES TAXABLE IN THE HANDS OF SPECIFIED EMPLOYEES ONLY [Sec. 17(2)(iii) & Rule 3} = The following perquisites shall be taxable in the hands of specified employees only. However, if bills are in name of employee or obligation to make payment is on employee, then the reimbursement of expenses shall be taxable in case of all employees n] s 17(2)(iv) (1) Gas, electricity and water sllpply for household consumption: The v~lue of perquisites shall be -

;.. In case supplied by employer from his own sources: Cost of production per unit ;.. In casesupplied from outside agencies: Actual expenditure incurred by the employer
Less: Amount, if any, recovered from the employee.

3.18

Students' Guide to DIRECT TAXES

(2) Sweeper, gardener, watchman or personal attendant provided to employee or any member of his household: The value the of perquisite shall be the salary paid or payable by the employer or any other person on his behalf for such services less any amount paid by the employee for such services. _
(3) Provision of free or concessional educational facilitiesfor Circumstance
(a) Employer incurs cost of education.

any member of employee's household:

Valuation of perquisite

Actual expenditure incurred by-the 'employer.

(b) (i) Educational institution is owned and Cost of such education in a similar institution in or near

maintained by the employer; or

the locality.

(ii) Free educational facility is provided in [TIu perquisite is exempt if free educationfacility is provided any other institution by reason of his to children of the emplouee and cost of education does not exceed Rs. 1,000 p.m. per child; oihenuise it is fully taxable] employment with that employer.
Note: Any amount paid or recovered from the employee shall be reduced from value of perquisite.

Case law

err v. Delhi

Public School [20091318 ITR 234 (Del.) [SLP denied in [20091312 ITR (St.) 342 (Sc}1

Held, upholding the decision of the Appellate Tribunal in ITO v. Delhi Public School [2008] 302 ITR (An 117 (Del.), in respect of employees' children undergoing education in school run by employer -

>

Free Education Facility - ful!y_,taxable

if cost thereof exceeds Rs.l,OOO p.m: per child: -Rule 3(5) doesn't grant blanket exemption of upto Rs. 1,000 p.m. per child. The perquisite in-respect of education-facility is exempt if its value is upto Rs. 1,000 p.m. per child If the value exceeds Rs. 1,000 p.m. 'it will be fully taxable.

)-

Concessional Education Facility - Exempt, if net value is upto Rs. 1,000 p.m. per child: If part of the cost of teaching is paid or recovered from the employee, then there is no question of treating that part of the facility as a perquisite. Only the facility for which payment was not made or recovered could be treated as a perquisite. Therefore, if after giving benefit for the amount paid or recovered from the employee, the cost of education or value of perquisite does not exceed Rs. 1,000 per month per child, then nothing was to be added on account of concessional treatment.
the determination of thg value of the perquisite is with reference to the cost of such education in a similar institution in or near the locality. The cost of education for other students in the same school cannot be taken as the perquisite value in the hands of the employee.

)-

"Cost" to be taken of similar institution - Not 'actual cost' of assessee itself: Under Rule 3(5),

(4) Motor car or other conuefance facility: The rules for valuation of perquisite in respect of use of conveyance provided to an employee or any member of his household are as follows -

Circumstances (Col. 1)

Used wholly for private purposes (Col. 2)

Partly for official and partly for private purposes (Col. 3)

I.Conoefance other than motorcar Amount actually incurred by Actual expenditure incurred by the (Scooter, motorcycle etc.), is employer for maintenance employer - Rs. 900 p.m. [Note C] owned by _the employee and and running less Amount
the employer meets its running recovered from employee expenses. [Taxable in case of all

ernpl9yees]

"'1

lii~~lit~rt~1!~j~tl~!:s"i~ll~f1~ittl~~!fg~~I~~fll~ili~1

Salaries
II. Where motor car is owned by Actual expenditure incurred Actual expenses employee and maintenance and by employer employer incurred

3.19
by

· running . ~xpenses including Less: Amount, if any, paid or Less : (a) If cubic capacity of engine · remulleration the chauffeur recovered from the exceeds ).6 litres: Rs. 2,400 p.m. (plus are met or reilllbu~sed by the employee. Rs. 900 if chauffeur is also provided): · employer. [Taxable In case of all or (b) In other cases: Rs. i.sco p.m. employees] (plus Rs. 900 if chauffeur is also provided). [Note CJ

III. When motor

car is owned or hired by the. emp loyer (A)When maintenance and Amount incurred or re- (a) If cubic capacity does not exceed 1.6 running expenses are met or imbursed by employer + litres: Rs. 1,800 p.m. (plus Rs. 900 p.m. reimbursed by employer. Chauffeur's salary + Normal if chauffer is provided); or wear & tear @ 10% p.a .. of (b) If cubic capacity exceeds 1.6 litres: actual cost of car or hire Rs. 2,400 p.m. (plus Rs. 900 p.m. if charges Amount chauffeur is provided)fNote DJ recovered from employee . (B)When maintenance and Normal wear and tear @10% (a) If cubic capacity does not exceed 1.6 running expenses are met by p.a. of the actual cost of the liires: Rs. 600p.m. (plus Rs. 900 p.m. employee. "_/ car or hire charges. if chauffer is provid~c:!); or

[Taxable in cas~ of specified employeetfonly]

(b) If cubic capacity exceeds 1.6 liiree: Rs. 900 p.m. (plus Rs. 900 p.m. if chauffeur is provided) [Note DJ

Notes (A) Use of conveyance wholly & exclusively for official purposes is not a perquisite. (B) Valuation when one or more motor cars allowed: Where one or more motor-cars are owned or hired by the employer and the employee or any member of his household are allowed the use of such motor-car or all or any of such motor-cars otherwise than wholly and exclusively in the performance of his duties, the perquisite shall be valued as followsAnyone car to be valued as if it were used partIy for personal purpose and partIy See (III) for official purpose. Col. 3 Other car(s) to be valued as if it were provided. exclusively for his private or See (III) Col. 2 personal purposes.

(C) Where~

(a) the employer or the employee claims that the conveyance is used wholly and exclusively in tile performance-of official duty; or (b) actual expenses on running and maintenance of the conveyance owned by employee for. official purposes is more than amounts deductible in items (I) and (II) of the above Table, he may claim a higher amount attributable

to such official use, if-

3.20

Students' Guide to DIRECT TAXES

(i) the employer has maintained
complete details of journey undertaken for official purpose ( .'including date of journey, destination, mileage, and expenditure incurred thereon; and

(ii)the employer gives a certificate to the effect that the expenditure was incurred wholly and exclusively for the performance of official duties. (D) In these cases, nothing is deductible in respect of any amount recovered from the employee. (E) Month: The perquisite is valued for each calendar month. Calendar month is the month starting from any particular date of a month but ending on a date immediately 'prec~ding the corresponding date of next month. Eg. 15thJuly to 14thAugust constifiile a calendar month. Any part of a calendar month is to be ignored for perquisite valuation. (5)

Transport facility provided by a transport undertaking to employee or any member of his household: Value of personal or private journey provided free of cost or at concessional rate, by undertaking engaged in the carriage of passengers or goods, in any conveyance owned, leased or made available by any other arrangement = Value at which such benefit or amenity is offered by such undertaking to the public - Amount, if any, paid by or recovered from the employee for such benefit or amenity. Exemption. : This rule shall not apply to employees of an airline or the railways ..

Illustration 7 - Valuation of car facility

: Mr. A is provided with two cars, to be used for official and

CarlRs. Car 2 Rs. 4,00,000
r_-:::'
\.:,__..

. personal work by his employer ABC Ltd. The following information is available from the company records:

Cost of the Car Running and maintenance (Borne-by ..J:{e company) t Salary of driver (Borne by the company)

6,00,000
D

,,-.-.

40,800 24,000

-_-

28,000 24,000

C'

The taxable monetary emoluments of Mr. A are Rs. 90,000. Compute the taxable 'Perk' in respect of Cars on the assumption car 2, is exclusively used by IAI.

Solution: The perquisite in respect of motor car will be taxable in the hands of Mr. A, as he is a 'specified
employee'. Since the question requires the problem to be solved assuming that Car 2 is used exclusively by 'A', therefore, Car 1 is assumed to be used for personal and official use. (Rs.) Car 1 (Partly official and partly personal, assumed to of above 1.6 litres cc) [(2,400 + .900) x 12] Car 2 (Private use only) [Expenses actually incurred 28,000 and 24,000 + 10% of cost of car]
-

39,600 92,000 1,31,600

Total value of perquisite

3.20 VALUATION OF SPECIFIED SECURITY FOR COMPUTING PERQUISITE ON ESOP OR SWEAT EQUITY [SECTION 17(2)(VI) & RULE 3(8)jRULE 3(9)] : The fair market value of any specified security or sweat equity share alloted or transferred under Employee Stock Option Plan or Scheme on the date on which the option is exercised by the employee, shall _ be determined in accordance with the provisions given in the following table: CASE Fair market value shall be -

(1) Listed equity shares: If, on th~ date of exercising

of the option, theshares of the company are listed_ ..

i..j~,
:':~:--':.",.:

;>,,,

(a) on only one recognised stock exchange and (Opening price on that date on that stock exchange shares are traded on that date on that exchange + Corresponding Closing Price) + 2.

Salaries

3.21

(b) on only one recognised stock exchange but Closing-price of the share on that recognised stock shares are not traded on that date on that exchange exchange on a immediately preceding date closest to the date of exercising of the option.

stock exchanges (Opening price on that date on stock exchange, and shares are traded on that date on any of the which records the highest volume of trading in the exchanges " share + Corresponding Closing Price) + 2.
(d) on more than one recognized stock exchanges Closing price of the share on any recognised stock butshares are not traded on that date on any of the exchange, which records the highest volume of exchanges trading in such share, 'as on immediately preceding date closest to the date of exercising of the option.

(c) on more than one recognized

(2) Unlisted equity shares : If~ on the date of Such value of the share in company as determined exercising of option, shares of the company are not by a 'Category I Merchant Banker registered with listed on any recognised exchange. the SEB!' on the specified date.
(3) Specified security not being an equity share Such value as determined by a merchant banker on the specified date.

Note: For the purposes of the above, (1) Closing price of a share on a recognised stock exchange on a date shall be the price of the last settlement on such date on such stqck exchange. However, where the stock exchange quotes both buy "and sell prices, the closing price shall be the sell price of the last settlement.
...... -.r..:.~-

(2) Opening price of a share on a recognised stock exchange on a date shall be the price of the first settlementon such date on such stock exchange. However, where the stock exchange quotes both buy and sell prices, the opening price shall be the sell price ojthe first settlement. (3) Specified date means - (i) date of exercising of option; or (ii) any date earlier than date of exercising of option, however, such date shall not be more than 180 days earlier than date of the exercising.

Analysis of Certain Aspects (Based on CBDT Circular on erstwhile similar provisions) :

(1) Taxation of ESOPs as perquisite: The liability to tax as perquisite on Employee Stock Option Plan arises in the previous year in which the allotment/transfer of securities is made to the employees. Therefore, the date of allotment/ transfer of securities under the plan shall be relevant for deciding year of charge. The date of exercising of the option is relevant only to determine the value of the option. No perquisite in the nature of,~alary is chargeable on allotment/transfer of securities to non-executive .directors, who are not employees, or persons other than the employees. However, in such cases, the taxability of such benefits in the hands of the non-employees will be determined in accordance with the existing law i.e. other provisions of the law (i.e. profits and gains of business or profession).

(2) All sorts of schemes/plans

coveted : Allotment or transfer of securities under all plans such as "Employee Stock Purchase Plan", or "Employee Stock Option Scheme", or "Employee Stock Ownership Plan", or "Employee Stock Purchase Scheme", or "Employee Stock Option Scheme" or "Employee AppreciationRights or Plans" etc. shall be covered under perquisite. Tax consequences if a foreign company allots or transfers its securities to its employees or employees of its Indian subsidiary - Perquisite taxable in hands of the employee: If a foreign holding company

(3)

allots or transfers its shares to the employees of.its Indiansubsidiary, it will be regarded as an indirect allotment or transfer of shares by the Indian subsidiary to its employees. Hence, it will be chargeable as perquisite in the hands of the employee, as the consideration therefor is 'employment'. "

3.22
i

Students' Guide to DIRECT TAXES

(a) If the ~hares of a foreign-company are not listed in a recognized stock exchange in India, the shares will be heated as unlisted even if they are listed on any globally recognised stock exchange. Accordingly, such shares will have to be valued by category 1 Merchant Banker registered with SEBI (the valuation by foreign merchant banker/ other expert will not be recognised). . (b) If the shares have been valued by more than one Merchant Banker or by one Merchant Bankero~ more than one occasion, ~then/the valuation on the specified date, which is closest to the date of the vesting of the option, should be adopted. (c)

(4) Valuation ~~t1todology in case of unlisted shares:

Valuation made by merchant banker is binding: It is binding upon the Assessing Officer to accept the valuation made by the Merchant Banker unless the valuation by such banker is unreasonable.

. (5) Deductibility of value of perquisite provided to employees under ESOP in computing taxable income of employer: In case where the employer purchases the shares and then subsequently transfers such shares to its employees under ESOP, the expenditure so incurred is allowable as deduction in computing tile taxable income of the employer company. However, if the shares are allotted to the employees from the share capital of tile company, no deduction is allowable in computing tile taxable income of the company since no expenditure has been incurred by it. Illustration 8 -Computation of perquisite on ESOP when shares listed on one stock exchange: On 31-72010, M/ s. XYZ Ltd., a company listed on Bombay Stock Exchange, decides to issue Employee Stock Options under a scheme whereby option are to vest in the employees on 26-9-2010. The scheme provides for allotment of 2.5 lakh options and consequent shares on exercise thereof, The price of shares of the company on Bombay Stock Exchange were (The BSE was closed during 27-9-2010 to 30-9-2010 on account of holidays) : .,
'-" ..,

~'

.-.-

As on 26-9~201O R~.1/055
Rs.1,495

As on 1-10-2010
Rs.l,550 Rs.1,410

As on 1"-3--2011
Rs.l,600.00 Rs.1,800.00

Opening Price Closing Price

Mr. X an employee exercised his option on 1-10-2010 and was alloted the 500 shares on 1-3-2011. Compute the value of perquisite in the hands of Mr. X. What would be your answer in case Mr. X had exercised his option on 28-9-2010 and had paid Rs.195 towards each option? Solution: The value of perquisite taxable in the hands of Mr. X in case he exercises his option on 1-10-2010: (A) Fair Market Value of each Option
== ==

• k~
i

i'i-:@

(Opening Price on 1-10-2010 + Closing Price on that date) + 2 (Rs. 1,550 + Rs. 1,410) + 2 = Rs. 1,480.

(B) Value of perquisite taxable in the hands of Mr. X = Rs. 1,480 x 500

= Rs. 740000.

Value of perquisite if Mr. X exercised his option on 28-9-2010 on which date the BSE is closed: (A) Fair market value of each option = Closing Price on 26-9-2010 = Rs. 1,495 [In this case, option is exercised on 28-9-2010, which is holiday. Since shares are not traded on ,that day, the immediately preceding date closest to the date of exercising of option is 26th September, 2010. Hence, the closing price on that day shall be taken to be the fair market value of each option.] (B) Value of perquisite taxable in the hands of Mr. X = Rs. (1,495 -195) x 500 = Rs. 650000. The cost of acquisition of such shares, as per section 49(2AA), shall be the FMV taken for the purposes of computing perquisite. Hence, the cost of acquisition shall be Rs. 1480 andRs. 1495 respectively, as the case may be and, in case of sale, the capital gains shall be computed with reference this cost.

@I
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_---.-.'.
_".

" ~I
:,::/e

Salaries

3.23

Illustration 9 -Compuiation of perquisite on ESOP when shares listed on more than one recognised stock exchange: On 31-7-2010, Mjs. ABC Ltd., a company listed on three recognised stock exchanges (viz. RSE-l,
RSE-2 and RSE-3) decides to issue Employee Stock Options under a scheme whereby option are to vest in the empl?yees on 1-9-2010. The scheme provides for allotment of 21akh options and consequent shares on exercise thereof. The price of the shares of company on three recognised stock exchanges were as follows:

As on 26-9-2010 RSE-1
Trading Volume (in %) Opening Price (in Rs.) Closing Price (in Rs.) 53% 2,050 2,255

As on 1-10-2010 RSE-3
.47% 2,100 2,180

RSE-2

RSE-1

RSE-2
58% 2~50 2,450
I \

RSE-3
42% 2,250 2,550

Mr. X an employee exercised his option on 1-10-2010 and was alloted the 500 shares on 1-3-2011.
Compute the value of perquisite in the hands of Mr. X.
\'

What would be your answer in case Mr. X had exercised his option on 28-9-2010 and had paidRs. 1155 towards each option?

Solution: The value of perquisite taxable in the hands of Mr. X shall be computed as follows (A) Since shares of Mj s. ABC Ltd. are traded on 1-10-2010,hence, the average of the opening and closing prices on the recognised stock exchange, which records highest trading volume shall be taken to be the fair market value of each option. .
o

(B) Fair Market Value of each Oplion"':: (Opening Price on 1-10-2010 on RSE-2 + Closing Pr_i~~) ;-2 = (Rs. I,
o

2,350 + 2,450) -;-2 = Rs, 2,400.

(C) Value of perquisite Value of perquisite

Rs. 2,400 x 500 = Rs. 1200000.

if Mr. X exercised his

option on 28-9-2010 on which date the BSE is closed:

(A) Since shares of Mjs. ABC Ltd. are not traded on any stock exchange on 28-9-2010, which is holiday,
and also on 27-9-2010, which is also holiday, hence, the closing price on immediately preceding date closest to the date of exercising of option (i.e, 26th September, 2010).on therecogllised stock exchange, which records highest trading volume shall be taken to be the fairw~<et value of each option, (B) Fair market value of each option = Closing Price on 26-9-2010 on RSE-1 = Rs. 2,255.

(q Value of perquisite ;= (Rs. 2,255 - Rs. 1,155) x 500::: Rs. 550000.

,

",.

..

Illustration 10 -Computation of perquisite on ESOP when shares flat listed t., On 31~7-2010, Mj s. PQR Lid.,
a company not listed on any stock exchange, decides to issue Employee. Stock Options under a scheme whereby option are to vest in the employees on 1-9-2010.' The scheme provides for allotment of 2 lakh options and consequent shares on exercise thereof. The Value of the shares of the company, as determined by the Category I Merchant Banker registered with the SEBI, as on 4thApril, 2010 is Rs. 1,050. ' Mr. X an employee exercised his option on 1-10-2010 and was alloted 500 shares on 1-3-2011. Compute the value of perquisite in the hands of Mr. X. What would be your answer ill case the company gets value of its shares determined on date of exercising ,of the option i.e. as on 1-10-2010 and the value so determined is Rs. 1,200?

3.24

Students' Guide to DIRECT TAXES

Value as on 4th April, 2010 (i.e, a date earlier than the date of exercising of the option by not more than 180 days) = Rs.l,050
=
t" -, -:."

Solution: The value of perquisite shall be computed as follows:

(A) Fair Market Value of each Option (B) Valu.~·~f:perquislte

= Rs.

1,050

500 = Rs. 525000.

Value is perquisite if the value of shares is det~ined on 1-10-2010: If the value gets deterrcin~d on the . date of exercise of the option, the value so determined shall be taken to be the fair market value. In that event, the values determined earlier need not be considered. Accordingly, the computations shall be:

(A) Fair market value of each -option = Value as,0i11-10-2010 = Rs. 1,200. (B) Value of perquisite = Rs. 1200
x

500 = Rs. 600000.

3.21 VALUATION OF PERQUISITES BEING PRESCRIBED FRINGE BENEFITS TAXABLE IN HANDS OF ALL EMPLOYEES [SEC. 17(2)(VIII) & RULE 3] : The following benefits provided by the employer or by any other person on his behalf to the employee or any member of his household shall be valued as follows . (1) Interest free or conceseional loans: The value of benefit resulting from the loans made 'available to the . employee or any member of their household shall be Rs. Maximum outstanding monthly balance" x Rate charged p.a. by 5BI for similar purpose, as --on I" day of relevant previous year (i.e. as on 1-4-2010 for assessment year 2011-12) Less: Interest, if any, actually paid by him or any such member of his household. "Maximum outstanding monthlYbalance as on the last day of each month. means the aggregate outstanding balance for each loan .

~ Exemption: The perquisite in respect of interest is exempt (a)Where the amount of loans are petty not exceeding in the aggregate Rs. 20,000; or (b)1f such loans are made available for medical treatment in respect of diseases specified in rule 3A.

:~·::.C
i-·i.•
•

~ No exemption: In case of loan provided for medical treatment in respect of diseases specified in Rule 3A, the exemption shall not apply to so much of the loan as has been reimbursed to the employee under any medical insurance scheme.
(2) Travelling, touring, accommodation and any other expenses paid for or borne or reimbursed by the employer for any holiday, other than leave travel concession/ assistance, availed of by an employee or any member of his household: The perquisite shall be valued as the sum equal to the amount of the expenditure. incurred by the employer in that behalf. ,/ Notes(A) Valuation when facility is maintained by employer and is not available uniformly to all employees: Value of benefit = Value at which such facilities are offered by other agencies to the public. (B) If employee is on official tour and expenses are incurred for any member of his household accom. partying him, the amount of expenditure so incurred shall also be a fringe benefit or amenity.

W~ ~f~i
E:

••

(C) where any official tour is extended as a vacation, the value of such fringe benefit will be limited
to the expenses incurred in relation to such extended period of stay or vacation. ~ The amount so determined shall be reduced by the amount, if any paid or recovered from the employee for such benefit or amenity.

I
.

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'(3), F!_eeood & non-alcoholic beverages provided by employer: Value of benefit = Amount of expenditure f Incu_rred by employer - Amount paid or recovered from the employee for such benefit or amenity. Exemption: The following.will not be treated as perquisites (A) Free food and non-alcoholic beverages provided by employer during working hours' at office or . business premises or through paid vouchers which are not transferable and usable only at eating joints, to the extent the value thereof either case does' not exceed Rs. 50 per meal. If the value exceeds Rs. 50 per meal, the excess amount shall be taxable.

I'

(B) Tea or snacks provided during working hours. (C) Free food and non-alcoholic beverages during working hours provide1d in a remote area or an offshore installation. (4)

Gift including gift uouchers and tokens received by the employee or any member of his household on ceremonial occasions or otherwise: Value of benefit == Sum equal to ~mount of such gift. Exemption: If the value of such gift or voucher or token is less than Rs. 5,000 in aggregate during the previousyear, the value of perquisite taken shall be 'nil'.

(5) Credit card or Add on card provided to employee or any member of his household": : Value of perquisite = Amount of such expenses (including the membership fees and annual fees) charged to such credit card or reimbursed by the employer - Amount paid or recovered from the employee.

Exemption: Perquisite is exempt if expenses are incurred wholly & exclusively for official purposes.
(6) Club facility provided to employee or any member of his household'" : Value of be~efit= Actual, expenditure (including the amount-of annual or periodical fee) paid or reimbursed by the employerAmount paid or recovered from'fue employee.

Exemption:-the perquisite shall be exempt in the following cases(A) Where the employer has obtained corporate membership of the club and the facility is enjoyed by the employee or any member of his household, the initial fee paidfor acquiring such membership shall be exempt. (B) If expenditure is incurred wholly & exclusively for business purposes it shall not be a perquisite.

(C) Use of health club, sports and similar facilities provided uniformly to all employees by the
employer shall not be taxable as perquisites. **Note for (5) and (6) : Where the expenses are claimed to be incurred wholly and exclusively for official. purposes, the perquisite in (5) & (6) above shall be exempt only if the following conditions are fulfilled - '

, (i) 'complete details in respect of such expenditure

is maintained by the employer which may include the date of expenditure, the nature of expenditure and its business expediency; and ' wholly and exclusively for 'the performance of official duties.

[ii] the employer gives a certificate for such expenditure to the effect that the same was incurred
(7)

Use,' by-the employee or any memberof hie household, of movable assets (other than assets elsewhere -specified in Rule Jl_belonging to the employer or hired by him: The value of perquisite shall be 10%
_ p.a. of the actual cost of such asset or amount of rent or hire Charges paid or payable by the employer less amount paid or recovered from the employee. '

Exemption: Use of Laptops and computers, belonging to or hired by the employer is exempt. ..
.-'

(8J Transfer of miy movable asset. beionging to the employer directly or indirectly to employee or any member of his household: The value of-benefit shall be calculated as follows: - '

3.26

Students' Guide to DIRECT TAXES

Computers & electronic gadgets"
Actual cost

Motorcars
Actual cost

Others
Actual cost

Less: Depreciation @ 50% under Less: Depreciation @ 20% under Less: Depreciation @ 10% Reducing Balance Method Reducing Balance Method under Straight Line Method Less: Amount, if any, paid or Less: Amount, if any, paid or Less: Amount paid by or recovered from the employee recovered from the employee recovered from employee Note 1 : The deduction on account of depreciation (normal wear and tear) isallowed completedyear during which such asset was put to use by the employer. for each

Note 2 : *Elecb:onic gadgets in this case means data storage and handling devices like computer, digital diaries and printers. They do not include household appliance (i.e. white goods) like washing machines, microwave ovens, mixers, hot plates, ovens etc. Note: Member of household shall include - (a) Spouse(s); (b) Children and their spouses; (c) Parents; and (d) Servants and dependants. (9) Any other benefit or amenity: Value of any other benefit or amenity, service, right or privilege provided by the employer = Cost of the same to the employer under ali. arm's length transaction Employee's' contribution. However, expenses on telephones including a mobile phone actually incurred on behalf of the employee by the employer shall not be taxable. RELiEF IN RESPJ?5!9F ADVANCE OR ARREARS OF SALARY

3.22 RELIEF WHEN' SALARY, ETC., PAID IN ARREARS OR IN ADVANCE [Section 89] : Section 89 read with Rule 21A provides for relief when an assessee is in receipt of a sum in the nature of salary, being paid in arrears or in advance; or in anyone financial year, salary for more than 12 months, or, profits in lieu of salary under section 17(3) or family pension as referred to in section 57(iia) being paid in arrears, due to which his total income is assessed at a rate higher than that at which it would otherwise have been assessed. Such relief is granted on an application made by the assessee to the Assessing Officer. Computation of relief in case of arrears or advance of Salary and arrears of family pension: admissible relief will be calculated as per the following steps (1) Calculate the tax payable on the total income, including the additional salary/family previous year in which the same is received. (2) Calculate the tax payable on the total income, excluding the additional salary/family previous year in which the same is received. (3) Find out the difference between the tax at (1) and (2). (4) Compute tax on total income after including the additional salary/family year to which such salary/pension relates. (5) Compute tax on total income after excluding the additional salary/family year to which such salary/pension relates. . (6) Find but the difference between tax at (4) and (5). pension in the previous pension in the previous . The

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= Tax computed

at (3) - Tax computed at (6) ..

~ If additional salary/family pension relates to more than one previous year, salary / family pension would be spread over the previous years to which it pertains in the manner explained in (4) to (6) above

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No relief, if exemption claimed ufs lO{lOq in respect of VRS compensation : No relief shall be granted under this section in respect of any amount receiyed or receivable -by an assessee on his volmtlaIy retirement or termination of his service under Volunfa_ry Retirement or Separation Scheme if an exemption u/_s 10(10q ~en claimed in respect of such or any oilier assessment year.-

Effect: The cumulative effect of sections 10(10q and 89 is (1) The assessee cannot avail of exemption u/s lO(10C} arid simultaneously claim relief u/s 89 in respect of the nn-exempt portion in the same assessment year i (2) Once exemption is claimed u/s 10(10C), no exemption u/s 10(10C) and no relief claimed for any other assessment year inrespect of VRScompensation;

u/s 89 can be

(3) Once relief is claimed u] s 89 in respect of VRS compensation received, no exemption ~Js 10(lOC) can be claimed for any other assessment year. However, if any VRS compensation is received subsequently from any other employer, relief u/s 89 can be claimed. Therefore, relief u/s 89 can be claimed more than once.

Illustration 11 -Compuiation of SalanJIncome: Naresh, who is neither a director nor he has substantial
interest in any company, is offered an employment by Freewheel Ltd., Mumbai With following alternatives :

AItenudii1e I (Rs.)
Basic pay Bonus Education allowance for 2 ~drenl Education children in a school maintained by employer facility
;/:

AItemaiWe H (Rs.)
66,OCm 9,000

66,000 9,000 facility for 2

30,200·

-_-

30,200

, :Sweeper-allowance/Sweeper

Entertainment Allowance/ Club facility Transport allowance/Free owned by the employer) car (1200cc) facility for personal use (car

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10,000
I

10;,000
6))00

6,000

12,000
18,000

12,000

Medical allowance/ Medical facility for Naresh and his family members-in a hospital maintained by employer ~
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18))00

Allowance for gas, electricity and water supply j Free gas, electricity and water supply (bills wm be in the name of tue employer) Holiday home allowance/Holiday home facility
x

4,500

4,500

8,000 50 days) 18,000 7,500 14,000

8))00

Lunch allowance/ Free lunch (Rs. 70 x 200 days + Rs. 80 Diwali gift allowance/ Gift on Diwali

18)}OO

7.500
14))00

A rent-free unfurnished home -:- lease rent

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Which of .the two alternatives Naresh should opt for on the assumption that both employer and employee will contribute 10% of salary towards unrecognised providentfund? Interest-free loan of Rs. 20,000 V\TilI given to him for purchasing household items. be

Solution: Computation of Taxable Salary of Naresh under two Alternafives {amounts in Rs.]

3.28

Students' Guide to DIRECT TAXES

.,
II:

Alt.! 66,000 9,000 27,800 10,000 6,000 2,400

Alt. II 66,000 9,000 30,200 10,000 6,000 12,000

Basic pay Bonus

Education allowance for 2 children [30200 - 100 x 12 x 2J/ Education facility for 2 children, fully taxable as the value exceeds Rs. 1,000 p.m. per child Sweeper allowance/Sweeper facility facility

Entertainment Allowance/Club

Transport allowance (12000 - 800 x 12)/ Free car (1200 cc) facility for personal use (assumed that Rs. 12000 includes all expenses incurred including normal wear & tear) Medical allowance/ Medical facility for Naresh and his family members in a hospital maintained by employer Allowance for gas, electricity and water supply/Free supply (bills will be in the name of the employer) Holiday home allowance/Holiday home facility gas, electricity and water .

18,000 4,500 8,000 18,000

o

Exempt 4,500 . 8,000 5,500

I

I Lunch
.1

amount

allowance/ Free lunch [free lunch exempt upto Rs. 50 per meal, hence, taxable == (Rs. 80 - Rs. 50) x 50 days + (Rs. 70 - Rs. 50) x 200 days] Gift on Diwali (fuJJy-filxable as amo~nt of gift exceeds Rs. 5000)

i Diwali gift allowance/

7,5001-__ 7,500 14,000 1,91,200 11,250 1,69,950 ~ ..: Alt. II 26,580 14,000 11,250 14,000
:

Rent-free unfurnished-home

(See Note)
Total Taxable Salary

Hence, Naresh should opt for Alternative II, as taxable income is less in that case.

.....

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.•

Note: Value of rent free house shall be lower of the following (a) 15% of Monetary Salary (15%of Rs. 177200 and 15% of Rs. 75000) (b) Lease rent paid

Alt. I

•••

•••

4
INCOME FROM HOUSE PROPERTY
4.1 BASIS OF CHARGE OF INCOME UNDER 'INCOME FROM HOUSE PROPERTY' : The basis of charge of income under the head 'Income from house property' is the annual value of the property. Annual value is the inherent capacity of the property to earn an income. It is the amount for which the property might reasonably be expected to let from year to year. Income from house property is charged to tax on notional basis, as generally tax is not on receipt of income but on the inherent potential of the house property to generate income. 4.2 CONDITIONS TO BE SATISFIED FOR INCOME TO BE CHARGED TO TAX UNDER THE HEAD 'INCOME FROM HOUSE PROPERTY' [Section 22] : As per section 22, the following conditions are to be satisfied for ,an income to be charged under the head 'Income from House Property' (I) The property must consist of buildings or lands appurtenant thereto: The appurtenant lands in respect of a residential building may be in the form of approach roads to and from public streets, compounds, courtyards, gardens, cattle-shed etc. (a) Vacant Plot: Vacant plot cannot be said to be a land appurtenant to a building and thus, income from such vacant ploti.§}:l.Gttaxable u] s 22, but u] s 56 as income from other sources. (b) Incomefrom.tuell within the outer walls of house: A well within the walls of a house cannot be said-to be land appurtenant to house, as it is not necessary for enjoyment of the honse. Thus, income from sale of water of well is not chargeable ix] s 22, but u/ s 56 as income from other sources. - M. Ramalakshmi Reddyv. CIT [1998}232 ITR 281 (Mad)

(2) The assessee must be the owner of such house property: For the purpose of Section 22 'owner' is a
person who is entitled to receive income in his own right. Owner includes deemed owner u/ s 27.

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(a) Dispute in title of property: In case there is dispute in relation to ownership of the property, the income therefrom shall be assessed in the hands of the person who is in receipt of such income. (b) Sublet receipt: Income from sub-letting of property is .not assessable as income from house property as the person sub-letting the property is not the owner thereof. Subletting receipt is taxable as income from other sources. However, if sub-letting is carried on as a business activity, the income therefrom will be chargeable as Profits and Gains of Business or Profession. (c) Building constructed 011 leasehold land: The income from property being building or land appurtenant thereto is assessable under this head. In case of building constructed on a leasehold land, though the assessee is not the owner of land but he is the owner of the superstructure i.e. the building. Thus, income arising from building is assessable as "Income from house property'.

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(3) The property

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should not be used by the owner thereof for the purpose of any business or profession carried on by him, the profit of which are chargeable to tax: If the property is used by the owner thereof for any business or profession carried on by him; and the profits of such business are chargeable to tax, then, income from such property shall not be chargeable to tax under this head. (a) Use for busines« must be by owner: E.g. if a company. gives its house property to its subsidiary for business of such subsidiary, then, income from such property shall be taxable under this head, as use for business purposes is not by owner of house i.e. the company, but by its subsidiary.

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The following points are-relevant to explain this point-

E:
Y:-

Students' Guide to DIRECf TAXES

(0) Letting md: for busittess purposes is use for business purposes: For example, when a house property owned by an assessee is oc....'tlpied-furTesidence by its employees/directors etc., whether on payment of rent or of her wise, to enab1e them. to discharge their functions efficiently and 1etiUtg out of the property is subseroiel1.t rum incidental to the main business of the assessee, "SUCh an occupation amounts to use of the properly by the assessee itself for the purposes of its business, even thou.gh no business is actually carried on in such premises. Income from such property is not assessable as 'Income from. House Property',' but as income from business or profesSion.- CITv. Mndi Industries Ltd. [1994] 210 ITR 1 (Delhi) (FBJ (e) P~rfner' propa.l1y in which fum carries on business is to be treated as used by the partner for his s business and is, fherefore, not assessable n] s 22.- QT v. Rasiklal Balablmi [1979] 119.ItR. 303 (Guf.>". (d) Prope...'i:yof HUF let out to fum in ~vhlm HUF is partner through the Karta is to be treated as used by Lhe owner (HUF) for ifs(fum's) business, However, where the Karta/other member of hW Is parmer i.eli individual capacity, the property is to be assessed u] s 22. - CIT v. Shri Champa Lal Je...~7''lj[19951215 ITR 289 (Mad.) and OT o. Shiv Mahan LaI [1993] 202 ITR 60 (All).

Principle of u!!f!t.mllity : Wnen the: assessee is governed by principle of mutuality, then, even the income D:~lmassessee' s property will be goeemed by the said principle of mutuality. Therefore, annual value of P!Op&-ty of a social club will be ou.tside the purview of the levy of income tax. - Chelmsford dim v. C1T[2Jl(JfJ1243 ITR 89 (SC)~
4.3 INCOME mOM
OR1INCOME

HOUSE PROPERTY

v. PROFITS AND GAl.~S OF BUSINESS OR PROFESSION

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FROM OTHER SOURCES:

On an analysis of tile various Supreme Court d....oclSions the subject, the following principles

down for classmcafim1.of mcomeunderthese heads........ r.__:;~·

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be laid

(1) HmlSe Propert]r held -as 1rouse property' VI. H(mse property 1-t£ld as Istock in trade' [East India Housing mId Land Development Trust Ltd. tr: CIT [1962]42 1TR 49 (SC)i and Karanpura Development . Co•.Ltd.. u: CIT"[1962144 ITR 362 (SC)1:
t Income attributable

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to occupation of properly as 'property' i.e. if the ownership and letting out of property is done as a landowner with a view of exploit property

Property Income Business Income

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Income: from letting of properly held by the owner thereof as 'stock-in-trade' of business, which letting forms integr-al part of the business of the owner

For example, in case of an assessee engaged in the business of promotion and development of markets, the income from letting out of shops and stalls of that market along with ancillary services be Income from House Properly. However, for a builder/developer, the income from letting of flats, etc; before their sale, is business income,

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(2) Lease '11. License: If assessee merely grants license to use its place and there is no lease/letting

out of properly, then, the income cannot be assessed as property income, the same will be assessable as 'business income'. [CITv. National Storage Pvt. Ltd. [1966] 661TR-596 (SC)1

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For example, where an assessee constructs specialised safety-vaults on his property (resembling safe~/lockers prm}iaeci by banks) and also provides various facilities like fire alarm, parcel booking, canteen
and telephone, etc., then, there is no lease to the vault-holders; they are merely licensees of the vaults. It am be said. that assessee is carrying on an. adventure or concern in the nature of trade on its own account. Since property is being used for business carried on by the ass esse, hence, the entire income therefrom would be business income. (3) Composite Rent for letting out of property as toell as rendering of services - Apportionment of Income u. Classification entirely as property income or business income [Kamani Properties Ltd. ". ,CIT [1972]82: ITR 54.7 (SCI and Sltamblm Investment P. Ltd. v. CIT [2003] 263 ITR 143 (SC)] :

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(a) Where letting of property and rendering of services constitute two different line of activities or two different sources.

4.3
Apportioned as 'property income' and 'business income or income from other sources'

(b) Vvl1erethe two activities are related so much so that it constitutes

single activity for all purposes, then, (i) if main intention of assessee is to let out property or part thereof (ii) if the primary object is to exploit the immovable property

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Property Income

by Business Income

way of complex commercial activities For example, in case where assessee lets out residential flats; and provides various facilities like provision of power through power-house; watching and warding; lifts; cleaning services etc., then, if the two activities constitute separate line of activities, the income may·be apportioned as 'property income' and 'business/other sources income' respectively. However, depending upon the intention, as aforesaid, the entire sum may be property income or business income.

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(4) Composite letting of building and planf/macl-zine/jurniture - Inseparaie letting, entire income either business income or Income from other sources; separable letting, income to be apportioned [Sultan Brothers Pvt Ltd. v. CIT [1964151 1TR 353 (SC)1: In view of express provisions of section 56(2)(ili),
the composite rent for use of property and hire charges of machinery, plant or furniture belonging to the owner shall be assessed as follows -' .
(i) If letting of property is inseparable

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from letting of other assets

(ii)

Entire income is taxable as 'business income' or as 'Income from Other Sources, if not taxable as business income'. Rent for house taxabl~ as property income; and rent for other assets taxable as business income or income from other Sources.

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If letting of property-is-separable
of other assets

from le~g

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No consideration as to primary or secondary letting: For applicability of section 56(2)(iii), it is not necessary that primary letting should be of building and secondary of plant/ machinery/furniture, or vice-versa. The only requirement is that the letting of both must be inseparable. Inseparable letting : The inseparability referred is] s 56(2)(iii). is not physical inseparability; such inseparability is an inseparability arising from the intention of the parties. A letting may' be termed as inseparable if - (i) the intention in making the lease was that the two should be enjoyed together and the letting of the two was practically one letting; (li) either of the two could not have been let alone and a lease of either could not have been accepted without the other. If these conditions are satisfied, then, the fact that lease of two is governed by separate agreements or that rent/hire for the tw9 is given separately would not make any difference. 4.4 CONCEPT OF DEEMED OWNERSHIP [Section

271 :

Generally, ownership itself is the criteria for assessment under the head incomefrom house property, However/ there are instances in which the income from property is assessable in the.hands 'of an assessee, who is not the legal owner thereof. These instances are covered under. section 27. Asper section 27, the following persons shall be deemed to be the owners of the house property: {l} Transfer tospouse or minor child without adequate consideration : An individual who transfers his house property otherwise than for adequate consideration to (a) .His or her spouse (not being a transfer in connection with an agreement to live apart) or (b) Minor child (not being married daughter),
is deemed to

be the owner of such house property ..

4.4

Students' Guide to DIRECT TAXES

(2) Holder of Impartible Estate: The holder of impartible estate of an HUF is deemed to be individual owner of ,all the properties comprised in the estate. Note: Impartible estate means an estate, which is not divisible between the members of the HUF. The concept of impartible estate has become outdated after .commencement of Hindu Succession Act, 1956. (3) PropertlJ alloted under house building scheme: A member of a co-operative society, company or an Association of Persons to whom a building or part thereof is allotted or leased under a house-building scheme of society I company I association, shall be deemed to be owner of that b~g:or Part thereof. (4) Possession holder of property: A person who is allowed to take or retain possession of any building' or part thereof in part performance-a-rei contract of the nature referred to in section 53A of the Transfer of Property Act, 1882, shall be deemed to be the owner of that building or part thereof. Note: Therefore, registration of sale deed is not necessary. A buyer who has taken possession of the property without getting sale deed registered will be deemed to be the owner of that property. - CIT v. Podar Cement (P.) Ltd. [1997] 226 ITR 625 (SC) (5) Holder of substantial lease or other rights: A person who acquires any rights in or With respect to any building or part thereof by virtue of any transaction referred to ul s 269UA(f) shall be deemed to be the owner of that building or part thereof. [Note: Section 269UA(f) refers to the following transactions (a) lease for a period of 12 years or more, or, for a period which is extendable to l:x~ars or more; (b) doing of anything (whether by way of admitting as a member of or by way of transfer of shares in a co-operative society or company or other association of persons or by way of any agreement or arrangement or ill any other manner whatsoever) which has the effect of transferring, or enabling the enjoymentof, sl1chyroperty.] "'_,-...:c-" Exceptions:The above provision excludes any rights by way of a lease from month to month or for a period not exceeding one year. Deemed owner, not actual owner liable for tax : Since the abovementioned persons are deemed to be the owner of the properly, therefore, the property income will be assessable in their hands even if they are not legal owner of such property, and the legal owner will not be liable to be taxed in respect of such property. Illustration L -Deemed Ownership: Answer the following .(a) Mr. Ram transfers a property of market value Rs. 10,00,000 to his wife only for Rs. 4,00,000. The income from such property is Rs. 1,50,000. How will the properly income be taxed? (b) Mr. Rohan gifts a property valuing Rs. 5,00,000 to his minor child being a married daughter. The annual income from such property is Rs. 25,OOQ. How will the property income be taxed? . (c) Mr. Sohan gifts Rs. 20,00,000 to his wife and the wife purchases a house property of Rs. 20,00,000 out of such money. Will Mr. Sohan be the deemed owner of the house property? (d) Mr. A gives his house property on lease to Mr. B for a total period of 13 years, but the lease is to be renewed by Mr. B annually during this period. In whose hands will the property income be assessed? (e) Mr. X gives his house property on lease to Mr. Y for a period of two years. Mr. Y can get the lease renewed for another two years on payment of a specified sum and so on for indefinite period. In whose hands will the property income be assessed? (f) 1~:5
,

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Mr. P leases his house property to Mr. Q for 8 months, which can be renewed every six months for
indefinite period. In whose hands will the property income be assessed?

Solution : The above issues can be answered as follows (a) Here Mr. Ram has transferred his house property to his spouse otherwise than for adequate consideration. Therefore, he 'will be deemed to be owner of property to the extent of such inadequacy

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4.5

of consideration i.e. 60% of house and the part of house representing the consideration i.e~40% of the house shall be assessed in the hands of spouse. Thus, property income will be assessed as follows 7 In the hands of Mr. Ram: Rs. 1,50,000 x 6,00,000 + 10,00,000 = Rs. 90,000
I

In the hands of Mrs. Ram: Rs. 1,50,000 x 4,00,000 + 10,00,000 = Rs. 60,OOD (b) In case of property transferred by way of gift to minor chilc"f being a married daughter, the transferor shall not be deemed to tile owner of the property because section 27 specifically excludes married .daughter from this purview. Hence, the property income will be assessed in the hands of tile minor married daughter by way of her representative assessee. (c) Section 27(i) speaks of transfer of house property and not the triinsfer of any other asset. In this case, Mr. Sohan doesn't transfer house property but what is transferred is money. It is immaterial that out of such money the Mrs. Sohan purchases a house property. The owner of tile house property will be Mrs. Sohan. Mr. Sohan cannotbe deemed to be the owner of such.house property. (d) In UUscase the lease is for a period exceeding 12iyears, but the same is to be renewed annually i.e. for a period not exceeding one year. Hence, the same doesn't fall uls 27 and therefore, Nil. B is not the deemed owner of tile property uls 27. The property income will be assessed in tile hands of Nil. A. (e) The lease is to be renewed after every two years. but the lessee i.e. Nil. Y has a rightto get it renewed after every two years for indefinite period. Hence, the total period oflease be more than 12.years and therefore, Mr. Y will be deeined to be the owner of the house property and property income will be assessed in ills hands.

tan

(f)

Since the lease is to be renewed every six months i.e. for a period not exceeding one year, therefore, lease doesn't fall under section 27 and Nil. Q cannot be deemed to be the owner of the house property. Thus, the propertyinco_l11.~will assessed in the hands of Mr. P.

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4.5 DETERMINA TION_ OF ANNUAL VALUE OF A HOUSE PROPERTY [Section 23(1)] : The computation of Atmu~l Value of a House Property involves the following two steps(1) Computation of Gross Annual Value (GA V)
i

(2) Computation of Net Annual Value (NA V) oriAnnual Value (1) COMPUTATION OF GROSS ANNUAL VALUE (GAV): The gross annual value of a house property \vill be calculated as per the following three steps STEP I: Expected Rent (ER) [Sec. 23 (1) (a)]: Expected rent-is tile sum for which the property might reasonably be expected to be let out from year to year. It is the sumhigherof Fair Rent and Municipal Rent (Valuation) but it cannot exceed Standard Rent fixed by any Rent Control Act. i.e. Expected Rent == Higher of Fair-rent or Municipal valuation; subject to maximum of Standard rent.
,-:..,

Upia this 'step, Gross annual value =Expecied rent.

STEP II: If Actual Rent Reoeiued or Receivable (ARR) exceeds.Expected Rent (ER) [Sec. 23 (1) (b)]: Where the pl:~ty 'or illY part thereof is let out and the actual rent received or receivable by the owner in respect thereof is in excess of the Expected Rent referred to in Step I, then, Gross- Annual Value (GAV) Notes (A) This step is applicable-only when the property or any of its part has been let out during any part of the previous year. (B) Actual rent receioed/receioable (ARR) : Amount of actual rent received or receivable by owner (Le. ARR) shall not incl~de unrealised rent i.e. amount of rent, which the owner cannot realise. Therefore, w~e~_o~puting ARR always deduct the amount of unrealised rent, if any.
= Actual

Rent Received or Receivable (ARR)

4.6

Students' Guide to DIRECT TAXES

Unrealised-Rent: As per-Rule 4 the unrealised rent is the amount of rent payable but not paid by a tenantof the assessee and so proved to be lost and irrecoverable. It shall be deducted from ARR only if following conditions are satis!ied (a) The tenancy is bona fide; (b) The defaulting tenant has vacated or steps have been taken to compel him property;

to vacate the

(e) The defaulting tenant is not in occupation of any other property of the assessee; and
(d) The assessee has taken all reasonable steps to institute legal proceedings for the recovery of the-unpaid rent or satisfies the Assessing Officer that legal proceedings would be useless. STEP III: Actual rent receioed/receiuable (~) is less than Expected Relit (ER) [Sec. 23(1)(c)]= H1:%1 \;;,;,1

(a) The property or any part thereof is let out; and

(b) Such property was vacant during the whole or any part of the previous year; and (c) Owing to such vacancy the actual rent received or receivable by the owner in respect thereof is less than the Expected Rent referred to in Step I i.e. ARR is less than ER due to vacancy, then, Gross Annual Value (GA V) Computationai Notes:
= Actual

Rent Received or Receivable CARR)

(A) Determining whether actual rent received/receivable is less than expected rent due to vacancy: For determining whether ARR is less than ER due to vacancy adopt following procedure (a) First of all find the ARR for the period for which the property was let
(b) Then find out the annual e,pected rent of the property as per Step I above. (c) Now find out the p;~p;rtioriate expected rent for the period for which property was occupied whether let out or self occupied i.e. Proportionate ER ER x·Months for which property was occupied, whether let out or self occupied

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12

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--

(d) If ARR exceeds such proportionate ER, it can be said that ARR is less than ER due to vacancy and GA V = ARR. In any other case GAV = Expected Rent as per Step 1 above. (B) Property remaining vacant for whole of the year: In case the let out property has remained vacant during -the whole of the previous year then the annual value in respect of such property will be taken as nil because in that case ARR (which is NIL) is less than the ER due to vacancy. (2) COMPUTATION OF NIT ANNUAL VALUE (NA V): Net Annual Value is the sum computed after deducting from Gross Annual Value, the taxes levied by any local authority in respect of the property. Thus, NAV
=
1.:-.:'.

GAV - Municipal Taxes actually paid by the assessee during the previous year.

Other points in respect of Municipal Taxes: (A) Municipal taxes include service taxes levied ill respect of property: Vide Sec. 27(vi) taxes levied by a local authority in respect of any property shall be deemed to include service taxes (such. as fire tax, education cess, water tax) levied by local authority in respect of property. (B) Tax deductible only if actually paid: Such municipal taxes are deducted from GA.V of the previous year in which such taxes are actually paid by assessee (irrespective of the previous year in which liability to pay such taxes was incurred by the owner according to the method of accounting regularly employed by him). In other words, municipal taxes are deducted from GAV only if they have been actually paid by the assessee during the relevant previous year.

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Income from House Property

4.7

(C) Taxes must be paid by assessee; if they have been paid by tenant, no deduction will be allowed.
f.

(D) In case of a resident assessee, his entire global-income is chargeable to tax. So, income from his house property situated outside India will be computed as per the provisions of Section 22 to 27. Thus, municipal taxes levied by local authority in that country and actually paid by the assessee are deductible in determining the annual value of the property. . Case Laws (1) Municipal Tax Refunds not taxable under any head: If municipal taxes allowed as deduction on . payment basis are refunded on appeal or otherwise, the same cannot be brought to tax under any head. It cannot be brought to tax under 'income from house property' because there is no specific provision taxing remission or waiver of liability corresponding to Section 41(1). The same cannot be . brought to tax under income from other sources because heads of income are mutually exclusive and if an income falling under particular head cannot be brought to tax under that head, it cannot be brought to tax under any other head. - CITv.lndia Automobiles Ltd. [2001] 251 ITR 117 (Cal). (2) Notional interest on interest-free advances not taxable: In absence of any provision to this effect, no notional interest on interest-free advances/ deposit from the tenant can be added for the purpose of. assessing income from house property. - CIT v. Asian Hotels Ltd. [2010]323 ITR 490 (Delhi).

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4.§ TAXATION OF INCOME FROM PROPERTIES SITUATED OUTSIDE INDIA: Income from properties situated outside India is liable for taxation in India if (a) The owner of the property is resident in India; or (b) The owner of the property is non-resident or not ordinarily resident in India and the income from such property is received in India. When income from a house property' is taxable in India, then, the computation ; made in accordar:~e with the provisions of this Act i.e. sections 22 to 27.
.

;/.

of such income shall be

The municipal taxes paid outside India shall be deductible from the gross annual value of the house property if such taxes have been actually paid by the asses~ee during the previous year. Illustration 2 -Computaiion of Gross Annual Value: Determine Gross Annual Value in following cases -

Particulars
Fair Rent (FR) Municipal Value (MV) Standard Rent (SR)
I House Rentals (p.m.)
I "-

House 1 (Rs.)
1,00,000 2,00,000 1,50,000 20,000 12 NIL

House 2 (Rs.)
1,50,000 3,00,000 4,00,000 30,000 5 NIL

House 3 (Rs.)
4,00,000 5,04,000

House 4 (Rs.)
6,00,000 3,00,000 2,00,000 15,000 . 7 NIL

HOllse 5 (Rs.)
4,00,000
,

6,00,000

--50,000 . 61

--60:000 10
1

IUnrealised
Solution:

I Let out period

(in months)

Rent (Rule 4)

54,OO~ House 2
1,50,000

90,000

Computation of Gross Annual Value

House 1
Actual Rent Received/Receivable [Actual Rent - Unrealised Rent] (ARR) 2,40,000

House 3
2,46,000

House 4
1,05,000

House 5
5,10,000

Step I: Expected Rent = Higher of FRor MV subject to maximum of SR Step II: If ARR exceeds ER, GA V = ARR

1,50,000 . 2,40,000

3,00,000 NA

5,04,000 NA

2,00,000 NA

6,00,000 NA

·4.8

Students' Guide to DIRECT TAXES

Step III: If iis less tfJan ER due to vacancy, GAV= ARR(See Note below) Gross Annual Value'

J\.RR

NA 2,40;000

1,50,000 1,50,000

NA
5,04,000

NA 2,00,000
I

510,000 .5,10,000

Note: Mode of determination whether ARR is less than ER due to vacancy

House 2 Actual Rent Received/ Receivable (ARR) Proportionate ER. [i.e. ER . property is let ...12]
x

House 3 2,46,000 2,52,000

House 4 ··1,05,000 1,16,667

HouseS 5,10,000
...--.

1,50,000 for which 1,25,000

Months

5,00,000 to

If ARR exceeds Proportionate ER, then ARR is less than Due vacancy ER due to vacancy, Otherwise ARR is less than ER not due to vacancy .
.

to Not due to Not due to Due vacancy vacancy vacancy

..

. 4.7 ANNUAL VALUE OF A SELF-OCCUPIED HOUSE PROPERTY [Section 23(2) TO 23(4)] : (1) Self-Occupied Property [Sec. 23(2)]: In the following cases, the annual value is taken to be NIL - . (a) Where the property consisting of house or part thereof is in the occupation of the owner for the purposes of his own residence; or (b) Such property cannot actually be occupied by the owner by reason of the fact that owing to his employment, business or profession carried on at any other place, he has to reside at that other place in a building not belQ~giPg to him. . Important po~~ts: (A) Since in these cases annual value of the property is taken to be NIL, the municipal taxes paid by the owner of the house need not be considered. • (B) Exemption of self-occupied is available only if the house property is occupied by the owner himself for the purposes of his residence. . If the house property is occupied by relatives of owner for the purposes of their residence, benefit of self-occupation will not be available. (C) Similarly, where the assessee let out his house to his employer and the employer allotted the house to the assessee as rent-free quarters, the benefit of allowance for self-occupation uls 23(2) would not be available to the assessee. (2) Withdrawal of Exemption of Self-Occupied [Section 23(3)]: The exemption under section 23(2) in case of self-occupied property shall not apply if, (c) Such house or part thereof is actually let during the whole or any part of the previous year; or (d) Any other benefit therefrom is derived by the owner

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If exemption doesn't apply: When exemption of self-occupied doesn't apply then, the annual value of-house property is to be computed as per Section 23(1), as if the property is not self-occupied. (3) Two or more Self-Occupied Houses [Section 23(4)]: Where the self occupied house property referred to under section 23(2) consists of more than one house, then, (a) Anyone to be treated as self occupied: Annual Value (NA V) of anyone such house as specified by the assessee shall be taken to be NIL. 'Thisoption may be changed from year to year. (b) Others to 'be treated as deemed let out: The annual value of the other house(s) shall be determined as per Section 23(1} as if such house(s) had been let out.

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Income from House Property

Note: In case o{ a property whose one portion is self-occupied and other portion is let out: The value of self occupied PQitiqn".'WillpeitPinputed separately as per Section 23(2)(a) i.e. the annual value of such , housej'portion will be nil aJ;la the value of let out portion will be computed separately as per Section 23(1). Municipal valuationor _lair rent, if not given separately, shall be apportioned between the let out portion and.self-occupied portion-either on plinth area or built-up floor space or on such other reasonable basis. The ;Saih~pr-in~!ple",,$~ll'appiyior property taxes if given on a consolidated basis. Illustration 3 -TJcnefit of uacano] available even if property intended to be let out: Ram is the owner of a ,house property, which is self-occupied upto 31-3-2010, since the date of his purchase. After that he decided to let it out. Despite his efforts to let the same out, the property remained vacant for a period of 3 months and it could be 'actually let on 1-07-2010 at Rs. 10,500 pm. The Fair Rent of property is Rs. 1,20,000. Compute Gross Annual Value of the house property. Solution: Since self-occupied house is let out subsequently, no exemption benefit shall be available under section 23(2). Its GAV shall be computed under section 23(1). Here ARR is less than ER i.e. Rs. 94,500 (10,500 x 9) is less than Rs.l,20,000 . .Though section 23(1)(c) uses the expression 'let out and vacant' and, prima fade, it would appear that benefit of vacancy is available only if the letting out precedes vacancy. However, it was held in Premsudha Exports Pvt. Ltd. v. ACIT [2007] 295 ITR (AT) 341 (Mumbai) that the expression 'let out' in section 23(1)(c) means 'intended to be let out'. Therefore, where the assessee had an intention to let out the property and he had made requisite efforts to let out the property, then, he will be eligible for the benefit of vacancy and the annual value of such property shall be computed under section 23(1)(c). Accordingly, the computation shall be as follows '(a) during the previous year, the prgperty was occupied for a total period of = 9 months ; (b) Proportionate expected re~t1or9 months

= 120000 x 9.;. 12 = Rs. 90,000;

(c) Since ARR'is greeted than PER, therefore, it can be concluded than ARR is less than Expected Rent due to vacancy. Henqe, Gross AIU1ualValue = ARR = Rs. 94,590. 4.8 DEDUCTIONS ADMISSIBLE IN COMPUTING INCOME FROM HOUSE PROJ?ERTY [Section 24] :
.'

Income chargeable under the head "Income from house property" following deductions Nature of deduction (a) Statutory deduction

shall be computed after making the

Quantum of deduction 30% of annual value (i.e. 30% of NA V)

(q) Interest payable on capital borrowed for Actual amount of interest for the year on accrual basis

acquisition, construction, repair, renewal or Add: 1/5'" of the interest, if any, pertaining to the prereconstruction of house property. acquisition or pre-construction period** **Interest of pre-acquisition period is computed and allowed as deduction as follows -

2}

(a) Pre-acquisition/ pre-construction period

= Period

starting from date of borrowing and ending on the 01'

(i) 31'1 March immediately prior to date of completion of construction

acquisition of property, or

(ii) date of repayment of.loan,

whichever is earlier. (b) Interest of pre-acquisition or .pre-construction period = Funds borrowed for acquisition construction of a house property x Rate of Interest x Pre-acquisition or pre-construction period (c) and

Deduction = 1/5th of the interest of pre-acquisition or pre-construction period, for 5 consecutive years starting from the previous year in which the property is acquired, or constructed.

'4.10

Students' Guide to DIRECT TAXES "

Maximum limitof deduction in respect of interest on capital borrowed in case of a Self-occupied property , whose annual ualue is assessed at NIL : The maximum limit is Rs. lSO,OOO with following break-up Case Maximum deduction 1,50,000

(1) Interest on capital borrowed on or after 1-4-1999for acquisition or construction of house. ~ New loan also covered: Deduction is admissible even if the interest pertains toa new loan taken by the assessee for repayment of whole or any part of capital borrowed earlier. ~ Conditions : This case is applic~ble only if(a) such acquisition or construction is completed within 3 years from the end of the financial year in which capital was borrowed; and (b) the assessee futnishes a certificate, from the person to whom any interest is payable on the capital borrowed, specifying the amount of interest payable by the assessee. (2) In any other case i.e. if the interest relates to(a) Capital borrowed (b) Capital (c) before 1-4-1999 for acquisition, construction, repair renewal or

30,000

recons~ction of house property; or

o~rowed on or after 1-4-1999 for repair, renewal or reconstruction of house: or Capital borrowed as per (1) above but any condition mentioned therein is not satisfied.

IMPORTANT POINTS, CASE LA WS AND CIRCULARS: '-(a) Partly let out and partly self-ocr:llpi~d property (portion-wise) : In case a portion of the property is let out and other portion is self-occ'iipied, interest relating to the let out portion shall be allowed fully '~ithout any restrictionand interest relating to the self-occupied portion is shall be allowed upto Rs. 30,000 or Rs. 1,50,000, as the case may be.

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(b) Scope of 'interest' : Interest includes service fee or other charges in respect of money borrowed. Hence, brokerage or commission to arrange the loan is deductible as interest on capital borrowed. (c) Interest on unpaid interest is not allowable asdeduction, - Shew Kissen Bhatter v. CIT [1973] 89 ITR 61 (SC). as unpaid interest is not' capital borrowed',

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(d) Interest on unpaid purchase price is allowable : If, instead of raising a loan from a third party, the buyer pays the sale price to the seller in instahnents along with interest, then, such interest is allowed, - CIT v. Sunil Kumar Sharma [2002] 254 ITN. 103 (P& H). 4.9 AMOUNTS NOT DEDUCTIBLE [SEC. 25] : Notwithstanding anything contained in section 24, if -

(a) any intetest payable outside India is chargeable under this Act in the hands of recipient thereof i and (b) no tax has been paid or deducted at source on such interest; and (c), there is no person in India who may be treated as an agent under section 163 in this respect, then, such interest shall not be allowed as deduction in computing "Income from house property". Illustration 4 -Comprehensioe Illustration Ott Computation of Income from House Property : A and B construct their houses on a piece of land purchased by them at New Delhi, The built up area of each house is 1,000 sq. ft. (ground floor and an equal area in the first fIoor). A starts construction on April I, 2009 and completes it on March 31, 2010. B starts the construction on April 1,2009 and completes on June 30,2010 and lets out the first fIoor for a rent of Rs. 15,000 per month. The tenant vacates the house on December 31, 2010 and B occupies the entire house during the period January I, 2011 to March 31,2011. The following is the other information: Rs.

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IlfI1Iti~iiftlfl"I!J!~~tl~1~~I\filll!j'lfftf&iit;~lrj~'6111t*i\\)~~~\~~l

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Income from House Property

Fair rental value of each unit (ground floor/ first floor) (per annum) Municipal value of each unit (ground floor/ first floor) (per annum) Municipal taxes paid by - A B Repair and maintenartce charges paid by - A
B

4.11
72,000 1,00,000 8,000 8,000 28,000 30,000

A has availed a housing loan of Rs. 20 lakhs @ 12 %on April 1, 2009. B has availed a housing loan of Rs. 12 lakh @ 10% on July I" 2009. No repayment is made by either of them till March 31, 2011. Compute the income from house property. (Nov. 2003) Solution:
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Computation

of Income from House Property of A and B (amounts in Rs.) A Self occupied Unit 1 - Self occupied B Unit 2 - Partly SOP and partly let out 75,000 54,000 90,000 75,000 90,000

Municipal value (a) (for 9 months) Fair rent (b) (for 9 months) ARR (15,000 x 6) (c) Step I: Expected Rent [(a) or (b) whichever is more] Step II: ARR exceeds ER Step III: Not applicable GROSS ANNUAt VALUE Less: Municipal taxes Net Annual Value Less: Deductions under section 24 Statutory deduction (30% of NA V) Interest on borrowed capital (Note 3) Income from House Property Notes: Nil Nil

90,000 4,000 (50% of 8,000) 86,000 25800 69000 -8,800

1,50,000 -150,000

69,000 -69,000

(1)' 'A' has occupied the entire house for self-occupation. So, annual value of house of A shall be 'NIL'. (2) B has occupied the ground floor for self-occupation from 1.07.2010. Its annual value will be computed under section 23(2). The first floor is let for a part of the year and then it is self-occupied. Its annual value will be computed under section 23(1). However, since the house has come into existence on 1.07.2010, the annual fair value and annual municipal value for the period when the 'property was in existence (9 months) shall be considered for computing Gross annual value. (3) . Interest on-borrowed capital: It has been computed as follows(a) 'A' startedconstruction on 1-4-2009, which ended on 31.03.2010. Since A had taken loan on 1.4.2009 and the construction was completed on 31.03.2010, there is no pre-construction period. The interest for period from 1.4.2010 to 31.03.2011 i.e. Rs. 2,40,000 shall be deductible, subject to maximum limit of Rs~1,50,000. (b) In case of 'B' the pre-construction period starts from 1.07.2009 (date of loan) and ends on 31.03.2010.The interest for the said period i.erfor 9 months shall be: -

4.12

Students' Guide to DIRECT TAXES ...

Rs. 12,00,000 x 10 % x (9 7- 12) = Rs. 90000; Rs. 45,000 for ground floor and Rs. 45,000 for 151 floor.
The said interest is deductible ill five equal annual instalments starting with previous year 201011, each installment being Rs. 9QOO Rs. 45,000 7- 5). (i.e. Interest of Rs. 1,20,000 for current year will be apportioned between the two units at Rs. 60,000 each. Therefore, total interest deductible = Rs. 69000 (i.e. Rs. 60,000 + Rs. 9,000) in each case.

4.10 TAXATION OF REALISATION OF U.NREALISED RENT OF EARLIER YEARS [SECfION 25AA] & TAXATION OF RECEIPT OF ARREARS OF RENT [SECTION 25B] OR EXCEPTIONS TO THE RULE THAT PROPERTY INCOME IS CHARGED TO TAX ONLY IF THE ASSESSEE IS THE OWNER THEREOF IN THAT PREVIOUS YEAR: (1) Recovery of unrealised rent [Section 25AA]: Any amount of rent realised by the assessee during the previous year, which he could not realise from a property let to a tenant, shall be deemed to be income chargeable under the head "Income from house property".
c} Such recovery of unrealised rent will be charged to tax as the income of the previous year. in which it is realised whether or not the assessee is the owner of that property in that previous year.

Taxable Amount: 100% of the amount actually received. (2) Arrears of Rent [Section 25B]: This section applies when(a) the assessee is the owner of any property consisting of any buildings or lands appurtenant thereto which has been let to a tenant; and (b) he has received any amount, by way of arrears of rent from such property, not charged to income-tax for any previous year.
r::} Arrears of rent shall be deemed to be income chargeable under the head "Income from house property". It shall be charged tQjrrtome tax as income of previous year in which it is..received, whether or not the assessee is owner of that property in that Year.

Taxable Amount: The amount received as arrears of rent

xxx xxx
_ ...

Less: 30% of such amount

Amount taxable as arrears of rent

_-

xxx

il~ r(;~
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Illustratiott 5 ..Property income itt case of receipt of unrealised rent as well as arrears of rent: Rohitashava is the owner ora commercial property let out at Rs. 20,000 p.m. The municipal tax on the property is Rs.
25,000 per annum, 50% of which is payable by the tenant. This tax was actually paid on 15th April 2011. He had borrowed a sum of Rs. 10 lacs from his cousin, resident in U.S.A. (in dollars) for the construction of the property-on which interest @ 10% is payable. He has also received the following during the previous year (a) Recovery of unrealised rent of Rs. 40,000. (b) Arrears of rent of Rs. 20,000, which was not charged to tax in the earlier years. (c) He was asked to pay Rs. 60,000 as municipal tax last year. He had paid that amount and claimed deduction while computing annual value last year. He went into appeal and the municipal tax was determined at Rs. 25,000 p.a. Consequently, he was granted refund of Rs. 35,000 during this year. Compute the property income of Rohitashava for the assessment year 2011-12 ?

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Solution: Computation of Income from House Property of Rohitashava for Assessment Year 2011-12 Rs.
Gross Annual Value of property [20,000 x 12] Less: Municipal-taxes (Not deductible as not actually paid during the previous year) Net Annual value 2,40,000 0 2,40,000

Rs.

Income from House Property

Less: Deduction under section 24 (a) 30% of Net annual value (b) Interest (Deductible assuming that tax has been deducted at source and paid) Recovery of unrealised rent taxable u/ s 25AA (It isfully taxablein the year of receipt) Arrears of rent received Less: Deduction under section 25B (30% of arrears of rent received) Income from house property 20,000 6,000 72,000 1,00,000

4.13

68,000 40,000 14,000 1,22,000

).

Note: Municipal tax refunds of Rs. 35,000 are not taxable under any head. [CIT v. India Automobiles Ltd. [2001J 251 ITR 117 (Cal).J Illustration 6 -Income from House Property: Rohit is owner of a house property, its municipal valuation is
Rs.80,OaO. It has been let-out for Rs:11.20,OOO per annum. The local taxes payable by the owner amount to Rs.16~000,but as per agreement between the tenant and the landlord, the tenant has paid the amount direct to municipality. The landlord, however, bears the following expenses on tenant's amenities (amounts Rs.): Extension of water connection 3,000 Water charges 1,500 Lift maintenance 1,500 Salary of gardener 1,800 Lighting of stairs 1,200 Maintenance of swimming pool 750 The landlord claims the following deductions : .~ . Repairs and collection chargesv.>" 7,500 Land revenue paid 1,500 .Compute the taxable income of Rohit from the house property for the assessment year 2011-12.

Solution: Computation

of income from the property:

Total sum received from the tenant

1,20,000 -3,000 -1,500 -1,500 -1,800 -1,200 -750 1,10,250 33,075 77,175

Less: Sum incurred towards tenant's amenities (See Note 1) Extension of water connection Water charges Lift maintenance ~alary of gardener Lighting of stairs Maintenance of swimming pool Annual Value/Total Rent received for the property (No deduction for municipal tax - Note 2)

Less: Standard Deduction @30% Income from house property Notes:

(1) Value of personal amenities of tenant- Not form pari of 'rent' received : Computation of property income is in two stages, one determination of annual value under section 23 and the other, computation of income from property by deductions allowable from annual value under section 24. Where the landlord bears the tenant's burden, it should go to reduce the annual value, but where the tenant undertakes the burden of the landlord, the annual value will be correspondingly increased. Section 22 attempts to assess is the annual value of the property consisting of any building or land appurtenant thereto. The rent being charged by the assessee is only an alternate measure of the said annual
\

4.14

Students' Guide to DIRECT TAXES

. value. The expenditure on items like the salary (including bonus) to the maintenance staff of the facilities as electric motors, lift, cleaning, etc., as well as that on the electricity consumed in respect of apy common area and the electric motors,is not attributable d~the .house property as such, but to its enjoyment by the tenantj users thereof. The said expenditure is incurred by the tenant with the landlord having no role therein, so that who pays the same inthe-firstsinstance, is only a matter of mutual arrangement or convenience. The rent being charged by-the assessee, which represents the measure of its annual value; would be computed in accordance with such arrangement and would stand correspondingly reduced, -' The sum incurred by the landlord towards amenities of the tenant is included in Rs. 120000, the sum for which the property was )et out. Accordingly, the "actual rent" for the property is to be computed by . excluding such sums, which are incurred on behalf of the tenant, for his personal amenities. The expenses so incurred as per the' terms of the agreement cannot form part of the rent uj s 22. - J. B. Patel and Co. v. Deputy CIT (Assessment) [20091312 ITR (AT) 171 (Ahmedabad). (2) Since the municipal tax has not been borne by the landlord, no deduction can be claimed in its respect. (3) Repair and collection charges and land revenue incurred by the landlord are not deductible; Only q. standard deduction@ 30% of the Net Annual Value shall be available. 4.11 TAX TREATMENT OF PROPERTY OWNED BY CO-OWNERS [SECTION-z6f;
,

Under section 4, an association of persons is also one of the entities on which tax shall be charged in respect of the previous year on the income accruing or arising or received or deemed to be received. There is an exception to this rule. The exception is section 26. This section provides for tax treatment of property owned by co-owners in the following manner (1) Where property consisting of buildings or buildings and lands appurtenant thereto is owned by two or more persons and their respective shares are definite and ascertainable, then, .., (a) in respect of such property-suchpersons (i.e. co-owners) shall not be assessed as an Association of Persons, but, . <".,,_/ (b) the share C?f each such person in the income from the property will be computed in accordance with sections 22 to 25 and shall be included in his total income. (2) In case of self-occupied property ujs 23(2), the annual value of the property for each such co-owner shall be nil and each of the co-owner shall be entitled to the deduction of interest on borrowed capital. (3) If the respective shares are not definite and ascertainable, the co-owners shall be assessed as Association of Persons in respect of such property. 4.12 CIRCUMSTANCES IN WHICH INCOME FROM HOUSE PROPERTY IS EXEMPT FROM TAX: Property income from or Property income of the following is exempt from tax (a)Farm house [Sec. 2(lA)(c)]; (d)Propei·ty held for charitable purposes [Sec. 11]; (b) Local authority [Sec. 10(20)]; (c)Trade union [Sec. 10(24)];

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(e)An approved scientific research (f) Anyone palace of ex-ruler association [Sec. 10(21)]; [Sec. 10(19A)];

(g) Hospital. or other medical (h) University or other educational (i) In case of a person resident of institution [Sec. 10(23C)]; institution [Sec. 10(23C)]; Ladakh [Sec. 10(26A)];

(j) Property
[Sec. 13A];

of a Political party

(k) Property used for own business (I)One self-occupied or profession [Sec.22]; [Sec.23 (2)];

property

(m) Property income of an authority constituted for the purpose of planning, development or improvement of cities, towns and villages [sec. 10(20A)]; (n)Any income derived from letting of godowns or warehouses for storage, processing or facilitating the marketing of commodities by an authority constituted under any law for the time being in force for the marketing of commodities [Sec. 10(29)].

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5
PROFITS AND GAINS OF BUSINESS OR PROFESSION
IN1RODUCTION 5.1 INCOMES CHARGEABLE TO TAX UNDER THE HEAD "PROFITS AND GAINS OF BUSINESS OR PROFESSION" [Section 28] : (1) Profits and gains of any business or profession carried ~n by assessee at any time during previous year; (2) Compensation or other payment due to or received by any person-, (a) managing whole or substantially whole of affairs of an Indian company or any other company in India at or in connection with the termination of his management or modification of the terms and conditions relating thereto. . (b) on termination or modification of contract of his agency in India. (c) for vesting the management of any property or business in Government or any corporation owned or controlled by the Government. (3) Income derived by trade, professional or other similar association from specific services rendered to its members. This clause is an exception to general rule' that income from mutual activitlj is not chargeable 'to tax . (4) Profits on sale of import.licence: or Profits on transfer of Duty Entitlement Pass Book (DEPB) or Duty .-/: Free Replenishment Certificate«BFRC) under EXIM policy; __ .
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(5) Cash assistance against exports from Government of India and Duty Drawback; (6) Value of any benefit or perquisite, whether convertible into money or not arising from exercise of business or profession. (7) Interest, salary, bonus, commission or remuneration due to or received by partner from the firm. Such income is taxable. ill hands of partners to the extent it is allowed as deduction in hands of finn. Any amount not allowed as deduction tofinn under section 40(b), is not taxable in the hands of partner. (8) Any sum received or receivable, in cash or in kind, under an agreement for (a) Non-competition i.e. not carrying out any activity in relation to any business; or (b) Exclusivitlj i.e. not sharing any know-how, patent, copyright, trademark, licence, 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 provision of services.
.

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Exceptions: However, sum received for transfer of business, or transfer of right to manufacture, produce
or process any article/thing, which is chargeable under 'Capital Gains' is not taxable under this section. (9) Any sum (including bonus) received under Keyman Insurance Policy. (10) Any sum, whether 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 a deduction under section 3SAD. Balkris]ma Hira~al

IPayment 1- Payment

011

retirement of advocate-partner - Retiring partner not to practise for 3 years not a benefit in exercise 'Ofprofession uls 28(iv) :

Want v. ITO! The assessee, a partner in a firm of solicitors, received a lump sum on retirement from the [2010J 321 firm on his superannuation. The partnership deed provided that a partner who retired ITR 519 vohmtarily or was required to withdraw from tlle firm,.would not practise for'the next
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5.2
(Bom)

Students' Guide to DIRECT TAXES

three years. The Assessing Officer, in view of this provision in the deed, inferred that the payment on retirement was compensation for renunciation of the right to carry onprofession, hence, a taxable perquisite u/ s 28(iv). it could riot be said that the payment was for renunciation of right to carry on profession. Further, income which can be taxed under section 28(iv), must not only be referable to a benefit or perquisite, but it must be arising from exercise of profession, which was not in the present case. Further, since the payment was in cash, section 28(iv) could not apply, as section 28(iv) applies to benefits in kind "whether convertible into money or not"; money itself is not covered.

Held that, since the assessee had retired on superannuation,

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5~2·MODE OF COMPUTATION OF INCOME UNDER THE HEAD 'PROFITS BUSINESS OR PROFESSION' {Section 29] : Net Profit as per Profit and Loss Account

AND GAINS OF xxxx xxxxxxxx

Add: Non-Allowable expenses debited to Profit and Loss AI c. [Sec. 37(2B), 38,40, 40A, 43B; expenses allowable under any other head or capital expenditure] Less: Expenses Allowable under this head but not debited to P&L

AI c [Sec. 30 to37(1)]

Less: Incomes credited to P&L A/ c but not taxable under this head [Section 15, 22, 45 and 56 or incomes e;einpt u/s 10] Add: Incomes not credited to P&L A/ c but chargeable under this head [Section 28,41] Profits and Gjlins of Business and Profession
0

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xxx x

5.3 GENERAL CONDITIONS TO BE FULFILLED FOR CHARGING AN INCOME UNDER THE HEAD ·"PROFITS AND GAINS OF BUSINESS OR PROFESSION' : (1) There should be profits & gains : Only real profits and gains are liable to tax and not mere gross receipts. However, there is an exception, stock-in-trade is valued at lower of cost or market price. (2) Profits and gains may be of any business or profession: also chargeable to tax under this head. Profits and gains from an illegal business are .

(3) Business or profession must be carried on by assessee : The profits and gains from business or profession are taxable in the hands of the person who has the right to carryon the business. becomes a legal entity in the eye of law only when it is incorporated. Therefore, the preincorporation profits cannot be included in the assessment of the assessee-company. For such profits only the promo~ers can be held liable. (4) Business or profession should be carried on at any time during previous year : The business or profession must have been carried on for some time during the previous year. However, a temporary suspension of activities of the business does not necessarily amount to discontinuance of the business. However.In the following cases, the receipts are taxable even if the assessee/recipient business or profession during the previous year .; (a) Amount unutilised or misutilised from Tea/Coffee/Rubber (c) Sale of telecommunication license [Section 35ABB] (b) Amount unutilised or misutilised from Site Restoration Fund [Section 33ABA] (d) Amounts taxable under section 41(1), 41(2), 41(3),41(4) and 41(4A); (e) Sale of mineral oil business [Section 42] (f, Any sum received after discontinuance of a business or profession. [Section 176(3A)/176(4)] carried on no
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>- A company

Development A/ c [Section 33AB]

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Profits and Gains

or Business

or Profession

5.3

Income from letting of business assets: In case of temporary letting out of business assets while assessee is
carrying out his other business activities, the letting income is taxable as business profits. Butif the business never started or has started but ceased with no intention to be resumed, then letting income 'will be taxable as income from other sources. - Universal Plast Ltd. v. crr [1999] 237 ITR 454 (SC) 5.4 CONCEPT OF -BUSINESS' AND 'PROFESSION' : (1) Business: According to Section 2(13), 'Business' includes any trade, commerce, manufacture or any adventure or concern in the nature of trade, commerce or manufacture.

Trade Commerce Manufacture Any adventure or concern in the nature of trade, commerce or manufacture

It means purchase and sale of goods carried on with profit motive. It means trade carried on a large scale. Definition of manufacture already discussed in Chapter - 1.
I

I:}The expression adventure in nature of trade clearly suggests that the transaction cannot. be properly regarded as trade or business. A single isolated transaction outside the assessee's line of business may constitute adventure in nature of trade and commerce. I:}Whether <Ill activity is an adventure or concern in the nature of trade, commerce or; manufacture is to be decided on the basis of cumulative effect of the facts and. circumstances of each case. I:} example of such adventure or concern is where the assessee purchases a plot of land An . and builds a complex on it and divides it into office spaces and sells each of these, thereby" makinga profit from the entire activity. . -,

Essential features of a busiiiessar!:,;_(a) Regularity of transactions or continuity of activities; (b) Objective of : earning Profits; (c) Application of labour and skill.

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(2) Profession:

As per Section 2(36) profession includes vocation.

Prafession . Vocation

It involves occupation requiring purely intellectual or manual skill, which is based 'on continuous learning & experience. It is exercised to earn a living. E.g. Politics is a profession. It means any work performed on the' strength of one's natural ability for that work. It need not be for making an income nor need it involve any systematic and organized activity.

55 METHOD OF ACCOUNTING FOR COMPUTING BUSINESS INCOME [SECTION 1451: .' Income under the head 'Profits and gains of business or profession' is computed as per the method of accounting regularly employed by the assesseee. If the assessee follows mercantile system of accounting, the income will be computed on. accrual basis and adjustments will be made for outstanding incomes/expenses, prepaid expenses and unearned incomes. However, if the assessee follows cash system of accounting, only the items of incomes/expenses received/ paid during the previous year will be considered. actually

5.6 METHOD OF ACCOUNTING IN RESPECT OF SALES, PURCHASES & INVENTORY [5. 145AJ : For computing income chargeable under this head, the valuation of purchase and sale of goods; and inventory (opening and closing), shall done as per method of accounting regularly employed by assessee.

be

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Tax, dun}, cess or fee paid to be included : The said value will be further adjusted by the amount of any
tax, duty, cess or fee actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation. Further, the amount of tax, duty, cess or fee, as aforesaid, shall include all such payment notwithstanding any right arising as a consequence of such payment.

5.4

",

Students' Guide to DIRECT TAXES

E.g. If the assessee is allowed any CENV AT credit of excise paid by him then such amount of credit shall be included in the valuation of purchase and sale of goods and inventory in determining business income. Section 145A applies even if separate account maintained: Even if the assessee keeps separate account for excise duty, the same will be included in value of sales, purchases and inventories in view of express mandate of section 145A. The same view shall apply to VAT or any other form of sales tax. Valuation of Closing Stock under various circumstances: Situations 1. Stock existing hi.the business' Valuation of stock Cost or market price, whichever is less Market price on the last day of the previous year Market price on date of such conversion Withdrawn at price at which it was r~corded in books

2. Stock acquired by inheritance, gift or will

3. Capital asset converted into stock in trade
4 5. Stock withdrawn from business When a firm is dissolved, and (a) business of fum is discontinued;

or

At market price-A.LA Finn v. CIT [1991J 189 ITR 285 (SC) [Sakthi Trading Co. v CIT [20011250 ITR 871 (SC)]

(b) business of the firm is continued by the Same mode of valuation as regularly adopted by the firm.

reconstituted firm. 5.7 Speculative TRANSACTIONS

(1) Speculative Transaction [Section 43(5)] : "Speculative transaction" means a transaction in- which a contract for purchase/sale of any commodity / stocks/ shares, is settled otherwise than by the actual delivery or transfer of the commodity or scrips. Transactions not regarded as speculative transaction: However, following transactions shall not be deemed to be speculative transactions -

and tax,pility of speculation business: "..-....

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(A) Contract in raw materials/merchandise

entered into by a dealer/manufacturer in the normal course of business to guard against loss due to price fluctuations in respecj of his contracts for actual delivery of finished goods; " to guard against loss through

(B) Contract in stocks and shares entered into by a dealer/investor price fluctuations in his holdings of stocks and shares.

(C) Contract entered into by a member of forward market or a stock exchange in the course of
jobbing or arbitrage to guard against loss in the ordinary course of business as such member. (D) Eligible transaction in respect of trading in derivatives carried out electronically in a recognised stock.exchange through a registered intermediary and supported by a time stamped contract note having unique client identity number and PAN number. (2) Deemed Speculation Business [Expl. to Section 73]: In case a company is engaged in business of purchase and sale of shares of other companies; then, such company shall be deemed to be carrying" on a speculation business to the extent of such business. However, in case of the following companies, the aforesaid business shall not be deemed to be speculation business -

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A Company whose gross total income consists mainly of income under heads "Income from house property", "Capital gains" and "Income from other sources "; and

(b) A Company whose principal business is banking or the granting of loans and advances.

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Profits and Gains of Business or Profession

5.5

(3) Taxability of Speculation Business [Explanation 2 to Section 28] : Where the speculative transactions carried on by an assessee are of such a nature as to constitute a business, such business shall be taxed as a distinct and separate business. Thus, in that case.> ~ ~
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The profits and gains arising from such business shall be shown separately. The loss of a speculation business cannot be set off against any other income arising under any other source or head but can be set off only against speculation income. . This loss can be carried forward for 4 years,

Damages relating to settlement of dispute - Not speculative: Damages awarded as compensation, on a dispute between parties due to breach of contract, cannot be regarded as a 'speculative transaction', because, in that case, damages do not relate to 'settlement of contract' but to 'settlement of dispute'. - CIT v, Hans Machoo & CO.[2001J 247 ITR 79 (DeI,) Clarification regarding allotoing losses on account of forex derivatives [Instruction No. 03/2010, dated 23-3-201 OJ: The Instruction refers to two kinds of Forex Derivative Losses (1) Treatment of loss from actual transactions in forex-derioatiues : In case a loss on a forex-derivative transaction arises on actual settlement / conclusion of contract, then, the following points are relevant -

(i) an inquiryshould

be made whether such transaction is a speculative transaction u/s 43(5) of the Act.

(ii) As per section 43(5)(d) of the Act, any 'eligible transaction' in respect of trading in derivatives that has been carried out in a recognized stock exchange shall not be treated as a speculative transaction, if it fulfils other conditions. Hence, if ~uch transaction fulfils the requirements of section 43(5)(d), the same shall not be speculative tra~a:eti(jn; otherwise it shall be speculative transaction. (iii) Any loss-arising from any such speculative transaction can be set off only against profit from speculative transactions.' (2) 'Marked to Market Losses': The following points are relevant(i) When a position is held in a financial instrument, that has not been settled/concluded on the Balance Sheet date, the said instrument is "market to market" by assigning it a value based on its market price on the closing day of the accounting or reporting record. (ii) Thus, in view of the requirements of Accounting Standards issued by rCAl, the financial instruments held on Balance Sheet Date are valued at market rate so as to report their actual value on that date.
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(iii) In accordance with the Accounting Standards, some assessees may reflect the loss (i.e the difference between the purchase price and the value as on the valuation date) on such financial instruments as a Balance Sheet item without making any entry in the Trading/Profit & Loss A/ c; while some other may pass an entry debiting such loss in the Trading/Profit & Loss A/c. (iv) This loss is a notional loss as no sale/ conclusion/ settlement of contract has taken place and .the asset (or financial instrument) continues to be owned by the company. (v) Ina case where any such loss has been debited in Trading/P&L A/c, then, since such a notional loss is contingent in nature, it cannot be allowed to be set off against the taxable income, The same should, therefore, be added back for the purpose of computing the taxable income of an assessee.

Authors' view - Some other grey areas: (a) Though not stated, it appears that the same treatment will apply in case of marked-to-market gains/profits carried to the Profit & Loss A/ c in respect of such financial instruments. (b) Such marked-to-market gains/losses will automatically get reflected in taxable income when the transaction is settled/concluded.

5.6

Students' Guide to DIRECT TAXES

(c) In case of traders of Forex Derivatives, such financial insttuments are held as stock-in-trade, which may be valued at cost or market value, _whichever is less. The loss resulting from valuation at market value, in case of stock-itt-trade, should have been allowed, which aspect doesn't find mention in the Instruction, . (d) The other derivatives may also get covered by the aforesaid Instructions.

5.8 DEDUCTION IN RESPECf OF LOSSES INODENTAL TO BUSINESS: A loss (other than capital loss), which is incidental to the trade, is allowable in computing the business profits on ordinary principles of commercial trading. Such trading losses can be claimed as deduction . provided the following conditions are satisfied: (a) Loss should be real in nature and not notional or fictitious; (b) It should be a revenue loss and not capital; (c) Loss should have resulted directIy from carrying on of business i.e. it should be incidental to business; (d) Losses should have actually occurred during the previous year; (e) There should be no direct or indirect restriction under the-Act against the deductibility of such loss.

E.g. Loss of stock-in-trade on account of fire, embezzlement/theft of cash in course of business, or loss on account of advances! guarantees granted during course of business, are admissible in the computation of taxable income on the basis of common principles of accounting and commercial expediency.
5.9 ~ASIC PRINCIPLES GOVERNING THE ADMISSIBILITY OF DEDUCTION U/S 30 TO 44DB: (1) The allowances laid down under .section 30 to 37 are cumulative and not alternative i.e. if an '---.-;-.-'. . expenditure of a nature described in a particular provision in allowablej disallowance in-view of that provision, thensuch itemcannot be held to be dlsallowable/' allowable under any other provision. (2) Expenditure should have been incurred in connection with assessee (4) Onus to prove the admissibility of expenditure lies on tile assessee. (5) No allowance in respect of expenditure incurred before date of setting-up of business: In case of newly set up business or profession, previous year commences on the date of its setting-up. SOt any expenditure incurred before setting up of business or profession is not deductible. It is only when tile unit has been put into such a shape that it can start fun-ctioning as a business or manufacturing organisation that it can be said to be set up. in CIT v. Stones and Minerals Associated Ltd. [2002] 257 ITR 479 (Raj.) that business is set up when steps for procurement of material had been initiated. Therefore, expenditure incurred for procuring material is allowable as business expenditure even if the assessee has not made any actual purchase or sale during the year.
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(3) Expen~iture should relate to the previous year in which business has been carried on.

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DEDUCfION

IN RESPECT OF RENT, RATES & TAXES - SECTION 30 & 31

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5.10 DEDUCTION L~ RESPECr OF RENT RATES, TAXES REPAIRS AND INSURANCE ETC. FOR BUILDINGS, PLANT AND MACHINERY r~'1) FURNITlJRE [Section 30 and 31] : The following are deductible in computing profits and gains of business or profession(1) Rent paid for premises occupied by assessee as tenant and used for his Business or Profession. (2) Expenditure 011 repairs of premises paid by owner thereof or tenant. However, capital expenditure on repairs shall not be eligible for deduction, but depreciation can be claimed thereon.

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As per section 32(1), for capital expenditure incurred by the tenant on extension, renovation, alteration of building, he shall be entitIed to claim depreciation on the said capital expenditure.
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5.7

and

(3) Land revenue, local rates or municipal taxes paid for premises, subject to the provisions of section 43B. (4) Insurance preinium paid for premises, plant and machinery or furniture against risk of damage or destruction thereof. ' (5) Current repairs (excluding capitalexpenditure) paid for plant and machinery or furniture.

Building etc. partly used for business or profession [Sec. 38] : If buildings or plant and machinery or furniture are not exclusively used for business and profession, then (a) In Cllseof rent of premises: Deduction value of entire premises];

= Rent

paid x {Annual value of part used for business + Annual

(b) In arJYother case: Deduction = Expenditure incurred x Proportion of part of asset (or expenditure) used for Business.

'Paid' - meaning of [S.43 (2)1 : "Paid" means actually paid or incurred according to method of accounting
on the basis of which profits/gains

,I

are computed under head "Profits and gains of business or profession", SECTION 32

BASICS OF DEPREOATION:

5.11 CONDITIONS TO BE FULFILLED IN ORDER

TO CLAIM

DEPREOATION

U/S 32 :

In order to claim depreciation under section 32, the following conditions are required to be fulfilled (1) Depreciation is available on 'assets' and 'block of assets' : The assets may be (a) tangible asset;s (Buildings, machinery, plant and furniture)' or (b) intangible assetsIknow-how; patents, copyrights, trade marks, licences, franchises or any oilier business or commercfurrfghts of similar nature). -_,' group of assets comprising of tangible or intangible assets in respect of which the S21me rate of depreciation is prescribed.

'Block of

as·sets' means

'.

Plant [So 43(3)1: Plant includes ships, vehicles, books, scientific apparatus & surgical equipment used for business and profession but does not include teabuehe« or li'vestock or buildings orfurniiure and fittings.
(2) Asset must be owned wholly or partly by assessee: Depreciation is allowable only to owner of asset. But, as per Mysore Minerals Ltd. v. CIT [1999] 239 ITR 775 (SC), registered ownership is not necessary, Other Points:

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(a) Depreciation is allowed on fractional ownership and co-ownership also in respect of part or fraction of asset owned by the assessee. . (b) In tile case of lease of asset, the depreciation on the leased asset shall be available to the lessor. The lease rentals paid by the lessee shall be eligible for deduction as revenue expenditure. This is so because mere hiring/renting of the asset doesn't result in any extinguishment of any right of the lessor and doesn't result ill creation of any asset for the lessee. - CIT v. Shaan Finance (P.)

Ltd. [1998J2311TR 308 (SC). Lessee is entitled to depreciation on construction of any superstruciure on land taken on lease; or on renovation/extension/improvement of building.
(c) Assets acquired under hire purchase: In CIT v. Nagpur Golden Transport Co. [1,998]233 ITR . 389 (Del), it was held that depreciation is to be allowed to the user in tile case of a hirepurchase agreement. Thus, hire purchaser will get the deduction of depreciation on the asset so acquired. (3) Asset must be used for the purpose of business or profession of the assessee : However, as per section 38(2), in case of an asset partIy used for business and profession, deduction shall be Deduction = Depreciation referred u/ s 32(1)(ii) (i.e, on Block of Assets) x Fair proportionate having regard to user of building, plant, machinery or furniture. part

5.8

Students' Guide to DIRECT TAXES

Depreciation to be halved, if asset usedfor lessthan 180 days: If the asset is (a) acquired by the assessee during the previous year and (b) put to use for less than 180 days during that previous year (i.e. in the year of acquisition), then depreciation thereon will be restricted to 50% of the depreciation allowable as per the rate prescribed for such asset. If asset is used for less than 180 days in any subsequent preVIous year, depreciation is fully allowable.
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(4) Asset should be used during the relevant previous year: Degree of utilisation is immaterial.

Depreciation claim is mandatory [Explanation 5 to Sec. 32(1)] : The provisions of section 32(1) relating to claim of depreciation shall apply whether or not the assessee has claimed it in computing his total income. Actual use v. Ready for use: The question 'whether depreciation is available only on actual use of the asset for the purposes of business or profession or the same is available even if asset is kept ready for use' has been a subject matter of wide litigation with differing views of various High Courts. The recent decision in DCIT v. Yellamma Dasappa Hospital [2007] 159 Taxman 58 (Kar.) also supports 'actual use theory'. The following points make an attempt to reconcile such differing views -

1.

No depreciation on an asset not 'available for use' : An asset that was acquired during the previous
year but could not be made available for use in that year, as it was not received during the previous year itself, cannot be eligible for depreciation.

2. No depreciation in yem"of acquisition until asset is put to use: Even if asset was available for use in year of its acquisition, no depreciation can be allowed thereon until it is put to use in that year itself. 3. No depreciation in subsequent years ifbl04 of asset not used at all during the previous year: Since,
in the year subsequent to theye,~I)Jf acquisition, an asset loses individual identity and becomes part of block, therefore, in subsequent years, 'actual user test' will apply to block as a whoie and no depreciation can be allowed if the 'block of assets' as a whole wasn't actually used even for a single moment in that previous year. Thus, even if a single asset forming part of the block is actually used for a single moment during the previous year, the block will qualify for depreciation.
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Depreciation allowable on 'Trial Run', as 'trial rim' is 'use': Even if the machinery is used for 'trial
run', it is 'actually used for purposes of business of assessee' and thus, it qualifies for depreciation.

5.

Depreciation allowable on spare engines/standby equipmenis : The specific nature of business of

certain assessees requires them to keep some engines or equipments as spare or as standby for use in case of need. When an. asset is devoted to the needs. of business, it is actually used for the needs of business, as it is required for efficient conduct of business. Thus, the same qualifies for depreciation.

11

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Other case law Techno Shares Membership and Ltd. Card of BSE - Intangible Asset - Eligible for depreciation:

Stocks Question: Whether the stock exchange membership card can be considered an intangible v. CIT asset for the purpose of depreciation under section 32(1)(ii)of the Income-tax Act, 1961 ? [2010] 327 ITR .. . . 323 (SC) Statutonj provisions: As per section 32(1), intangible assets, being know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature are eligible for depreciation. .

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Membership is a "business or commercial right"· (as per BSE Rules) : The right of
membership allows the non-defaulting member to participate in the trading session on the floor of the exchange. Thus, the said membership right is a "business or commercial right" conferred by the rules of the BSE on the non-defaulting continuing member.

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5.9

Membership is owned by the assessee and used for business of the assessee: Unless any
default is committed, the membership and nomination right "vests" in the member. Membership is a personal permission from the exchange which is nothing but a "licence" which enables the member to exercise rights and privileges attached thereto. The right to participate in the market has an economic and money -value. It is an expense incurred by the assessee which satisfies the test of being a "licence" or "any other business or commercial right of similar nature" u] s 32(1)(ii). Hence, the cost of membership card was eligible for depreciation as 'intangible asset'.

Clarification: The Supreme Court made it clear that this judgment has been rendered specifically in view of the provisions of the BSE Rules arid bye-laws. This should not be understood to mean that every 'business or commercial right' shall constitute 'licence' so as to be eligible for depreciation u] s 32(1)(ii).
DCIT v. N. K. Where machinery (viz. expellers) forming a block of assets didn't remain idle for the Industries Ltd. entire previous year i.e. the block was used for, at least, a moment during previous year, [2008] 305 ITR the depreciation was thereon admissible. 274 (SC) [Authors' Note: The Supreme Court, in this case, didn't enter into the larger question of law regarding the connotation of word 'used' appearing in section 32, whether 'used' meant actual use of the asset; .such question was kept open. However, it has been clearly held thatin case of block of assets the user-test should apply to block as a ~hole and if the block, considered as a whole, has been actually used for any part of the previous year, as found by the Tribunal in this case, the depreciation was admissible.]
-

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Keswani v. ACIT [2009[ "308 1TR (AT) 271 (Chennai)

R. G.

_Goodwill- Not depreciable: Goodwill is not an 'intangible asset' specified uls 32(1). It
can also not be characterised as "any other business or commercial rights of similar nature", as it is not similar fo know-how, patent, copyrights, trade-marks, licenses and franchises. Therefore, goodwill is not eligible for depreciation u] s 32(1).

5.12 RATES OF DEPRECIATION IN CASE OF BLOCK OF ASSETS: TANGIBLE ASSETS (I) BUILDING (1) Residential Buildings except hotel and boarding houses. (2) Non-Residential Buildings [office, factory, godown, hotels, boarding houses but other than (1) above and (3)(i) below] (3) (i) Buildings for installing Plant and Machinery forming part of water supply treatment system for infrastructure business ix] s 80-IA (4)(i). or water 5 10 Rate

100

(ii) Purely temporary erections such as wooden structures.

(II)FURNITURE AND FfITINGS (4) Furniture and Fittings including electrical fittings ("Electrical fittings" include electrical wiring, switches, sockets, other fittings and fans, etc.) 10

5.10

Students' Guide to DIRECT TAxEs

(5) Motor Cars not used in business of running them on hire; and ',Plant and Machinery other than those covered in other Blocks.

15

(7) Motor buses, lorries -and taxis used in business of running on hire; Moulds used in rubber & plastic goods factories; Plant & Machinery used in Semi-conductor industry including circuits;
- (8) Aeroplane-Aeroengines; Life-Saving Medical Equipments

30

40 50

(9) Glass and Plastic containers used as refills; New commercial vehicle which is acquired ott or after the 1-1-2009 but before 1-10-2009 and is pitt to use before the 1-10-2009 for the purposes of business "orprofession
(10) (i) Computer including computer software.

60

(ii) Books other than those covered in (12)(i) below. (iii) Gas Cylinders including valves and regulators
(iv) Glass Manufacturer- Melting Furnaces; Mineral Oil Concerns; (11) Flour Mills-Rollers; Rolling Mill:.rollg in Iron and Steel Industry; Energy renewal and energy saving devices; RoE-ersin Sugar Works.
c_"

80

(12) (i) (a) Books (annual publications) owned by assessee carrying on profession; and (b) Books owned by assessee carrying on business in running lending libraries. (ii)Plant and machinery in water supply and treatment system for infrastructure ujs 80IA(4)(i); Wooden part in artificial silk manufacturing Plant and Machinery; Cinematograph films-Bulbs of .studio lights; Wooden Match frames in Match factories; Mines and Quarries- tubs, ropes, lamps, pipes; Salt Works- Clay and salt pans etc.; Air-pollution, Water-pollution, Solidwaste control equipments and Solidwaste recycling system. INTANGIBLE ASSETS (13) Know-how, patents, copyrights, trademarks, licences, franchises, or any other business or commercial rights of similar nature.

100

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CONCEPT OF WDV AND ACTUAL COST - SECTION 43 DOWN VALUE (WDV)" [SECfION 43(6)] :

5.13 CONCEPT OF "WRITIEN

(1) WDV in general: In case of assets acquired in previous year, WDV = Actual cost to the assessee. Incase of assets acquired before previous year, WDV ::;:Actual cost to assessee less depreciation" actually allowed to the assessee. -

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Explanation 3 : Any allowance in respect of any depreciation

"unabsorbed depreciation"

carried forward uj s 32(2) .i.e. shall be deemed to be depreciation "actually allowed".

f~IIAt~I¥.'T;ti'ltI1111f.ttl\~1illl~~~liif~~~ll.1:tlll~1tl1

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Profits and Gains of Business or Profession

(2) WDV in case of Block of assets: Written Down Value of the block of assets as on 1st day of previous year Add: Actual Cost of asset falling within the block, acquired during previous year

5.11

Less: Moneys payable (including scrap) for asset falling within block which is sold, discarded, demolished, destroyed during the previous year to the extent of (A) + (B) above.
WD V of block of assets eligible for depreciation. Note: In CIT v. Kasturi and Sons Ltd. [1999] 237ITR 24 (SC) it has been held that the expression "moneys payable" has to be interpreted only as actual moneys payable in cash or cheque/ draft and not any other thing or benefit which can be converted into money. (3) WDV in Special cases : (A) In case of slump sale i.e. transfer of undertaking(s) without assigning values to individual assets and liabilities as such, the WDV shall be calculated as follows WDVof Block of assets as calculated in (2) above Less: Deduction on account of slump sale to the extent of amount above (See Note)

WD V of block of assets eligible for depreciation

Note: Deduction on account of slump sale is compute~ as follows Actual cost of a~se"~falli:fi'gin the Block, which is transferred by slump sale

-----

Less: Depreciation that would have been allowed if that asset was the only one in the block Deduction on account of slump sale
(B) In case of transfer of block in succession of business or profession in following cases (a) WDV in hands of successor u] s 170 = WDV in hands of the predecessor;

--

(b) WDV in hands of transferee company (being holdingisubsidianJ company, where transfer is made by one to the other fulfilling conditions u/s 47(iv)j(v)) = WDV in hands of transferor company; (c) .. WDV in hands of amalgamated Indian company (d) WDV of assets transferred to resulting company
= WDV = WDV

in hands of amalgamating company in hands of demerged company

Note: The WDV of the assets so transferred to resulting company shall be reduced from the
WDV of demerged company on the 15t day of the previous year.
(e)

WDV in hands of company formed by corporatisation of recognised stock exchange = WDV in the hands of such recognised stock exchange immediately before such corporatisation transfer complying with conditions U/S 47(xiiib)) = WDV of the block of assets in the hands of the transferor private/unlisted company on the date of conversion of the company into the LLP (Amendment by the Finance Act, 2010 w.e.f:1-4-2011)
e,

if) Actual cost of the block of assets transferred to the limited liability partnership (in case of

(4)WDV in case assessee was covered by exemption in any previous year ~ In case an assessee was not required to compute his total income for any previous year(s) preceding the current previous year i.e. assessee was covered by exemption from income-tax in any preceding previous. year, then, for the purposes of computing depreciation, the actual cost of any 'asset' shall be computed after ignoring the effect of any revaluation as follows-

5.12
Actual cost

Students' Guide to DIRECT TAXES

of an asset as per the books

of account

x x

Adjust: Amount attributable to the revaluation of such asset, if any, in the books of account (Add in case of downward revaluation; less in ~ase of upward reoaluaiion) Less: Depreciation on adjusted cost of the asset (i.e. Total depredation on such asset, provided in the books of account of assessee in respect of such preceding previous year(s) - Depredation attributable to upward revaluation + Depreciation attributable to downward revaluation).
Actual cost of the asset for the purposes of the Act (5) WDV in case of assessee having partly agricultural and partly business income: If-

(A) the income of an assessee is derived, in part from agriculture and in part from business chargeable to income-tax under the head "Profits and gains of business or profession", (B) then, for computing the written down value of assets acquired before the previous year,

(C) the total amount of depreciation shall be computed as if the entire income is derived from the
business of the assessee under the head "Profits and gains of business or profession", and (D) depreciation so computed shall be deemed to be 'depredation 5.14
If

actually allowed' under the Act.

ACTUAL COST" [SECTION 43(1)] :

"Actual cost" = Actual cost of the assets to the assessee less Portion of such cost as has been met directly or indirectly by any other person orauthority, . Mode of computation of actual cost : OJi combined reading of Section 43(1), Explanations 8 to 10 given thereunder and Section 43A, the actual cost of the asset can be computed as follows: -_ -_. Purchase price of the asset Add: Costs directly attributable to bring asset to its working condition for intended use (i.e. Expenses incurred for acquiring the asset- like freight, insurance, loading and unloading etc. and . expenses incurred in connection with the installation of the asset.) Add: Interest on capital borrowed for acquisition of asset till it is first put to use. (Interest for period after asset is first put to use is not included in actual cost) [Explanation 8] Less: Amount of Excise or Customs Duty levied on it and included in its cost, for which claim of credit has been made and allowed under Cenvat Credit Rules, 2004 [Explanation 9] Less: Portion of cost of asset met directly or indirectly by Government or any authority or any other person in form of subsidy/grant! reimbursement. However, if subsidy/grant/reimbursement cannot be directly related to the asset acquired, the following amount shall be deducted [Explanation 10] Amount to be deducted Total amount of subsidy / grant/ reimbursement x Cost of that Asset
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Total cost of the assets for which subsidy/grant/reimbursement

is given

AddfLess: Increase or decrease in cost due to exchange rate fluctuation [Section 43A] Actual Cost of the asset for purpose of Section 43(1) Case Laws (1) . Amounts given as loan subsequently convertedintogift : In case amounts advanced as loans to the assessee for purchases of assets are subsequently converted into gift, the actual cost of the asset will be reduced by the amount of such gift - Ravi Leathers Pvt. Ltd. v. CIT [1999j 240 ITR 702 (Mad.).

Profits an:d Gains of Business or Profession

5.13

(2) Subsidy for setting. up industry in backward - Not related to assets, not deductible from "cost" [CIT v. P. J. Chemicals Ltd. [1994]210 ITR .830 (SC)followed in Sasisri Extractions Ltd. v. ACIT [2008]307 ITR (AD 127 (Visakhapatnam)J : The treatmentof subsidy depends upon the nature thereof; not on
the measure or method of computation thereof. Where the .Covemment subsidy is intended as an .Incentive to encourage entrepreneurs to move to backward areas and establish industries, the specified percentage of the fixed capital cost, which is the basis for determining the subsidy, being only a measure adopted under the scheme to quantify the financial aid, is not a payment, directly or indirectly, to meet any portion of the "actual cost" of the assets. Even Explanation 10 to Section 43(1) applies only when the subsidy is granted to meet any portion of the "actual cost". The subsidy given as an incentive on setting-up industry in backward areas is not granted with a view to meet any portion of the "actual cost" of the assets. Therefore, a subsidy granted as an incentive to move to backward areas cannot be reduced from the 'actual cost' of the assets for the purposes of calculation of depreciation, etc.

[Authors' Note: As per para 10.1 of AS - 12 "Accounting for Government Grants", where the government grants are of the nature of promoters' contribution, i.e., they are given with reference to the total inveshnent in an undertaking or by way of contribution towards its total capital outlay (for example, central investment subsidy scheme) and no repayment is ordinarily expected in respect thereof, the grants are treated as capital reserve which can be neither distributed as dividend nor considered as deferred income.
Therefore, thejudgment in the aforesaid case accords with the accounting view of the matter.]

5.15 CIRCUMSTANCES WHEN ACTUAL COST OF AN ASSET IS TAKEN AT NOTIONAL FIGURES [EXPLANATIONS TO SECTION 43(1}] :
ti..

Expl
(1)

Mode of Acquisition-

"',-",~

/-

Actual Cost

-_,

Asset actually acquired for scientific research related to Actual Cost less deduction business and subsequently used for business purposes. under Section 35 (Le. NIL). Asset acquired by way of gift or inheritance. Where assessee purchases second-hand business assets and Assessing Officer is satisfied that main purpose of such transfer was to claim depreciation on enhanced cost and thereby reduce tax liability. WDV to the previous owner.

availed

(2) (3)

Actual cost as determined by Assessing Officer with prior approval of Joint Commissioner having regard to all circumstances of the case.

(1)
(4A)

Where assessee had transferred business asset owned by Lower of WDV at the time of original transfer, or price paid for reacquiring it him and now, the same is reacquired by him.

Sale & lease back: Assessee X purchases asset belonging to Cost to X shall be the WDV of the assets Y, who had earlier claimed depreciation on such asset, to Y at the time of transfer. and subsequently, leasesj hires the same to Y.
Building previously used for private purposes, now Actual cost of building less notional, rate at depreciation calculated brought into use for the business of the assessee. Note: Rate of depreciation applicable in previous year of applicable to that year upto year of bringing it to business use. bringing the asset into business use is applied. Capital asset transferred by holding co. to its subsidiary Ico. or vice-versa satisfying conditions ul s 47(iv)j 47(v) Cost to transferee company = WDV in the hands of transferor company

(5)

(6)

5.14
(7)

Students' Guide to DIRECT TAXES

Transfer of capital asset by amalgamating company to Cost to amalgamated company == WDV amalgamated Indian company in a scheme of to the amalgamating company amalgamation

In case of transfer of stock-in-trade, provisions of Section 43C shall apply .

the

. (7A)

Transfer of capital asset by a demerged company to the Cost to resulting company = WDV of resulting Indian Company in a scheme of demerger. the assets to the demerged company An asset acquired outside India by a non-resident, Purchase price less notional subsequently brought to India and used for his business depreciation .computed at respective and profession in India. rates from the date of its acquisition. Note: Depreciation is computed at rates that would have been allowable had the asset been used in India for his businessjprofession since the date of its acquisition.
'1
'@

(11)

€q

(12)

Capital asset acquired in scheme of corporatisation Recognised Stock Exchange approved by SEBI. Capital asset on which is deduction is allowed

of WDV of asset to such stock exchange had there been no such corporatisation or NIL,(a) in the case of such assessee; or

(13)

allowable uj s 35AD

(b) if the asset is acquiredj received,.,,<~,.-/

(i) by way of gift or will or an irrevocable trust;

(ii) on any distribution on liquidation of the company; and

by mode of transfer referred uj s 47(i)j (iv)j (v)j (vi)j (vib)j (xiii)j (xiiib)j(xiv). (Amendment by the

!.. "

:.

(iii)

>V;

Finance Act, 2010 w.e.j. 1-4-2011)

5.16 TREATMENT OF EXCHANGE RATE FLUCTUATIONS IN CASE OF PURCHASE OF AN ASSET FROM OUTSIDE INDIA [SECTION 43A] : (1) ~pplkabi1ity
. .

: The provisions of this section apply if -

(aj' an asset is acquired from outside India for assessee's business or profession; (b) subsequently, after the date of acquisition, there is a change in the rate of exchange of currency during any previous year; _(c) such exchange rate fluctuation results in increase 'Or reduction in the liability of the assessee (as expressed in Indian currency) at the time of making-the payment(i) towards the whole or part of the cost of the asset; or froin

(ii) towards the repayment (along with interest) of whole or part of the moneys borrowed by him

any person in any foreign currency specifically for acquiring the asset

'. (2) Treatment:

The amount by which the liability is so increased or decreased (along with increasej decrease in interest) at the time of making payment, shall be added to or reduced from the following (a) Actual cost of asset, or Capital expenditure incurred on scientific research or family planning; or

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(b) Cost of acquisition of capital asset (other than depreciable asset), in computing capital gains ujs 48.

('.~

;.
Profits and Gains of Business or Profession .
(3) Other relevant points: (a) These adjustments are to be made only on actual payment by assessee towards the cost of asset or repayment of the loan or interest irrespective of method of accounting adopted by assessee.
I

5.15

(b) Where whole or part the liability is not met by assessee but is met by any other person, no adjustments of exchange rate fluctuations shall be made with respect to the liability so met. (c) Where assessee has entered into forward exchange contract with "authorized dealer" for purchase of foreign currency to discharge the liability as referred above, the increase or decrease in liability is computed with reference to rate of exchange specified in the contract. Case law
-"~'/

J r

ACIT . v. Elecon Roll over premium charges for arranging foreign currency under a forward Engineering Co. Ltd. contract with a banker, required for discharging a foreign currency loan for [2010] 322 ITR 20 purchasing of a plant/machinery, falls ufs 43A of the Act and is required to be (SC) adjusted in the cosf/WDV of such plant/machinery. Facts )The assessee, a manufacturer of gears and mechanical handling equipment, obtained a foreign exchange currency loan for expansion of its existing business (i.e. for acquisition of fixed assets/plant & machinery). The said loan was to be i:epaid in instalments at predetermined rates. Accordingly, the assessee booked forward contracts withCitibank for delivery of the required foreign currency on the stipulated dates. The assessee claimed the roll over premium charges paid by it in respect of foreign exchange forward contracts to Citib.@k-N. A. as revenue expenditure in computing its total income u/ s 36(1) (iii) contending that the same were in the nature of interest and were, therefore, deductible expense.An alternative claim for deduction of such expense u] s 37(1) of the Act was also made. The Department contended that said expenditure was capital expenditure and as per section 43A, the same was to be adjusted in (added to) the cost of asset and depreciation computed accordingly.

»
I.

)-

Statutory provisions )Section 36(1)(iii), 37(1) and 43A of the Act

Question )Whether roll over premium charges were allowable as revenue expenditure?

Decision

» »

Sirice the purpose of the loan taken by the assessee was to finance the purchase of plant and machinery, and the rollover charges for forward contracts were to hedge against the risk of fluctuation in the rate of foreign exchange, hence, the same were covered by section 43Aof the Act.
.~ .

They were not allowable as revenue expenditure u/s 36(1)(iii); they were capital expenditure and were to be debited/ credited to the asset in respect of which liability was incurred.

5.17 DEPRECIATION WHEN ~(1) BLOCK EXISTS BUT WDV CEASES TO EXIST; AND (2) WDV EXISTS BUT THE BLOCK CEASES TO ExIST. . For allowability of depreciation, existence of the block of assets and positive WDV, both, is a basic prerequisite. Hence, when either of them ceases to exist no depreciation is allowable. Therefore -

5.16

Students' Guide to DIRECT TAXES

f'~i
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(a) When Block exists but WDV ceases to exist: If WDV of the block of assets is reduced to zero, though the block is not empty, no depreciation is admissible. The excess, if any, of sale price of assets over the WDV of block of assets, shall be short-term capital gains. (b) WDV exists but the Block ceases to exist: If the block of assets ceases to exist though the WDV is not zero, then also no depreciation is admissible. The shortfall, ifany, of sale price of assets from the WDV of the blocK of assets, shall be short-term capital loss. APPORTIONMENT OF DEPRECIATION, ADDITIONAL DEPREOATION UNABSORBED DEPREOA TION
&

5.18 APJ?ORTIONMENT OF DEPRECIATION IN CASE OF SUCCESSION AMALGAMATION! DEMERGER OF A COMPANY:

OF BUSINESS OR

In case of succession of firm or proprietary concern by a company as referred to in Section 47(xiii)/ (xiv): or succession u/s 170; or amalgamation or demerger of a company; or conversion of a private/unlisted

company into a limited liability partnership 1I/s47(xiiib) (Amendment by the Finance Act, 2010 w.e.f. 1-42011), the following provisions will apply(A) The total deduction for depreciation on tangible and intangible assets allowable to predecessor and successor; or to amalgamating company and amalgamated company; or to demerged company and resulting company, shall not exceed in any previous year the depreciation calculated at prescribed rates as if such succession or amalgamation or de merger had not taken place. (B) Such depreciation shall be apportioned between predecessor and successor, or amalgamating company and amalgamated company, or demerged company and resulting company, in the ratio of the number of days forwhich !,..4e assets were used by them.
--_-::"

5.19 PROVISIONS IN RESPECT OF ADDITIONAL DEPRECIATION [SECfION 32(1)(iia)] : (1) Applicability .... dditional depreciation is available on new machinery or plant (other than ships and A aircraft),which has been acquired and installed after 31-3-2005. (a) This provision is applicable only in case of an assessee engaged in the business of manufacture or production of any article or thing. (b) It is applicable to only those assessees who claim depreciation on block of assets is] s 32(1)(ii). (2) Deduction: A further deduction of 20% of actual cost of such plant and machinery is allowed. However, in case the asset acquired during previous year is put to use for a period of less than 180 days then additional depreciation on such asset will be calculated @ 10% of actual cost. (3) No Deduction : Additional depreciation is not allowed in respect of the following: (a) Plant and machinery which, before its installation by assessee, was used whether in India or '. outside India by any other person; (b) Any office appliances or road transport vehicles. (c) Plant or machinery installed in the office premises or the residential accommodation the g1,lesthouses). (cl)Plant (including

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and machinery whose whole of the actual. cost is deductible (by way of depreciationor otherwise) in computing income under this head of anyone previous year.

Computers used for. data processing in industrial premises are eligible for additional depreciation, CIT v. Statronics & Enterprises P. Ltd. [2007]288 ITR 455 (Guj.) .. 5.20 CARRY FORWARD AND SET-OFF OF UNABSORBED DEPRECIATION [Se~tion 32(2)] : (1) Amount of depreciation remaining unabsorbed shall be allowed to be carried forward whether the business/ asset to which it relates exists. It shall be treated as part of next year's depreciation.
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Profits and Gains of Business or Profession

(2) Return: of loss is not required to be submitted to carry forward unabsorbed depredation.

5.17

(3) Brought forward business losses (speculative or non-speculative) under Section 72(2) and 73(3) shall
be given priority of set off over unabsorbed depredation:

(4) Current year depreciation, Unabsorbed depreciation & Brought forward losses: Thus, first of all current year depreciation will be deducted from business income, thereafter, brought forward business losses will be set-off and, at last, past year unabsorbed depreciation will be set-off against business income. Unabsorbed depreciation may be set-off against any head of income: Any amount of past year's depreciation, remaining unabsorbed after set-off against business income, as aforesaid, can be set-eff against profits and gains under any head of income. - CIT v. Mother India Refrigeration Industries Pvt. Ltd. [1985] 155 ITR 711 (sq.

DEPRECIATION IN CASE OF POWER.;.GENERATING UNITS

5.21 DEPRECIATION IN CASE OF POWER GENERATING UNITS [SECTION 32(1)(1)] :

(1) Undertakings to which applicable: These provisions are applicable to undertakings engaged in the generation of power; or undertakings engaged in the generation and distribution of power. [Note that

'undertakings engaged in only the distribution of power are not covered here1
(2)
0

,-

Option available and. when can it be exercised : Such undertakings have an option to claim depreciation under the SJ;raig4t Line Method on individual assets acquired instead of Written Down Value method. The undertaking Can exercise this option before due date of furiUshing Return of Income under section 139(1) for the assessment year relevant to previous year in which the undertaking begins to generate power. The option once exercised shall be final and shall apply to subsequent ~ssessinent year. The rates of depredation are given in Appendix I-A to Income Tax Rules, 1962.
"-.,-.,<-'

(3) Consequences

on subsequent sale, discard etc. of such assets: If such tangible assets (on which depreciation under SLM is claimed) is sold, discarded, demolished or destroyed in the previous year (other than the previous year in which it is first brought into use); then, it gives rise to 'terminal depreciation' or 'balancing charge' the treatment of which are given below: -

t.

(a) Terminal depreciation [Section 32(1)(iii)]: If Moneys payable (including scrap) is less than the
written down value of the asset then the difference is written off in the books as 'Terminal Depreciation' in the year when such asset is sold or discarded etc. (b) Balancing Charge [Section 41(2)]: If the Moneys payable (including scrap) is greater than WDV of asset then such excess to the extent of depreciation already claimed is taxable as 'Balancing Charge' in form of deemed business profits ul s 41(2) in the year in which moneys payable become due whether or not business is in existence in that previous year. Surplus over and above the actual cost is taxable as capital gains. Thus, Balancing Charge = [(Lower of Actual Cost or Moneys Payable) - WDV of asset]. Capital Gains == [Moneys Payable - Actual Cost of the asset] (if positive). Notes: (a) Moneys payable include sale price, insurance, salvage & compensation in respect of such asset. (b) "Sale" includes exchange or compulsory acquisition under any law but does not include a transfer of any asset by an amalgamating company I banking company to an Indian amalgamated company I banking company LTl a scheme of amalgamation.

5.18
."

including additional depreciation : An industrial undertaking which commenced the manufacturing activity with effect from 1st September, 2010 has acquired the following assets during the previous year 2010-11 :

Illustration 1 ;..Depreciation

..

Students' Guide to DIRECT TAXES

Assets
Factory buildings Plant and Machinery : Air pollution control equipment Machinery A MachineryB MachineryC MachineryD MachineryE Machinery F (second hand) Motorcar Air conditioner (installed in the office)

Date of acquisition
04/04/10

. Date when put to use

01/09/10

Cost of acquisition (Rs.)

. 50,00,000

04/05/10 05/05/10 07/06/10 30.8.2010 01/09/10 01/01/11 11/01/11 01/02/11 01/02/11

01/09/10 01/09/10 01/09/10 01/09/10 .31.10.2010 28.2.2011 13.1.2011 01/02/11 02/02/11

4,00,000 2,00,000 5,00,000 10,00,000 4,00,000 3,00,000 2,00,000 5,00,000 1,00,000

Compute depreciation allowable for assessment year 2011-12 and the WDVas on 1-4-2011.

Solution: The relevant computations are Nature of Asset

. _,.-

-/

.......... ...::;':"""'" . .

Actual Cost
50,00,000
0

Rate of
dep. 10%

Normal Dep.
5,00,000

.Additional . WDVason Depreciation 1-4-2011

0 45,00,000

Factory buildings

:....:,.0
:.:

Plant & machinery :

Air pollution control equipment Machinery A, B & C Machinery D &E (used for less than 180 days) Machinery F, motor car & AC (used for less ·4,00,000 100% 17,00,000 7,00,000 8,00,000 15% 15% 15% 4,00,000 2,55,000 52,500 60,000 0 3,40,000 70,000 Not Eligible 0 11,05,000 5,77,500 7,40,000

; -: '(1)

!.•...••. ~

than 180 days) IZlustratio1l2 -Additional

On 1-4-2010-

depreciation: Gopichand Industries furnishes you the following information:

Block I: Plant and machinery (consisting of 10 looms) Rate of depreciation 15% ,.

1"lDV

IAcquired

Block II:Buildings (consisting of 3 buildings) Rate of depreciation 10%

on 5-7-2010 - 5100ms for ..

wav

12,50,000 4,00,000 . 10,00,000

Sold on 7-12-2010- 15100ms for

LA_c_q_.u_ir_e_d_o __ nl0_-_l-_2_01_J_.-_2_1_oo_n_~ __ fu_r Compute depredation claim for the assessment year 2011·12. ~

_j__ 3,OO,OO~

II

Profits and Gains of Business or Profession Solution :Computation of depreciation claim. for the assessment year 2011-12 :
Block I (plant) OpeningWDV Add: Assets acquired during previous year (4,00,000 + 3,00,000) 5,00;000 7,00,000 12,00,000 Block II (Buildings)

5.19

12,50,000 0 12,50,000 0 12,50,000 1,25,000 0 11;25,000

Less: Moneys payable in respect of assets sold during the year

I
i I

10,00,000 2,00,000 15,000 30,000 1,55,000

WDV as on 31-3-2011 eligible for depreciation (a) Normal Depreciation (2,00,000 x 7.5%) ~ (b) Additional Depreciation (3;00,000 x 10%) WDV as on 1-4-2011

I Less:

Note: Additional Depreciation is allowable by virtue of section 32(1)(iia) but the same is allowed under
section 32(1)(ii) only, in addition to the normal depreciation. While the normal depreciation shall be allowed only in respect of WDV of the blockadditional depreciation is allowable on the actual cost of the asset. No additional depredation shall be allowed in respect of 5 looms acquired on 5-7-2010 because they have already been sold and the WDVon which normal depreciation is allowed doesn't represent those looms.

Illustration 3- Computation of actual cost and treatment of.receipts during construction of project: r... s. 1/
ABC Power Corp. incorporated-on~""S-2010 has started a new mini power project on 1-4-2010 for which it ,,-took a loan of Rs. 100 crores at 12% p.a. The whole of the amount of Rs. 100 crores has been invested in the project and the plant/machinery is scheduled to be put into use w.e.f 1-4-2011. It furnishes the following •other information for the previous year ended 31-3-2011 : (a) During the on-going construction of the project, a part of the surplus loan funds had been invested in short-term deposits, for which interest of Rs. 20 lakhs was earned; (b) Certain sums out of the loan were given as advances to the contractors engaged in construction of the project, which yielded interest of Rs. 35 Iakhs; (c) Certain sums out of loan were deposited to open letter of credit for purchase of a plant forming part of the project, which yielded interest of Rs. 5lakhs. (d) -Certain quarters were constructed, which were rented to the workers/contractors construction of project, the aggregate amount of rent being Rs. 30.lakhs; engaged in

---

(e) Certain plant and machinery required for execution of project was acquired by the corporation and - was given on hire to the contractors engaged in execution of the project, the hire charges amounting to an aggregate of Rs. 70 Iakhs; (f) The: corporation collected a sum of Rs. 40 Iakhs from the contractors for the supply of water, electricity, etc. required for the execution of the project. You are required to compute the "actual cost" of the project so constructed in light of the aforesaid infonnationand also the total income, if any, of the corporation for the assessment year 2011-12. Solution: Computation

9£ actual cost" of the project (amounts in Rs. Iakhs)

/I

rAmount

invested in the project (plant and machinery)

lO~OOO
1,200

:iidd: Interest on loan taken for project, before it is put to use (12% of 10000)

Students' Guide to DIRECT TAXES

11,200

Less:' Capital receipts .. being the receipts of the corporation that are directly connected with or incidental to the work of construction of the project/ plant: .
'

t7f?: -, -;....

(a) Intereston advances to the contractors

35

(b)

Interest on deposits made for purchase ofplant/machinery Rent from quarters given to workers/contractors

5
30 70 40 180 11,020 -

(c)

(d) Hire charges

01': plant

and machinery given to contactors

(e) Collections from the supply of water, electricity, etc.to contactors

Actual cost of the project Total.income of the corporation for the assessment year 2011-12 Interest on short-term deposits (Income from other sources/Total Income) Notes:

(1) Interest on surplus loan funds invested in short-term deposits is not connected with or incidental to the work of construction of the project/plant, hence, such interest is revenue receipt liable to tax as Income from other sources. - Tuticorin Alkali Chernicals& Fertilizers Ltd. u. CIT [19971227 ITR 172 (SC)· (2) All other receipts being receipts connected-with/ incidental to the work of construction of the project/ plant are capital receipts', which shall go to reduce the cost. - Bonaigaon Refinery & Petrochemicals Ltd. v. CIT [2001J 2511TR 329 (SC) ;.pT vJ"-KarnatakaPower Corporation. [20011 247ITR 268 (SC) and CIT v. Kamal Co-operative Sugar Mills Ltd:Y19991243 ITR 2 (SC) - _,
I

G>

Illustration 4 - Sectiou43J1...&.section 32 : M/ s. Y Industries Ltd. purchased a plant worth USD 4lakh on 1- . 4~2009on which date the rate of exchange was.Rs. 50. The consideration towards the plant was payable in 3 instalments of USD 1.5 Iakh, 1.31akh and 1.2lakh respectively on 1-1-2010,1-7-2010 and 1-1-2011; the rate of exchange being Rs. 52, Rs. 48 and Rs. 51 respectively. Compute the amount of depreciation allowable on the plant for the two assessment years, assuming the rate of depreciation to be 25%. Solution : Computation of depreciation on the plant, assuming it to be the only asset in the block
x

........

()

Actual-cost on the date of acquisition (4 Iakh

Rs. 501

2,00,00,000 3,00,000 . 2,03,00,000

Add: Forex cliff. arising out of increase in liability u/s 43A on 1-1-2010 (1.5lakh x (52 - 50)) Actual cost for the purposes of section 43(1)fWDV as on 31-3-2010

.1 Less: Depreciation @45% (Normal @25% + Additional @20%)- Depreciation will be allowed

I for the whole

of the year, as the asset has been put to use for more than 180 days during the previous year; the date of increase in liability ul s 43A shall not affect depreciation. ' WDV as on 1·4-2010

-91,35,000

1~l1,65,QOO -2,60,000 1,20,000 1,10,25,000 ~56,250

Less: Forex diff. arising out of increase in liability u/ s 43A on 1-7-2010 (1.3 lakh x (50 - 48))
Add: Forex diff. arising out of increase in liability u/ s43A on 1-1-2011 (1.2Iakh x (51 - 50)) WDV as on 31-3-2011

Less: Depreciation @25%

~68'7501

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