5-7-2013

A 265 provides that No tax shall be levied or collected except by authority of law.

Govt cannot claim tax extra than the actual liability.

Consumer Welfare Fund – Extra tax collected goes to this fund.

Mafat Lal v. UOI – 9 Judge Bench – This issue was decided – Refund excess tax – Unconstitutional?
Illegal? – Doctrine of unjust enrichment, doctrine of

Liability and incidence is also on the manufacturer – exception to the general rule – where
manufacturer has to pay the tax as he cannot claim from the consumers.

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Person [2(31))

The term “person” includes:

(i) an individual
(ii) a HUF
(iii) a company
(iv) a firm
(v) an association of persons or a body of individuals, whether incorporated or not;
(vi) a local authority; and
(vii) every artificial juridical person, not falling within any of the preceding categories.

 The term “individual” includes a minor or a person of unsound mind. [Shridhar Uday Narayan v.
CIT)

 A firm is a taxable entity separate and distinct from its partners.

 Profit motive is not essential – An explanation is inserted in S. 2(31) w.e.f 2002-03. It provides
that an association of persons or a body of individuals or a local authority or an artificial juridical
person shall be deemed to be a “person”, whether or not it is formed or established or
incorporated with the object of deriving income, profits or gains.

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4 PRINCIPLES OF TAXATION

(1) Ability to Pay

 Equals must be treated equally and unequals must be treated equally
 We have a system of slabs – exemption upto a limit – different slabs.
(2) Benefit Approach
 Tax is for the civil society, infrastructure, benefit to the entire society.
(3) Certainty
 Assess should know as to how much he has to pay – so that he can plan in advance.
 Retrospective amendments are clarifications.
(4) Administrative Convenience
 Collection part – TDS (Tax Deducted at Source1) – Withholding Tax (WT)2
 Convenience to the assessee and the collector both.
 Austin O Malley – In levying taxes and in sailing ships, it is well to stop when you get down
into skin. [take the benefit of ship and at the same time protect it as well]
(5) Recent addition – International Compatibility (because of international taxation regime)
 Tax regime should be internationally compatible – harmonisation of tax regime.
 However, this is not followed practically.
 DTC 2009 provided for treaty override – it was withdrawn in DTC 2010 Bill.

Round Tripping

DTAA overrides the Income Tax Act – UOI v. Azadi Bachao Andolan – Whichever is more beneficial
will override the other.

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Singhania Book – Taxman

Bharat Publication

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9-7-2013

TAX BASE AND CONCEPT OF INCOME

Capital v. Income

Income is revenue and not capital receipts.

Capital Receipts = All CRs are exempted unless expressly taxable under the IT Act.

Revenue Receipts = Considered to be Income, except... (under Income Tax Act) – They are all taxable
unless expressly exempted.

S. 2(24) of IT Act – “Income” – Inclusive definition – “Income includes:

(a) profits and gains

1
Pay the tax on the source- If you earn something, duty is on the payer to deduct the TDS and deposit with
the government.
2
If the payee (receiver) is non-resident, then this term is used – If the payee is resident, then the term TDS is
used. For e.g, A is a non-resident, B is a resident, B took a loan from A, B has to pay interest to A, It is the duty
of A to deduct tax on the interest.
Non-resident is not supposed to file tax in India.
(b) dividend;

Definition of “Income”

“CIT v. Shaw Wallace (AIR 1932 PC 138) –Lord – they tried to define “income for tax purpose.
“Income connotes a periodical monetary return, comes in with a sort of regularity or expected
regularity from a definite source”. [This definition is not compatible with the concept of “income”
under the IT Act]. Even non-recurring incomes are also taxable. Even the condition of “definite
source” is also not feasible.

Kamakhya Narain Singh v. CIT (AIR 1943 11 ITR 513 PC) – Lord Wright (correct definition) – “Income
is a word difficult and perhaps impossible to define in any precise general formula .It is a world of
broadest connotation.” They did not try to define “income”.

Revenue Receipt and Capital Receipt

Sell trees (capital or revenue?) = It is a capital

Sell Fruits = Revenue

Dealer of trees (sell trees) = Revenue (because you are selling as a dealer) and selling fruits is
“income from other soruces”.

Building – sell building as investor = capital

Sell building as a dealer = revenue

Capital receipts are not taxable, they are exempted.

How the scope of S. 2(24) can be widened? – SC 1993 case = S. 2(24)(ix) provides that any winnings
from lotteries35, crossword puzzles, races including horse races, card games and other games of any
sort or from gambling or betting of any form or nature whatsoever.”

CIT v. G. R. Kartikeyan (AIR 1993 SC 1671) = 1974-75 assessment year – assessee (GRK) in individual
capacity – income tax – he had income from various other sources (including salary and business
income) – during the accounting year 73-74, he participated in ALL INDIA HIGHWAY MOTOR RALLY –
he was awarded the 1st prize of Rs. 20000 by IOCL, Rs. 2000 by AIMR – Rule said that one could start
either from Delhi/Kolkata/Madras/Bomnay and they had to come back to the same place – follow
traffic rules – less penalty – GRK won the rally and Rs. 20000 and 2000 – Question was whether this
was income?

SC held that the rally was a “contest” if not a race and the assessee entered the contest to win it and
to win the 1st prize. What he got was a return for his “skill and endurance”. There was no question of
“chance” unlike in lotteries where “chance” plays a very crucial role.
SC said that it would be wrong to find a place for everything under 2(24). You cannot cover every
receipt under S. 2(24). The definition is “inclusive”.

If some receipt partakes the nature of “income, it will still be income even if it is not covered
under 2(24). In this case it was held to be “income”.

LEGAL AND ILLEGAL INCOMES – THERE IS NO DIFFERENCE FOR THE PURPOSE OF IT ACT – IT Act is
not concerned with the illegality or legality of the income – You may be punished under other Acts
but not under IT Act for illegal income. Even certain benefits are provided to illegal incomes. IT Act is
based on “principles of accounting”, it allows expenditure as deduction even to illegal income.

However, 37(1) provided that expenditure is not allowed.

But what about ‘trading loss’, ‘business loss’, should be accounted for. It can be claimed as a
deduction. [this is the current position] – even the loss from illegal business can be claimed as a
deduction. [G A Qureshi v. CIT]

In 2011, HC Judgment – Businessmen dealing iin Tobacco – was on business tour to purchase tendu
leaves in MP forests – he was kidnapped by Naxalites – he paid 20 lakhs as ransom – he claimed this
as “business expenditure” as he was on his business tour – Whether it should be allowed or not? It
was allowed under the IT Act as “paying ransom” is nowhere prohibited under Indian Law.

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10-7-2013

CONCEPT OF INCOME

Diversion of Income v. Application of Income

Diversion of Income by overriding title is tax planning and is legal.

There are 3 types of diversion:

(1) Legal obligation (e.g. order of maintenance to wife)

(2) Contractual obligation (here comes the problem of tax evasion and tax planning -
(3) Statutory obligation (under Acts, rules – e.g. environmental fund under local laws)

How contractual obligation is diversion? – CIT v. Sunil J Kinariwala [(2003)1 SCC 660] – Assessee
was a partner in a partnership firm – he had 10% shares in the firm – On 27th Dec 1973, he created a
trust named Sunil Kinariawla Trust - by a deed of settlement – he assigned 50% of his 10% shares –
he diverted in the favour of his trust – there were 3 beneficiaries of the trust – brother, mother,
assessee – In 1974-75 year – he claimed as 50% of the income attributable to the trust – he claimed
it is a “diversion” and not liable for that 50% to pay income tax.

SC held taht assignee rights are very limited – if partnership right had been created, the case would
have been different – this is diversion of income and not application of income.
SC laid down the principle to find out “whether it is diversion of income or application of income” –
CIT v. Sheetal Das Thirath Das [(1961) 41 ITR 367] – Justice Hidayaltullah: “In our opinion, the true
test is whether the amount sought to be deducted in truth never reach the assessee as his income.
Obligation no doubt there are in every case, but it is the nature of obligation which is the decisive
factor. There is difference between an m which a person is obligated to oblige out of income and an
amount which by the nature of the obligation cannot be sad to be part of the income of the
assessee.” – Whereby the income is diverted before it reaches the assess it is deductible, but where
the income is required to be discharged ... it is the first kind of payment that
can be excluded.”

In case of salary, salary taxable as income,

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Diversion of Income

Diversion of Income is an obligation to apply the income in a particular way before it is received by
the assessee or before it has arisen or accrued to the assessee results in diversion of income. The
source is charged with an overriding title, which diverts the income. Therefore the essentials are the
following:

(i) Income is diverted at source,

(ii) There is an overriding charge or title for such diversion, and

(iii) The charge / obligation is on the source of income and not on the receiver.

Examples of diversion by overriding title are -

(i) Right of maintenance of dependents or of coparceners on partition

(ii) Right under a statutory provision

(iii) A charge created by a decree of a Court of law.

Case Laws on Diversion of Income

CL 1: In the case Jit & Pal X-Ray Pvt. Ltd. Vs. CIT (2004) 267 ITR 370 (All), an assessee purchased a
business as a going concern subject to the condition of payment of a percentage of profits to the
vendor’s wife. The amount of profits so paid should be regarded not as application of income but as
diversion of income at source by overriding title. Therefore, such amount of profit cannot be taxed in
the case of the assessee.

CL 2: In a case where, partnership firm making payment to the spouse of the deceased partner, the
Bombay High Court in CIT Vs. Nariman B. Bharucha & Sons – 130 ITR 863 has held that such payment
are in the nature of diversion of income at source by overriding title. Hence, it cannot be taxed in the
hands of partnership firm. Similarly, where a firm utilized the capital of retired partner, such
retiredpartner is eligible for share of profit u/s 37 of the Indian Partnership Act, 1932 until his share
is paid to him. The Allahbad High Court in CIT Vs. Varnasi Nagar Bika (2005) 275 ITR 140 (All) has held
that the firm is entitled to claim the amount so paid to the retired partner applying the concept of
diversion of income by overriding title.

CL 3: A co-operative society deducted certain amounts at prescribed rates from the cane price
payable to members pursuant to instruction issued by the Director of Sugar and credited to certain
funds such as Chief Minister’s Relief Fund, Hutment Fund, Area Development Fund and
Cane Development Fund. The assessee society exercised dominion over these funds and was
expected to utilize them in accordance with the guidelines issued by the by Government for which
the Director of Sugar acted in a supervisory capacity to oversee proper utilization. In such cases, the
concept of diversion of income at source by overriding of title does not apply and the entire income
is assessable in the hands of society. S. Sahakari Sakhar Karkhana Ltd. Vs. CIT (2004) 270 ITR 1 (SC).

Application of Income

An application of income is an obligation to apply income, which has accrued or has arisen or has
been received amounts to merely the apportionment of income. Therefore the essentials of the
concept of application of income under the provisions of the Income Tax Act are:

(i) Income accrues to the assessee

(ii) Income reaches the assessee

(iii) Income is applied to discharge an obligation, whether self-imposed or gratuitous.

Transfer of dividend – P Kumar v. CIT (41 ITR 624) – SC held that it just a right of assignment given
in favour of the wife – it is just transfer of income – wife has no superior of income. The shareholder
just transferred the dividends in favour of his wife – Wife has no superior title – but if in case of
charge – charge is a superior title – or in a partnership deed if it is mentioned that after the death of
partner his son A will be inducted in partnership but A has to give 50% share to the widow – then it
will be a superior title – here A is bound to follow that – Widow other had a superior title.

If the person who is receiving the income does not have a superior title, then it is not diversion of
income, it is just application of income.

CIT v. Bijoy Singh Dudharia (1933 ITR PC) – if something is mentioned in the will itself, that some
amount is to be transferred to the beneficiaries – A will receive property only if he transfers benefits
to others – this is bound to be followed – because the beneficiaries have a superior title here – so, it
is a diversion of income.

Amitabh bachan case 2006 – Case of application v. Diversion

CIT v. Imperial chemical Industries (74 ITR 17 SC) – Payment of compensation by employer to
employee or dependent – can it be claimed as a diversion? – It cannot be claimed as diversion but
can be claimed as expenditure – it is not diversion of income.

11/7/13

Diversion of Income v. Application of Income

Section 4: Charge of Income-Tax - Diversion of Income is allowed u/s 4. Diversion is based on the
concept that only real income is taxable and not all income is taxable.

When there is notional income (no tax), then also you can be taxed (Exception to the concept of
real income). E.g. House Property – If you own more than 1 house property, then you are liable for
other property even if there is no income from that property.

CIT v. Mathubhai C Patel [1999 238 ITR 403 SC]

UP Bhumi Sudhar Nigam v. CIT [2006 280 ITR 197 Al HC]

Read these cases – contractual obligation and diversion of income.

CIT v. Indramohan Sharma – Partition in HUF – Karta was a partner in a firm in his representative
capacity of HUF – After partition Karta continued to be a partner – But now no HUF – Karta
continued to receive profit in his individual capacity but not as a representative of the HUF – Karta is
liable only to the extent of his individual share and he will distribute the profits to others.

CIT v. Roopchand Prabhudas [(1982) 134 ITR 632 (Bom HC)] – HUF – 4 members – partner in a firm
– K becomes a partner in a firm in his individual capacity not representative capacity – but the
capital contributed to partnership belonged to the HUF – if partition takes place – whatever K will
receive from the firm diversion is there – everyone has a right as per their shaer of the capital
contributed – K will have to distribute the profit share to other family members – this is also
diversion.

CIT v. Travancore Sugars and Chemicals Ltd. [(1973) 88 ITR 1 (SC)] – Asseessee company entered
into an agreement with the govt to take over 3 companies of the government – Govt said that it will
purchase the goods produced by the assessee – in agreement there was a clause that the company
had to pay 25% of the net profit to the government – does this amount to diversion of income? –
Whether this should be allowed as a diversion of income but as a business expenditure? – SC held
that it should not eb allowed as a diversion of income but can be claimed as a business expenditure.

If in a will A (son) is to pay rent received from some property to B (mother), then this is not diversion
of income. But if the person paying the rent directly pays the rent to B, then it can be claimed as
diversion of income. [In the 2nd case, the money does not come into the hands of A and in the 1st
case, A transfers money to B].

Muralidhar Himmat Singh v. CIT [(1966) 62 ITR 323 (SC)] – Same facts like Kinariwala – “sub-
partners has same right as partners” – In this case diversion was allowed because there was “sub-
partnership” and not “assignment”.
V N Dev Raju v. CIT [(1950) 18 ITR 357 (Mad HC)] – Partnership – 4 partners A B C D – one retires
reserving the right that whatever contract has been made during his time, he will receive shares out
of those profits of those contracts – It is mentioned in the partnership deed itself – it is diversion of
income as there is an agreement.

CIT v. Nariman P Barucha & Sons [(1981)130 ITR 863 (Bom HC)] – Partnership deed provided that
after the death of the father, business would continue subject to certain % of net profit that will be
transferred to the mother – there is overriding title and there is diversion of title.

L Hansraj Gupta v. CIT {1969 73 ITR 765 SC) – Partnership deed provides that if any partner becomes
a partner in any other firm without the consent of the other partners – whatever profit D will receive
from new firm, belongs to the old partnership – D is not liable to pay for the same as this is
“diversion of income” as there is a deed.

When income is diverted at source – diversion of income.

When there is a charge or overriding title created on the source – if it is on the person it is not
diversion.

Jit & Pal X Rays Pvt Ltd. v. CIT [(2004) 267 ITR 370 All HC] – Assessee company purchased one going
concern from Mr. X – under the agreement or sale deed, over and above the sale consideration, a
certain sum was payable to the wife of Mr. X – the claim of diversion was accepted by the HC
because the transfer was one of the “term in the agreement itself”. It is stipulation in the sale deed
itself. If the party A and X were related, then it would have been application of income.

Amitabh Bachchan v. Dy. CIT [(2005) 3 SOT 428 Mum ITAT] – Agreement between assessee (AB)
and ABCL provided that AB would hand over all income to ABCL except from feature films and
motion pictures in the ratio of 70:30 – this was award given by the arbitrator – AB had to transfer
the award to ABCL – AB hosted KBC and transferred income to ABCL and claimed it as diversion of
income – ITAT gave judgment on basis of arbitral award – it is his legal obligation – it was diversion
of income. The case was decided on the basis of legal obligation and not contractual obligation.

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16-7-2013

S. 2(1A) – Agricultural Income

S. 10(1) – Exempt Agricultural Income

In 1860 – Agricultural income was taxable

Definition of Agricultural Income

In 1957, SC defined “agricultural income” in CIT v. Raja Benoy Kumar Sahas Roy 1957 32 ITR 466 SC

2 tests:

(i) Basic operation

(ii) Subsequent Operation

Vinay Kumar case – already discussed – What is agricultural purpose?

Bacha F Guzdar v. CIT [1955 27 ITR SC] – Guzdar was a shareholder in a company – company
distributed dividends – Company was doing agricultural business and all income was agricultural
income – which was exempted – Guzdar received dividend – he claimed that divided as agricultural
income and claimed exemption from IT Act – it falls in S. 2(1A)(a) – Land must be immediate source f
income and not remote source of income – Source of income is shareholding and not agricultural
and – SC held that land must be immediate and effective source of income, then only it is AI,
otherwise not – This was not held to be AI.

Kamakhya Narain Singh v. CIT (AIR 1943 11 ITR 513 PC) – If some rent is payable to B – A is landlord
– A charges 5000 rent to B – this 5000 is pure agricultural income – if B becomes defaulter and now
he has to pay interest also on the land – whether the interest on the rent will be agricultural income
(AI) – Same logic – Interest is not coming from land but because you have defaulted – Land is the not
the direct source of revenue.

Brihan Maharashtra Sugar Syndicate v. CIT [1946 14 ITR 611 (Bom HC)] – Conversion of sugarcane
into jaggery – what is the definition of “market” – How do you define “ordinary process” – if there is
a market in your reach (not far) for a particular product then it would be AI – but if you are
converting that then it is not an ordinary process and will not amount to AI.

K Lakshmanan v. CIT [1999 239 ITR 597] – Mulberry leaves are being produced – selling cocoons –
there is market for mulberry leaves – there is no ordinary process – apportion is not AI – upto the
stage of production of mulberry leaves it is AI, but after that any process to increase the value is not
AI.
COMPOSITE INCOME

AI + NAI = Composite Income

Certain cl crops are mentioned as commercial crops and their rate is pre-determined as to what is
agricultural and what is non-agricultural. = Tea (8), Rubber (7B), Coffee (7A) [IT Rules 1962]

Tea = 60-40 (Agricultural Income-Business Income)

Rubber = 65-35

Coffee = 75-25

AI is exempted u/s 10A.

Finance Act, 1974-75 – Taxation of Agricultural Income – INTEGRATION OF AGRICULTURAL

INCOME WITH NON-AGRICULTURAL INCOME

As per Finance Act, 1974-75, AI was considered for calculation of tax liability. Entry 82 to legislate on
IT Act (Income except AI) – but in 1974, FI Act, 1974, AI was also considered for tax -

Integration scheme is applied in case of:

A. The assessee should be:

(i) Individual
(ii) HUF
(iii) Association of Persons / Body of Individuals
(iv) Artificial and Juridical Persons
B. Net AI must be exceeding Rs. 5000 per year
C. He must be having some non-agricultural income.

Method of Calculation

Ist Step = add AI with NAI

2nd Step = Add net AI with Max threshold limit

3rd Step = Deduct Step I – Step II

X has a salary = Rs. 500000

X’s Agricultural Income = Rs. 300000

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Concept of Residential Status – S. 6 IT Act

For determination of status of an individual, there are two rules:

Rule 1 = If A stays for more than 182 days in India, he is a resident of India’
Rule 2 if stay in India in preceding year is 60 days, and total 365 days in preceding 4 years = this is
subject to 3 exceptions:

(i) If as a citizen of India you leave India as a crew

(ii) For purpose of employment 60 = 182 days [must be employed in India and not to seek
employment outside India]
(iii) Citizen of India or PIO 60 days = 182 days

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17-7-2013

RESIDENTIAL STATUS AND TAX LIABILITY [S. 6-9]

Section 6 – Determination of Status

Section 7 – Deemed Receipt

Section 9 – Income deemed to accrue or arise in India

Section 5 provides for “incidence of tax” – when you are liable, for what you are liable, for what you
are not liable = Scope of Total Income

Income Tax is tax on total income.

S. 4 r/w S. 5

Categories of Persons:

(i) Individual/HUF
(ii) Firm/HUF
(iii) Company
(iv) Any other Person

There is a presumption of residence in case of a firm. Even if a firm is partly in India and partly
outside India, then also the presumption is there.

However, in case of a company, this is not so. It should satisfy the conditions laid down in S. 6.

In case of Individuals and Firms, Court will presume that they are resident in India, unless the
contrary is proved.

If business of any firm is carried partly in India and partly outside India, but if the firm is controlled
from India, then it would be taxable as a resident in India.
What does “control and Management” mean? – Where the company takes the de jure decisions
and not de facto (i.e. shareholders) – where the business actually takes place – for income tax
purpose “policy decisions” are important – where such policy decisions are taken that is the place
relevant for our purpose.

Subaiyya Chettiar v. CIT [19 ITR 168 SC] – SC defined “control” and “management” – normally the
court will presume that if you are individual/firm/HUF you are resident in India, unless contrary is
proved – burden lies on the person claiming that he is a non-resident – but in case of a company the
burden lies on the department – company is always non-resident, unless the revenue department
proves otherwise.

What does “affairs” mean? – means some income-generating activity

“Control and management” signifies the head and brain of the company – de jure position of the
company and not de facto – where the Board of Directors take the policy decisions.

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Concept of “Business Connection”

Concept of “Permanent Establishment” -

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Article 4 of Model Convention – DTAA – if you fulfil the conditions of Article 4, then only benefit of
DTAA can be claimed.

Only the persons who are resident in either of the States, can claim the benefit of DTAA. Third state
resident cannot claim benefit of DTAA between two countries.

India-Mauritius DTAA

“liable to tax” – To claim the benefit of DTAA, a person must be “liable to tax”.

“subject to tax”

Persons having income upto Rs. 2.5 lakh are exempted from paying tax. They are liable to pay tax
but they are not subject to tax. This was explained by the SC in Azadi Bachao Andolan case.

Round Tripping – Indians investing in India through Mauritius

Treaty Shopping – Foreigners investing in India through Mauritius

India wants “LOB clause” to be inserted in India-Mauritius DTAA –

Another rule – “Controlled Foreign Corporation (CFC)” Rules – If you are controlled by a foreign
corporation, then not a resident.
Circular 789 of 2000 – CBDT – If you obtain a Certificate of Residence in Mauritius, you will become a
resident of Mauritius. IT Department challenged their own circular – Azadi Bachao Andolan case –
due to this circular a large no. of FIIs are coming to India through Mauritius – IT department issued
notice in 2000 that they are taxable in India, as they were bogus companies in Mauritius –
Clarification came from Ministry of Finance, that IT Department’s view was not view of the
Government – How can override the parent legislation through delegated legislation – S. 90
delegates power to Executive to enter into DTAA and S. 119 gives power to CBDT to issue circulars,
notifications, etc. – The contention was if there are set rules of residency u/s 6, how can these rules
be superseded u/s 90 through DTAAs – Delhi HC accepted the plea – But SC reversed the order in
Azadi Bachao Andolan v. UOI [2003 SC]– HC judgment was legally sound but SC judgment was
based on the prevailing situation in India – India needed foreign investment.

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18-7-2013

AZADI BACHAO ANDOLAN V. UNION OF INDIA (2003)

RESIDENCY STATUS AND TAX LIABILITY

SECTION 4 AND 5 r/w S. 90

TIEA – Tax Information Exchange Agreements – with tax haven countries

S. 5 starts with non-obstante clause (subject to S. 90) – that is why SC in Azadi Bachao case said that
S. 90 has an overriding effect on other sections.

If different rates under IT Act and DTAA, the rate which is more beneficial will be applicable.

Both S. 4 and 5 are subject to S. 90.

S. 5 says that you are taxable in India from whatever source you derive your income.

Non-Resident = liable of income “deemed to accrue or arise” in India.

UNION OF INDIA V. AZADI BACHAO ANDOLAN (2003 263 ITR 706 SC)

Two circulars – C. 682 of 30.3.1994 and C. 789 issued on 13.4.2000 – 682 provided that the capital
gains of any resident of Mauritius by share in Indian company shall be taxable only in mauritisu and
will not be liabe to tax in India – on the basis of this circular – large no. of FIIs invested in India – IT
Departmetn issued a show casue notice to FIIs in 2000 – on the ground that these FIIs are shell
companies and are not residents of Mauritius – so they are not resident and cannot take the benefit
of India-Mairutis DTAA and C. 682 – GOI issued a press note on 4.4.2000 and clarified that the view
taken by IT Department did not represent the views or policy of the Government.

Govt on 13.4.2000 issued C. 789 to clarify its position. It said that “how to determine the residential
status of a person” – will be based on Ceritficate of residence from the Mauritian Government –
again a writ petition was filed to chalelneg this circular in Delhi HC. – on the ground that the circular
is ultra vires of S. 119 and S> 90 – CBDT has no power to override the parent legislation through
delegated legislation – HC upheld the contention and struck down these circulars.

HC quashed the circulars on the following grounds:

(1) Ciruclar does not show that it has been issued u/s 119 or under any other provision; so it should
not be legally binding on the revenue department and they can challenge their own circulars.
(2) For the status of assessee = Criteria of a “similar nature” u/A 4(1) of DTAA = Whether this TRC
can be put in “similar nature” category (Nationality, Citizenship, Residence),

But SC reversed the judgment of the HC. SC held that TRC can be put in “similar nature” criteria. SC
decided the issue not on legal grounds but on the prevailing situation.

Legal Status of Circulars: Circulars are binding on the department but not the assessee.

Finance Act 2012-13 – Govt fixed a criteria for obtaining TRC in Mauritius.

THREE CRITERIA FOR TAX BASIS – (Residence, Source, TRC, etc.)

(I) Under Income Tax Act –

(II) Under DTAA
(III) Under mutual agreement procedure – TRC (Azadi Bachao Andolan case)

SECTION 5: provides that:

(i) received or deemed to be received in India

(ii) accrue or arise or deemed to accrue or arise in India
(iii) accrue or arise outside India

RESIDENT: ALL 3 CATEGORIES = TAXABLE IN INDIA

NON-RESIDENT: Only first two categories is taxable; not 3rd category

NOT ORDINARILY RESIDENT: ALL 3 CATEGORIES ARE TAXABLE – but for 3rd category, a condition is
there – taxable in India “only if that income accrue or arise from any profession or business set up in
India”.
What does “receive” mean? – first receipt – after first receipt it becomes remittance- when you get
the control over the money – if A receives salary in US , then US is the place of receipt and not India
even if A transfers all his money to India and utilises it in India.

What does “deemed received” mean? – Defined u/s 7 of IT Act – It includes “Contribution to
Provident Fund Account” – it is a deemed receipt.

Accrual v. Receipt = Accrual comes before receipt – first income is due then it is received – but in
some cases receipt comes first before accrual (e.g. advance salary).

If Advance salary is received outside India to a Resident and it is received before accrual = then it is
not taxable in India [Imp] – not covered u/s 5- lacunae in IT Act

Received through cheque or post-office from outside India = from US to India = sent to post office –
then it comes to India = not taxable in India

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19-7-2013

SECTION 9: INCOME DEEMED TO ACCRUE OR ARISE IN INDIA

(I) Business Connection

(II) Property
(III) Source
(IV) Capital Asset

“through or from” – even if the capital asset

If both A and B are non-resident. A has a property in Delhi. He lets out this property to B for 5000$
pm. He receives this money in USA itself. Because the property is in India – that income is taxable in
India u/s 9.

“Income from any asset or source” – e.g. shares, dividends, interest, royalty, etc. – Source must be
in India

“Capital Asset” – If the capital asset is in india, if you transfer that asset, it is taxable u/s 9.

BUSINESS CONNECTION

It is not defined in the IT Act. It includes “profession connection” as well.

What does “business connection” mean?

Explanation 2 to S. 9 – what all are included in “business connection”.

(i) The person has authority to conclude contracts on behalf of the Non-Resident;
If there is an independent agency (working for A also and B also) that does work for a Non-Resident,
then it does not come under “business connection”. Only if there is some dependency, then only
“business connection:” is there.

There is a contract between A and B – A sells machines to India - B paid 20 million to purchase A’s
machine – there must be some continuous business activity – isolated transaction is not business
connection even if there is some income.

CIT v. Fried Krupp Industries [1953 23 ITR 101 (SC)] – SC held that isolated transaction or stray
transaction or transactions on principal to principla basis – does not amount to a “business
connection”.

Barendra Prasad v. ITO [1981 129 ITR 295 SC] - SC extended the scope of “business connection” and
held that it includes “professional connection” also. “Business is one of the wider import and it
means an activity carried on continuously and systematically by a person by the application of his
labour and skill.”

Business profession includes profession because “business” is a word of wider import.

G B K Industries v. ITO [1997 228 ITR 564 SC] – SC laid down 4 principles to identify “business
connection”:

(i) Existence of non-existence of a BC is a mixed question of fact and law and it depends upon
the facts and circumstances of the case.
(ii) The expression BC is too wide to admit any precise definition. It is impossible to define BC.
(iii) The essence of BC is the existence of close, real and intimate relationship and common
sense of interest between the Indian person and the Non-Resident. [This principle was laid in
the case of R D Agrawal case]
(iv) There must a continuity of activity or operation.

CIT v. R D Agrawal & Co. [1965 56 ITR 20 (SC)]

For IT Act, business and profession are the same.

In DTAA, Business is taxable through “permanent establishment”. Under IT Act, business is taxable
through “business connection”.

Thus, the concept of BC is similar to that of PE.

BC includes PE but PE may not include PE.

S. 9 is subject to Article 5 of DTAA which defines “permanent establishment”.

DTAA does not create any liability. There is no charging section. It just describes certain sections. No
person can be made liable under DTAA.

Business Connection includes all PEs (service, agency, fixed place, insurance, construction, etc.) but
all PEs does not include BCs. If there is a PE, there is a BC. But if there is a BC, it need not have a PE.

EXCEPTIONS UNDER SECTION 9 which are not taxable

(1) Only those income can be taxed which are reasonably attributable to the operations carried out
in India.

Attribution of Profit Rule

(2) In the case of Non-resident, - if a NR purchases gold in India and exports it to US – it is not
taxable – but if converts gold into jewellery and he is exporting that – it is taxable – whatever
articles he purchases and exports as such, there is exemption but if there is soem value addition,
it is not exempted.

(3) News Agency or Magazine – collection of news and views for transmission purpose out of India, -
not taxable u/s 9 – if it is confined to this activity only.

(4) Shooting of Cinematograph film in India

CAPITAL ASSET

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23-7-2013

SECTION 9: INCOME DEEMED TO ACCRUE OR ARISE IN INDIA

Section 9(1)(ii) – When salary is taxable as income deemed to accrue or arise in India

Salary earned in India for services rendered in India, shall be taxable u/s 9.

Any salary received for servies rendered in India is always taxable, whether you receive in India or
outside India. It will be taxable on the basis of ‘accrue or arise in India’

Section 9(1) (iii): Income

If the payer is GOI and payee is citizen, if the services rendered outside India and salary received
outside India, is taxable in India. [E.g. Diplomats
Section 9(1)(iv): Dividend paid by Indian company outside India is taxable in the hands of
shareholders.

Section 9(1)(v); Income by way of “interest”

Income by way of interest, if it is payable by the GOI, whosoever is the payee, it is always taxable in
India.

Interest payable by a person who is a resident (payer),

Interest payable by NR to a NR, if money is used is India

If A is NR and B is a NR, A is a payer of interest and B is money-lender. A obtained loan of Rs. 1 lakh
to purchase shares in India – whether B is taxable for interest? – this is just investment – it is not
taxable as it is just investment and this is not covered under 3rd part – this is a big lacuna in 9(1)(v)

Section 9(1)(vi) Royalty

(i) By the Government – always taxable

(ii) Payable by a person who is a resident = where the royalty is payable in respect of any
right or property for the purpose of business profession in India is always taxable, except
if he uses it outside India.
(iii) If the payer is non-resident = lacuna is addressed here but not in case of interest = taxable
in India only if used in business profession in India or any other source in India.

Explanation 2 defines “royalty”

Income from royalty = passive income = taxable in both countries of source and host

Business income from royalty = only taxable in India, if PE is in India (even if all the other
conditions of S. 9(1)(vi) are fulfilled)

Citus of Intellectual Property – 2003 – In Re Pfizer Corporation (2000 271 ITR 101 (AAR)3 –
Three companies A and B and C– A is foreign company, B is Indian company, and C is third
country company – A is holding trademark for a product – A transfers trademark to B (Indian
subsidiary of A) without any royalty – this trademark was registered in India only – B had
exclusive right to use that trademark – C company enters into an agreement with A (Sale and
Purchase Agreement with A) to purchase this trademark – C pays 5 billion to A to purchase this
trademark – C made another agreement with B for extinguishment of claim (amounts to transfer
under IT Act) and paid 7 billion to B – A transferred this trademark to C in another country D – C

3
Ruling of AAR is not binding on the court. It has a persuasive value. SC Judges are presiding judges. It is
binding on the assessee and the revenue department.
 deducted tax at source and deposited with India – Whether C is taxable for 5 billion to A in India
or not? – Where is the citus (residence) of Intellectual Property – It was held that Citus was
outside India so it was not taxable.

Revenue argued that it was not a capital gain and a business income to A – then this 5 billion will
be taxable as business income and the PE is in India and it would be taxable in India.

If we see the impact doctrine – the impact was in India – market was in India – even if the
ownership is outside India – why it should be taxable outside India?

The trademark was registered in India – exclusively in India – so it should be taxable in India –
Citis of IP is to be considered in India

Foster Australia case – similar facts as above – exclusive license of foster brand to Indian
subsidiary – trademark transferred to company C – AAR said that in the case of trademark, we
should follow the market principle or impact doctrine.

Capital gain from royalty = It is taxable in the country of residents.

Section 9(1)(vii)Fees for Technical Service (FTS)

(1) Payable by Government

(2) Resident = when he utilises these services in a business profession or any other source outside
India, then not taxable – but taxable in all other cases.
(3) Non-Resident = when services are utilised in a business or profession carried on in India or in any
other source of Income in India.

This is a controversial section.

If A hires a foreign law firm for consultancy service in India – services are rendered from foreign –
but these services are utilised in Indian projects – whether fees is taxable in India or not? – nowhere
“rendering of service” is mentioned in S. 9(1)(vii) – whether rendering or utilisation must be both at
the same place? – SC says that both must be in India, then only it is taxable u/s 9(1)(vii), otherwise it
is not taxable – SC has clubbed S. 9(1)(vi)(c)

Ishika Wajima Harima Heavy Industries v. DIT (2007 288 ITR 408 SC) – the company was
incorporated in Japan – Co. Formed a consortium and entered into an agreement with Petronet LNG
– consortium of 4 companies in India – for setting up for storage and gasification facility – there are
2 agreements – (i) one on shore supply of goods and on shore supply of services; (ii) off shore supply
of goods and off shore supply of services – there is no problem regarding the 1st agreement (as it is
always taxable in India) – even in offshore supply of goods there is no problem as it is not taxable –
the problem arose in case of offshore supply of services – they are rendering the services but they
are utilising the services in India – whether offshore supply of services is taxable u/s 9(1)(vii) or not?
– SC held territorial nexus doctrine – there must be some nexus between the income and the
person – SC this doctrine does not exist in the case because the person is supply the services outside
India and services are utilised in India – SC held that for taxability of FTA, if the payer is NR, both
must be in India rendering and utilisation of services – if only one is there, it is not taxable.

To nullify the judgment of the SC in 2007, there was an amendment in the Finance Act – It provided
that for the removal of doubts, it is hereby declared that for the purpose of this section, the income of
NR shall be deemed to be accrue or arise in India in respect of S. 9(1)(v), (vi), (vii) will be taxable in
India –whether or not NR is a place of residence, place of business or any business connection in
India.

After 2007, two cases were decided by Bom HC CIT v. Siemens (2009 310 ITR 320 Bom HC) and
Clifford Chance v. DCIT (2009 318 ITR 237 Bom HC).

In Siemens case (decided in Nov)

In both cases the Bom HC followed the doctrine of territorial nexus of Ishika case and not the
amendment of 2007 – they have not followed the amendment – they say that the SC Judgment is a
good law because the amendment does not mention “rendering of service is required or not” – so
this amendment to overrule the Ishika Vajima Doctrine.

In 2010, to nullify the effect of these cases, one more amendment came in 2010 – it added one
more clause – whether or not NR has rendered the service outside India is not relevant at all – what
is relevant is utilization of services.

Two cases decided after this amendment – Link Laters LLP v. ITO (2010 TII 80 ITAT Mum) and
Ashapura Minichem Limited v. ADIT (2010 131 TTJ Mum 291) – Both cases have followed the
amendment and not the Ishika Wajima doctrine.

The final position that place of rendering is not important but the place of utilisation is important – if
the place of utilisation is in India, then it is taxable in India irrespective of the fact that rendering was
outside India.

G V K Industries Ltd. v. ITO (2011 3 SCALE 111) – Section 9 has extra-territorial application and it is
not unconstitutional – Parliament has power to legislation that has extra-territorial application –
SC upheld validity of S. 9 -

Utilisation is important, but place of residence or business connection is not relevant for 9(1)(v), vi or
vii.

ASSIGNMENT ON SECTION 9 – READ THESE 5 CASES

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25-7-2013

MODULE 2 – SOURCES OF INCOME

What is “total income”?

Income Tax it on total income.

Total income means income from all sources such as:

(1) Income from salary (Gross – Deductions = Net salary)

(2) Income from house property (Gross Annual Value – Deductions u/s 24 = Net Annual Value)
(3) Income from business and property (Net profit +/- adjustments under IT Act)
(4) Capital Gain -
a. Whether CG is part of total income or not?

If you earn any capital gain, it will be taxable separately, it is not a part of total income,
as there is separate rate for this.

(5) Other Sources – It is part of total income – Certain deductions are allowed u/s 57, 58

TI = S + HP + BP + OS (it does not include CG)

On the total income, deductions are allowed u/s 80C. After deductions whatever is remaining is the
taxable income.

Total Income – deductions u/s 80C-80U = Taxable Income

Deductions are done at two places. In the heads separately and in the total income as a whole.

INCOME FROM SALARY (15-17)

INCOME FROM HOUSE PROPERTY (22-27)

BUSINESS PROEFSSION (28-44)

CAPITAL GAIN (45-55A)

OTHER SOURCES (56-59)

SECTION 14 DEFINES THESE SOURCES/HEADS OF INCOME

Section 14A(1) – Any expenditure incurred for dividend or commission paid does not form part of
Total Income, so expenditure on this income is also exempted.

If the income is partly taxable and party exempted, then as per the ratio, it will be exempted or
taxable. [S. 14A(2)
SALARIES – SECTION 15

(i) Any salary due from an employer or a former employer to an assessee in the previous year,
whether paid or not;
(ii) Relationship must be of “employer” and “employee” [e.g. salary of partner is not taxable as
there is no employer-employee relationship).

It depends on the contract – if the director receives as an independent then it is not taxable
but if it is mentioned that he is employee, then it is taxable.

Salary of actors – it is a contract for employment – it is not taxable as alary – it is income

from profession.

Whether attorney general or advocate general are employee? – They are not employees

Whether SC or HC Judges are employees? – SC, HC Judges are employees – SC case held that
they are employees.

Law firm – It is income from profession and not salary – join as retainers not as employees.

If it is not legal, it is not taxable as a salary.

Allowances v. Perks

Allowances are always in cash and cannot be in kind, Perks can be in cash as well as kind.

Allowances are always part of contract of service, but perks cannot be. You know from the 1st day
itself what allowances you will get, but perks you do not know. Perks is not mentioned in the
contract, but allowances are mentioned in the contract.

Perks v. Fringe Benefit

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SECTION 17 –

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31-7-2013

PENSION

Pension received from UNO anywhere in the world is exempted.

Pension of HC and SC Judges is exempted

Family pension – except armed forces – is taxable u/s 56 and exemption is u/s 57.

There is New Pension Scheme after 2004 in case of CG.

Now pension has become contributory like provident fund. 10% from employer and 10% from the
employee.

REGULAR PENSION (before 2004)

(1) Uncommuted Pension – It is always taxable (both for govt, non-govt employees)
(2) Commuted Pension – it is provided as an exemption u/s 10(10A)
a. At the time of retirement, take as lump sum amount.
b. In case of govt employee, it is exempted
c. In case of non-govt employee, it is partly taxable and partly exempted.

Partly exempted and partly taxable:

(i) With gratuity = 1/3

(ii) Without gratuity = ½

LEAVE SALARY [10(10AA) – ENCASHMENT OF LEAVE – PAID LEAVE

At the time of retirement, earned leaves can be encashed = It is exempted in case of govt employee
(only if it is received after the age of retirement or superannuation).

If it is received during employment, it is taxable.

In case of non-govt employees –

RETRENCHMENT COMPENSATION (10(10B)

VOLUNTARY RETIREMENT SCHEME (VRS)

Golden Handshake Scheme

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SECTION 25

It has overriding effect on S. 24 (deductions)

If A takes loan from B and B is outside India. Payment of interest by A to B (is taxable in India u/s
9(1)(v)) – this interest is also deductible u/s 24 in the hands of A – in this case S. 25 will apply – A will
deduct the tax at source from the interest – if A will not deduct TDS then no deduction u/s 24 will be
allowed. A is obligated to deduct TDS.

Since B is outside India and there is no representative present in India, A is obligated to deduct TDS.

SECTION 25AA

Unrealised rent is deductible subject to certain conditions.

It can be claimed as a deduction from the gross annual value.

When this unrealised rent is realised subsequently, 25AA will apply – the amount so realised shall be
deemed to be income chargeable under the head “Income from house property” and accordingly
charged to income-tax, whether or not the assessee is the owner of that property in that previous
year.

If the assessee is owner in 2013-14 but not in 2015-16, then also if he receives unrealised rent of
2013-14 subsequently, he is chargeable u/s 25AA.

Even if he is not the owner subsequently, he is liable.

SECTION 25B

In 2013-14, to increase the rent from retrospective effect – A paid Rs. 5000 from 2009-10 – In 2013-
14, change in agreement – A is to pay rent but Rs. 6000 pm from 2009-10 onwards (retrospective) –
arrear of 2009-10,10-11,2011-12, 2012-13 and 2013-14 – This is “arrears of rent” – this is received in
2013-14.

Whatever arrears received in 2013-14 – deduct 30% Standard Deduction u/s 24 – rest will be taxable
even if you are not the owner of that house property in 2013-14.

Arrears are always taxable on received basis.

6th Pay Commission – Whenever the arrears is received, it is taxable.

SECTION 26: PROPERTY OWNED BY CO-OWNERS

A, B, C and D – joint owners – their portion is separable and identifiable – their shares are definite
and ascertainable - individually they are taxable and not as ‘association’ - taxable under “income
from house property” u/s 22-25.

CERTAIN HOUSE PROPERTIES WHICH ARE EXEMPTED U/S 10

(1) Income from farm-house (agricultural income) u/s 10(1) and 2(1)(A)
(2) Annual value of any one palace of an ex-Ruler [S. 10(19A))
(3) Property income of local authority (e.g. Municipality, Panchayat) (s. 10(20)
(4) Property income of approved scientific research association (S. 10(21))
(5) Property income of an educational institution and hospitals
(6) Property income of trade union (10(24))
(7) Property income of political party (S. 13A)
(8) Property income which is chargeable under business profession u/s 22
(9) Property income of one self-occupied house is also exempted (S. 23)
(10)Not under specific section – Judgment – Properties owned by clubs or societies – Rotary Club,
Lion’s Club – they are for mutual concern and not for profit.

Principle of Mutuality – Exempted – Not working for profit – fees is charged but not for profit –
Chelmsford Club v. CIT (2000 243 ITR 89 SC) – Any property held by the clubs, society –w hcih
work on no profit basis – are exempted.

Must read cases:

(1) Poddar Cement Case

(2) National Storage
(3) N Natraj v. DCIT (2004 266 ITR 277 Mad HC) – if Partner let out his building to his firm – and the
firm can claim benefit of S. 22? – property used for business profession is not taxable u/s 22
(4) DLF United Ltd. v. CIT (1984 149 ITR 24 Del HC) – Concept of “ownership”
(5) Sheela Kaushik v. CIT (1981 131 ITR 435 SC) – SC laid down the rule of “standard rent” –
expected rent will not exceed “standard rent” – the maximum rent which you can realise legally
– Rent Control Act provides maximum rent.
(6) Karnani Properties Ltd. v. CIT (1971 82 ITR 547 SC) – Commercial Malls – Court discussed that
commercial malls are taxable as house property and not business income – even if it is your
business.
(7) Attukal Shopping Complex Pvt Ltd v. CIT (2003 259 ITR 567 Kar HC) – Same as above.

INCOME FROM BUSINESS AND PROFESSION (28-44)

Section 2(13)

Section 2(36)

Holding shares as investment = capital gains

Holding shares as trading asset = business income

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14-8-2013

Income from Business or Profession

For the purpose of charging, there is no difference between business or profession.

They are charged under S. 28

Business is defined under S. 2(13)

Proefssino is defined under S. 2(36)

Business = trade, commerce or manufacture, or any adventure in the nature of it. [even a single
activity, wherethere is intention to carry on business – even intention is not conclusive test – even
single activity can eb cosndiered bsuienss –

Investment in a land and selling small plots – may be termed as business.

(i) Activities
(ii) Nature

What are the implications of S. 28? When income is chargeable u/s 28?

Even the assessee himself is not carrying on the business, then also he is taxable.

Even if he does business even for a single day, then also he is taxable.

When does business activity start? – Any “income generating activity” would be the “business
activity” – if you have started business – then also it is taxable – even if it is a return for the loss –
Income may be loss also.

Any pre-incorporation profit = it is taxable under “other sources” – but if the company ratifies the
acts of promoters – it would come under “income from business”.

ITO v. Rani Ratnesh Kumari (1980 123 ITR 343 All HC) – Court laidd down certain tests to find out
whether iti s business or adventure in the nature of business – whether it is capital gain or business?
– there are three tests (not conclusive tests):

(i) Nature
(ii) Activity
(iii) Intention of the Parties

CIT v. B M Kharwar (1969 72 ITR 603 SC) – There must be two persons – one cannot indulge in
business with himself – but there may be business between a partner and a partnership firm
(because they are two persons) – even though they are in law one person – but they are two
individuals.

CIT v. CT Mills Distributors (1996 219 ITR 1 SC) – Pre incorporation profit and promoters business – if
the company ratifies – then pre-incroration profit would also come under “business”.

Director of State Lotteries v. CIT (1999 238 ITR 1 Gau HC) – Trader – there are certain unsold or
unclaimed lotteries – won a prize – Court held that it is income from business or profession – it is not
income from winning of lotteries – it is income from BP.

CIT v. Lakshmi Vilas Bank (1996 220 ITR 305 SC) – Bank was purchasing shares and securities on
behalf of the constituents – Bank obtained commission and service charge – Purchase was made
during the course of business – it was business of bank to purchase shares and securities – Margin
money of constituents was forfeited due to non-taking of scripts – Whether that margin money is
taxable as business income? – Activity is incidental to the activities of the bank – So it is income from
BP.

SECTION 28(2) – SPECIAL INCOMES TAXABLE SPECIALLY AS BUSINESS INCOME EVEN IT MAY BE A
CAPITAL RECEIPT

All capital receipts are exempted unless expressly made taxable.

All revenue receipts are taxable unless expressly exempted.

(1) Any compensation or other payment due to or received by:

(a) Any person managing the whole or substantially affairs of an Indian Company in connection
with termination of his management or the modification of the terms and conditions
relating thereto;
(b) Any person managing the whole or substantially the whole of the affairs in Indian of any
other company --------;
(c) Any person holding an agency in India for any part of the activities relating to business ---- ;
(d) Any person for or in connection with vesting with Government,

Employee = taxable under “income from salary”

Professional = taxable under “income frmo BP”

(2) Income derived by a trade, professional or similar association from specific services performed
for its members;

(3) (a) (b) (c) (d) (e) – Export incentives = Taxable as business income
(a) Profits on sale of a license granted under Import Act;
(b) Cash assistance received or receivable;
 (c) Duty of customs or excise repayable
(d) DEPB Scheme
(e) DFRC

(4) The value of any benefit or perquisite, whether convertible into money or not, arising from
business or profession; [If received as an employee – then income from salary, but if professional
– income from BI) – Advocate – perquisite from client – taxable as BI.

(5) Any interest, salary, bonus, commission or remuneration, due to or received by a partner of a
firm from such firm:

(5A) – Important

Income under non-compete agreements

(i) Any sum, received or receivable, in cash or kind, under an agreement....

“Agreement” means any arrangement or understanding whether or not it is in writing or it is

intended to be enforceable by legal means.

Proviso:

(a) Transfer of right to manufacture – chargeable u/s 45 but not under BI;

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16-8-2013

SECTION 28

(6) Any sum received under a Keyman insurance policy including the sum allocated by way of bonus
on such policy.

What is Keyman Insurance Policy? – Life Insurance Policy taken by a person on the

(7) S. 35AB – Inserted in 2009 – Specified Business – Certain deductions are available – which is
more than expenditure – weighted deductions – certain business are subjected weighted
deductions – eg. Hospitals, cold storage, etc. – specified business defined u/s 35AB – if
deduction is claimed u/s 35AB regarding any specified asset – deduction is allowed – Rs.
20,00,000 for consutraction of cold storage – full deduction of Rs. 20 lakh allowed – but if you
transfer that building after deduction – then whatever deduction is taken – it is income under S.
28(vii)

Explanation = Where speculative transactions carried on by an assessee are of such a nature as to

constitute a business, the business shall be deemed to be distinct and separate from any other
business.

General Business v. Speculative Business = Why this distinction? – Because of S. 73 – If there is any
loss from SB, that cannot be set off against the profit of GB.
What is Speculative Business? – S. 43(5) defines – “Speculative transactions” – Provisos S. 43(5)
(These 4 transactions are not Speculative transactions).

Davenport Co. Pvt Ltd. V. CIT (1975 100 ITR 715 SC) –“ST” are in the nature of “gamble” – there is an
element of gambling in ST – SC held that even if there is no intention to gamble then also there is ST.

CIT v. S C Kothari (1971 82 ITR 794 SC) – SC held that the “Contract for sale and purchase” must be
an enforceable contract.

Pankaj Oil Mills v. CIT (1978 115 ITR 824 Guj HC) – “Hedging contracts” must be genuine contracts –
person must be a dealer and not a consumer/user. The transaction must be a genuine transaction to
claim the proviso to S. 73.

2006 Amendment = Derivative transactions through SE are not ST. Earlier they were ST.

SECTION 29: INCOME FROM PROFITS AND GAINS OF BUSINESS OR PROFESSION, HOW COMPUTED

The income referred to in S. 28 shall be computed in accordance with the provisions contained in S.
30-43D.

Income Tax provisions override the accounting standards. It is expressly mentioned in S. 29 that
computation of profits and gain will be in according to S. 30-43D. Whether you are following certain
accounting standards, it is not relevant, but for the IT Act, S. 29 is to be followed.

DEDUCTIONS (S. 30-37)

40, 40A, 41, 42, 43 – DEFINITIONS/CONDITIONS WHERE DEDUCTIONS ARE ALLOWED OR NOT
ALLOWED

There are certain deductions not mentioned in any provision of IT Act but are allowed

Business Loss or Trading Loss = Loss in the course of business, Loss of stock in trade, Dacoity – loss
of cash, etc.

a. It should be a revenue loss not a capital loss.

b. It must arise in the course of business

SC held that IT must be calculated on true income. If there is business loss or trading loss, it
should be allowed as deduction.

CIT v. Nainital Bank (1965 55 ITR 707 SC) – Loss must be incidental and must arise in the course of
business. SC held that whether the loss is incident or it arises in the course of business, is a question
of fact and it must be decided on the facts and circumstances of the case having regard to the nature
of the business and the risks involved in the business.
Calcutta Co. Ltd. v. CIT (1959 37 ITR 1 SC) – SC held one has to keep in view the general commercial
principles while determining real and true profit of the business and profession.

Business Loss v. Business Expenditure = Under the IT Act, if there is an illegal business expenditure,
that business expenditure will not be allowed (S. 37). However, even if an illegal business loss arising
out of illegal business is allowed.

If business is dealing in narcotics which is illegal business, if police seizes consignment, it can be
claimed as business loss [T A Qureshi v. CIT 2006 SC). S. 37 talks only about business expenditure
and not business loss.

Person on business tour – forest area to purchase leaves – got kidnapped by Naxalites – he paid Rs.
10 lakhs as ransom – he claimed this as business expenditure – Court allowed it as business
expenditure – as it is not illegal business expenditure.

Payments made by pharmaceutical companies to doctors in cash/kind – they allowed it as business

expenditure – Court disallowed it as it is illegal business expenditure – as it is prohibited under
medical regulations.

However, Income from legal business or illegal business is taxable.

SECTION 30-37

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22-8-2013

SECTION 32: DEPRECIATION

Conditions:

(1) Ownership – must be owned by the assessee

(2) Tangible asset/Intangible asset
a. Buildings
b. Plant
c. Machinery
(3) It is on the block of assets and not on individual assets

Methods:

(1) Straight-line method (SLM) – It is applicable in case the assessee engages in business of
generation of electricity.
(2) Written down value method (WDV) – in rest cases, this method.

Concept of Actual Cost

Depreciation is on actual cost only.

“Actual Cost” - Whatever expenditure that you have incurred to brought that asset into use. Even
commission paid to the agent to purchase that asset is part of “actual cost”.

S. 43(1) defines “actual cost” – 13-14 explanations are there – in these situations what will be the
“actual cost”.

Explanation 1

 No depreciation is allowed as the actual cost of the asset is “zero” as full deduction is
allowed u/s 35. [E.g. Research and Development Cells in Pharmaceutical Companies – full
expenditure is allowed as deduction u/s 35)

Explanation 2

 Previous owner – who has not received the property by way of gift or inheritance. A- B- C –
D – E --- Here A is the previous owner.
 If E purchased a building in 1991 for 5 lakhs – gifted to F in 2013 - here E is the previous
owner – what will be the actual cost? – Depreciation of 22 years – even if the property is not
used in business – this is called notional depreciation.
 The actual cost in most of the cases will be NIL.

Explanation 3

 This is an example of transfer pricing.

 A purchased some asset in 1995 for Rs. 10 lakh – he solds it to B in 2013 for Rs. 12 lakhs –
what will be the actual cost? – If B paid Rs. 12 lakhs then 12 lakhs should be the “actual cost”
– this is determined by “assessing officer” and not A or B – this is provided under
Explanation 3.
  Assessing Officer will determine the fair market price = 10 lakhs minus depreciation for all
these years.
 If property is sold for more, then more depreciation can be claimed.

Explanation 4

 This is again a case of transfer pricing.

 The actual cost will be actual price minus depreciation for all the years since he acquired
that asset or the cost he paid for re-acquiring the asset, whichever is less.
 A purchased asset in 2000 – used till 2010 and then sold it to B in 2010 – B used till 2012-13
and then A re-acquired it. Here depreciation from 2000 to 2012-13 will be subtracted from
the actual cost and the price paid by A in 2012-13 for re-acquiring the asset wil be taken into
consideration – whichever is lesser – is the actual cost.

Explanation 4A

 Sale and Lease Back (SLB) Transaction

 B purchases A’s property for Rs. 5 lakhs in 2000 – uses it till 2010 and charges depreciation
for the period – then A acquires the property in 2010 – what will be the actual cost? – Actual
cost to B minus depreciation will be the actual cost to A – then A again transfers the
property to B on lease basis.

Explanation 5

 A purchases a building in 2000 for Rs. 50 lakhs – In 2013, A after retirement starts practicing
– opens office in his building – now depreciation can be claimed in relation to the building as
it is used for business and profession – what will the actual cost in 2013? Actual cost will be
the actual cost when A prucahsed the building minus depreciation from 2000-2013 (notional
depreciation) = 50 lakhs minus depreciation for 2000-2013 – After 13 years the value will be
negligible or NIL.

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23-8-2013

Explanation 6

 47(iv) and (v) – 100% subsidiary

 Presumption that there is no transfer

How do you charge depreciation = Written Down Value on 31st March (Financial Year = 1st April to
31st April) – Charge depreciation on WDV – Subtract this from the WDV

Explanation 7: Amalgamation – Same as above – fulfilment of S. 47 is necessary

Explanation 7A: Demerger – Same as above – fulfilment of S. 47 is necessary

Explanation 8

A started construction of a building in 2001-02 – he took a loan of Rs. 20 lakhs on 31st May 2001 – for
this loan he is paying EMI – but the building is incomplete so it is not used in business or profession –
it is completed in 2003-04 but the EMI is being paid since 2001-02 – he paid 1 lakh interest till 2003-
04 – he is still paying interest after 2003-04 – this interest till 2003-04 is part of “actual cost” – but
the interest paid after 2003-04 is not part of “actual cost” – this is provided under Explanation 8.

This interest is deductible u/s 36 but not under S. 41.

Explanation 9

Explanation 10

Depreciation is not available on land – if a building is constructed on a land – then the value of land
is to be subtracted and only the value of building will be taken into consideration for charging
depreciation. [Proviso)

Explanation 11

If A bought a car outside India in 2005 and then subsequently brings it in India for business and
profession – depreciation will be charged from 2005-2013 when the asset was acquired, not when it
was brought in India.

Explanation 12

Explanation 13

SECTION 50: Concept of WDV and Block

Block means similar types of asset forming part of the block itself.

Depreciation is charged on the “actual cost” = WDV

WDV on 1st April 2013 of 1 Block = 10 lakhs --- this block consists of 5 assets (residential apartments)
A + B + C + D + E – On 31st May 2013 – another building is constructed F for Rs. 5 lakhs --- again on
31st July 2013, another building G purchased for 5 lakhs --- on 31st December 2013, block A, B, C and
D was sold for Rs. 15 lakhs --- On 31st March 2014, what is the WDV of this block??
Opening WDV = Rs. 10 lakhs

F + G = Rs. 10 lakhs

Total = 20 lakhs

Sold = A, B, C and D for Rs. 15 lakhs

Remianing WDV = Rs. 5 lakhs

The Remaining WDV on 31st March 2014 = Rs. 5 lakhs

There may be a situation when there is a WDV but there is no block, or there may be a block but no
written down value. For example, in the above examine, if all the blocks were sold for Rs. 15 lakhs,
then the WDV is Rs. 5 lakhs but there is no block left. This is short-term capital loss which you set off
or carry forward as per the availability.

There may be a case when all the blocks were sold for Rs. 25 lakhs, then there is a short-term capital
gain u/s 45 as capital gain - If the money payable is more than the written down value (WDV).

Here there is no depreciation since there is no block.

If all buildings are sold except F for Rs. 20 lakhs, there is no WDV even if there is block. Here also no
depreciation can be charged since there is no WDV.

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SECTION 43(6) – WRITTEN DOWN VALUE

DEDUCTIONS – SECTION 32

32A: Investment allowance is not not avaluable after 31st March 1999 – not in effect

32AB – not in effect

33: Development Rebate – not in effect

33A: Development Allowance- not in effect from April 1990

SECTION 33AB: TEA DEVELOPMENT ACCOUNT, COFFEE DEVELOPMENT ACCOUNT, RUBBER

DEVELOPMENT ACCOUNT

Read with Rule 5AC.

Tea, Coffee and Rubber are commercial crops – they are subject to partly agriculture and partily
non-agriculture.
S. 33AB provides the deductions avlaiable to tea, coffee and rubber industries.

Who can claim the deduction?

Any person (including company) who is in the business of growing and manufacturing tea, coffee or
rubber in India – before the expiry of 6 months from the end pf previous year or before filing of
return deposited the amount in the bank designated by the Tea, Coffee or Rubber Board.

What is quantum of deduction?

It is the amount that is deposited in the bank.

The amount equivalent to the deposited in the bank or 40% of profit charge under business and
profession.

If A is in a business of growing Tea – profit of Rs. 10000 – what is taxable under BP? – out of 10000
some portion is not taxable as it is partly agricultural income – 60% is AI and 40% NAI – 60% is
exempted and 40% is taxable – 40% of 10000 = 4000 – if 4000 is deposited in the bank – then
deduction can be claimed for 4000 or 40% of 4000 (business income) (1600) – whichever is less –
thus 1600 can be claimed as deduction from the profit.

Why deposit in the bank? – This amount can be withdrawn at any time – but it can be used only for
the purpose which is specified by the Tea, Coffee or Rubber Board – e.g. to purchase any plant or
machinery or to purchase any land or to construct any factory – if this money is used for any other
purpose – it is deemed profit u/s 41.

Closure of business, or death of assessee, or dissolution of firm, or liquidation of company, or

partition of HUF – then in these cases (except closure of business or dissolution of firm as these can
be manipulated, but death, partition cannot be manipulaetd) – money can be withdrawn for any
reason any purpose – but in case of closure of business or dissolution of firm – money withdrawn
will be taxable as deemed profit.

If A withdraws the money as per the specification of the Board for buying plant and machinery – it
was specified by the Tea Board – if A withdraws to purchase tractor – and A transfers this tractor
within 2 years – then whatever is withdrawn that will be taxable as deemed profit – whatever asset
A is purchasing form the money deposited in the bank – that asset has to be retained for at least 6
years – if sold before 6 years – then the full amount will be taxable as deemed profit.

SECTION 33ABA: SITE RESTORATION FUND

Assessee who engages in any business of extraction of petroleum or natural gas – agreement with
CG – whatever profit arising from that business – if deposited in SBI under scheme of Petroleum
Ministry – in any other bank as Site Restoration Account – then deduction can be claimed under this
section – this deduction is equivalent to the amount deposited in the account or 20% of the profit as
BP, whichever is less.

33AC: NOT IN EFFECT

33B: NOT IN EFFECT

34: CONDITIONS FOR DEPRECIATION ALLOWANCE AND DEVELOPMENT REBATE – NOT IN EFFECT

34A: NOT IN EFFECT

SECTION 35: EXPENDITURE ON SCIENTIFIC RESEARCH

“Scientific Research” is defined in S. 43(4).

E.g. NLU incurred expenditure on building for research in law – this expenditure can be claimed as
full deduction – even if it is revenue or capital expenditure – u/s 35

Here deduction is more than expenditure. This is called weighted deduction.

Revenue Expenditure can be claimed subject to “weighted deduction”. Caiptal expenditure can be
claimed is equivalent to the expenditure incurred and not more than that.

SECTION 35A: NOT IN EFFECT

SECTION 35ABB: Expenditure for obtaining license to operate telecommunication services

This is capital expenditure. License is capital expenditure.

A obtained a license from 1990 to 2010 to operate TS – A started business in 1992 – 50 crores

29-8-2013

35AC: Expenditure on eligible projects or schemes

35A

35B

35C

35D

36(1)(iii) (vii)
SA Builders v. CIT (2007 288 ITR 1 SC) – Laid down the test of “commercial expediency” – imp u/s 37
of IT Act

5-9-2013

SECTION 37

Expenditure should be incurred in the previous year – It means

Bharat Earth Movers v. CIT [(2004) 245 ITR 428) – SC said “If a business liability has definitely arisen
int he accounting year, the deduction should eb allowed although the liability may hae to be
quantified or discharged at a future date, what should be certain is the incurring of the laibulity and
the capacbility of estimating it with certainty....” – What is not certain is the date of payment, but
the payment is certain – then in that case expenditure in the previous year can be claimed.

SC said that it is not contingent liability but certain liability and it can be claimed.

Explanation - This is added by 1998th Amendment Act from retrospective effect since 1962 – Any
expenditure on prohibited by law - Only legal expenditure is allowed as deduction.

Gifts provided by pharmaceutical companies – they claim tehse as business expenditure u/s 37 – SC
disallowed this as it is prohibited under the guidelines of Medical Council of India.

CBDT issued a circular – Circular No. 5 of 2012 dated 1-8-2012 – It was challenged in Confederation
of Indian Pharmaceutical Industries v. CBDT (Feb 20 – 2013 - HP High Court) – Court disallowed
claim of pharmaceutical industries of freebies and gifts provided to doctors.

37 only applies in case of expenditure and not loss.

CIT v. Tihara Singh (1980 124 ITR 40 SC) – Business loss – Important

T A Qureshi Case (2006 SC) - Important

J K & Co. V. ITO (2012 344 ITR 329 Kar HC)

If a company violates certain rules or regulations of FEMA and the company is supposed to pay
penalty for that – can they claim this as business expenditure – Court say that for civil offence this
expenditure can be claimed but not so if the payment is for criminal offence.

Payment of penalty is not an offence – so it should be allowed?? – Some courts allow and some
done – there is a controversy – SC said that if it is a civil offence it is allowed but not in criminal
offence – Shri Minakshi Mills v. CIT (1967 63 ITR 207 SC)
CIT v. Hirjee (1953 23 ITR 427) – Even litigation expenses same rule apply – for civil allowed, for
criminal not allowed.

SECTION 37(2B) – It was inserted by AA 1970 but removed by 1976 – again re-inerseted by 1978

SECTION 38 – IMPORTANT – BUILDING, ETC. PARTLY USED FOR BUSINESS, ETC. OR NOT
EXCLUSIVELY SO USED

CONDITIONS FOR CLAIMING EXPENDITURE (40, 40A, 43B)

SECTION 40

SECTION 40A

SECTION 43B

These sections are very important – Important

Deductions are subject to the conditions in the above 3 sections. These have overriding effect n S.
30-38.

Section 40 talks about TDS provision

If salary, interest or royalty is paid – these are epxneidutre for business – but these are deductible
only at source – if not deducted at source, then no expenditure is allowed.

Similarly interest is deductible – but if the payer who is paying interest, he is not deducting TDS, then
no expenditure u/s 36 can be claimed.

Payment of income tax cannot be claimed as a deduction.

40(2) says that payment of tax on profits is not allowed – but what about when the payment is on
total turnover or gross receipt (both profit and loss) - ?? – then this provision will not apply – then
that tax can be claimed as a deduction.

Explanation

Payment of Wealth Tax is also not allowed.

SECTION 40A

It has overriding effect on whole Income Tax Act (not just 30-38).

40A(2) - Domestic Transfer Pricing

If payment is excessive having regard to the fair market value, then the excessive and unreasonable
payment is not allowed as a deduction –t his will happen when the parties are related – Company A
is subsidiary of B – Company A solds raw materials at a highly excessive price above fair market value
– then the excessive amount is not allowed under the IT Act.

If a softwarae engineer is hired – who is your relative – you are paying higher amount to him – to
claim more expenditure – fair market value is less – that excessive amount is not allowed as a
deduction.

6-9-2013

SECTION 40A(1) (2) (3) (3A)

Rule 6DD lays down certain condition – when payment can be made not through cheque/DD – still
deduction can be claimed – even cash payment is allowed

2nd proviso to 3A – Mode of Payment is similar – limit is exceeded to 35000

(4)

Agreement between A and B – B agrees to take payment from A in cash – but A has to claim
expenditure under IT Act – fro claiming conditions of S. 40(3) has to be fulfilled i.e. the payment has
to be made in cheque and not cash – it has overriding effect – that cannot be a plea before a court –
if payment is to be claimed it has to be made in cheque or BD or DD.

Even donation to political parties exceeding 25k should be in cheque, otherwise it is not allowed.

Any payment exceeding 25k, it should be made in cheque in order to claim deduction.

SECTION 43B

If certain payments amount to expenditure (such as PPF, etc. ) – these are expenditure – they are
allowed to be claimed under IT Act only if there is actual payment.

For example, payment towards sales tax, excise duty – these can be claimed only if there is actual
payment of that tax.

Interest on capital can be claimed as deduction u/s 36 only when there is actual payment of interest,
not on due basis.

Any contribution by employer in recognized fund, this can be claimed only when there is actual
payment, not on due basis.

SECTION 41: DEEMED PROFIT

41(1) – Loss, expenditure or trading liability

In 2010-11, A claimed certain loss (Rs. 10 crore) as deduction – in 2011-12, Police recovered some
amount (e.g. 5 crore) – this 5 crore will be deemed profit for the assessee and 5 crore will be taxable
as income from business and profession in 2011-12 – even if the business of the assessee has been
discontinued, then also this 5 crore will be taxable as income from business.

This provision also applies in case of business expenditure or trading liability.

Business Expenditure = Tax, Excise Duty – if A paid excise duty of 10 lakh in 2010-11, but after
assessment the dty was found to be Rs. 9 lakh – he claimed refund of 1 lakh in 2011-12 – this 1 lakh
which A received is “deemed profit” and is taxable as income from business and profession.

Duty under Protest = In appeal, it has to be deposited.

If Assessee deposits duty under protest – court gives judgment in favour of assessee and A gets 10
lakh as refund – this 10 lakh is income in the hand of the assessee – this is “deemed profit”.

Trading Liability

41(3)

Under S. 35, expenditure on scientific research is allowed.

If A purchased scientific equipment in 2011-12 for Rs. 75k – full deduction is claimed u/s 35 of Rs.
75k – in 0213-14, these assets are sold for Rs. 50k – this 50k is “deemed income” or Business income
– it is taxable u/s 41.

41(4) – Bad Debts

Any bad debt – claimed by assessee in previous year – if assessee or their successors receives any
amount of bad debts – it is taxable as deemed profit u/s 41.

SECTION 44

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10-9-2013

INCOME FROM CAPITAL GAIN (S. 45 – 55C)

Section 2(14), 2(29A, 29B), 2(42A, 42B, 42C, 47)

SECTION 45

Conditions for chargeability:

(1) There must be a capital asset;
(2) There must be a transfer of a capital asset,
(3) Such transfer must be affected in the previous year,
(4) It should not be exempted u/s 54

There must be a capital asset

S. 2(14) defines “capital asset” – Amendment in Finance Act, 2012 – after Vodafone Judgment

Capital Asset means property of any kind held by an assessee, whether or not connected with his
business or profession, but does not include:

(i) Stock in trade, consumable stores, or raw materials = not capital assets
(ii) Personal effects, i.e. movable property (including wearing apparel and furniture) held for
personal use by the assessee or by any member of his family dependent on him, but
excludes:
(a)Jewellery

Gold work in Saree = capital asset and sale is taxable as capital gain.

Furniture – stone work = jeweller = capital asset – if sold = capital gain = taxable as
capital gain.

Gold bar, silver coins offered to deity = capital asset

1 Dining set for personal use = not a capital asset, if more than 1 = capital asset

(b) Archaeological collections;

(c) Drawings
(d) Paintings
(e) Sculptures
(f) Any work of art

(iii) Any agricultural land in India, not being a land situated outside jurisdiction of municipality.

(iv) 6.5% Gold Bonds

Types of Capital Asset

It is defined u/s 2(29A) and (29B) and 2(42A and 42B)

Long term capital asset means a capital asset which is not a short-term capital asset. [2(29A) and
2(29B)

Short term capital asset means a capital asset held by an assessee for not more than 36 months
immediately preceding the date of its transfer.
This differentiation is important because of the difference in the rates of taxation of these two types
of capital asset and the manner of computation of tax.

LTCA = It is calculated on the basis of cost-price index. It is not available to STCA.

From which date, 36 months is calculated?

This period is explained in the explanation of S. 42A.

(a) Company in liquidation = period on which company goes into liquidation shall be excluded. [This
is important as Long-term capital gain on share is exempted u/s 38).
(b) S. 49(1) talks abt cost of acquisition and the period of acquisition of any capital asset – if any
person receives any asset by gift or inheritance – then what will be the period of holding? –
Period for which the asset was held by the previous owner shall be included.
(c) Amalgamation – if Mr. A holding 100 shares in ABC in 1990 – amalgamation of this company into
XYZ in 2013– A is holding 10 shares of XYZ – if A sells the shares in 2013 itself – whether it is
long-term capital gain? – it is long-term capital gain as per this explanation.
(d) Read the rest explanations.

TRANSFER (S. 2(47)

“Transfer” in relation to a capital asset, includes:

(i) Sale, exchange or relinquishment of the asset, or

Example of Relinquishment

If A is ready to purchase property D of B and pays Rs. 40k as advance in 2010-11 – In 2011-
12, there is another agreement between A and B, where A is ready to give up this right to
purchase and for this B pays Rs. 2 lakh to A – this is a transfer of a capital asset – this 2 lakh
is the sale consideration – cost of acquisition is Rs. 40000. So 2 lakhs – 40k = capital gains in
the hands of A.

(ii) Extinguishment of any rights therein, or

Amalgamation = extinguishment of right in amalgamating company into the amalgamated

company.

Reduction of share capital by reducing the face value of a share = This is extinguishment of a
right.

(iii) Compulsory acquisition under any law, or

If govt acquires any property, it is transfer – whatever capital gain is there, it is subject to
tax.

(iv) Conversion of capital asset into Stock-in-trade

 This conversion is transfer and capital gain is levied on it.

Generally transfer is between two persons, but in case of conversion there is only one
person.

If A is having some gold as investment – if A starts business of jewellery and it converts the
gold into business – A has converted gold into stock-in-trade. This is conversion of capital
asset into stock-in-trade. This conversion is transfer and subject to capital gains tax. What is
the gain in this conversion? – The fair market price of this gold in 2013 is Rs. 10 lakh – now
he sells the jewellery made out of this gold in 2013 for Rs. 12 lakhs. This is taxable in the year
of sale. (generally taxability of capital gain is in the year of transfer, but this is an exception).

It should be r/s S. 45(2) (it is a charging section) – It says that notwithstanding contained in S.
45(1) – the profit or gains arising ...... shall be chargeable to income tax.

SC Judgment in 1980 held that this conversion of capital asset does not amount to transfer
as there is no 2nd person – Amendment was made and S. 45(2) was inserted and 2(47) was
inserted.

In 1991 the price of gold (100gm) was 1 lakh, in 2013 – conversion – the fair market value
was Rs. 10 lakhs – in 2014, A sold this gold for Rs. 12 lakhs.

Business Income = 2 lakhs

Capital Gain = 10 lakh minus cost of acquisition

Cost of Acquisition = COA x CII year of transfer/CII year of acquisition

(v) Maturity or redemption of zero coupon bond, or

(vi) S. 53A of TOPA
(vii) Transaction which has the effect of transferring, or enabling the enjoyment of, any
immovable property

COMPUTATION OF CAPITAL GAINS TAX

(1) Sale Consideration – Sale price = fair market value in the year of transfer
(2) Deductions:
a. Cost of Acquisition
If cost of acquisition is not identifiable, then no capital gains tax, even if there is sale
of asset – s. 45 will not apply in that case – as S. 45 is subject to S. 48, which provides
for computation of capital gains tax – so if S. 48 is not applicable then S. 45 will not
be applicable. (Important)

“Deemed Cost of Acquisition” u/s 49 – even if there is no cost of acquisition – where

cost of acquisition is not ascertainable – SC Judgment in 1989 – SC said that if cost of
acquisition is not ascertainable there is no capital gains tax – to nullify this an
amendment was made.
 b. Cost of Improvement
c. Any expenditure relating to transfer of property

(3)

SECTION 45

Conditions for taxability of capital gain – 45(1)

45(1A) – It was inserted by the 1999 Amendment - amendment was made to nullify a SC Judgment.

In 1991, CIT v. Vania Silk Mills (1991 SC), there was destruction of capital asset by fire – then the
insurance claim is taxable as a capital gain – there is no asset as it is destroyed – then how can it be a
transfer? – SC held that it is not taxable for the purpose of capital gain – then S. 45(1A) was inserted
by the 1999 Amendment.

If A is a building – destroyed by fire – claims insurance – what is the capital gain there? – Receipt of
insurance money minus cost of acquisition – this is taxable u/s 45(1A) and not 45(1) (if the asset is
the long term, then cost of acquisition is indexed cost).

If the asset is used for business, then difference in the insurance money minus the Written Down
Value (WDV) = Capital Gain.

In 2000 SC decided another case CIT v. Mrs. Grace Collis (AIR 2001 SC 1133). It was a case of
extinguishment of a right in amalgamating company to the amalgamated company – there is no
asset as the amalgamating company has ceased to exist – SC upheld the validity of 1999 Amendment
– they overruled their own judgment of Vania Silk Mills – SC held that there is no extinguishment of
a right in this case.

45(2) – discussed above

45(2A)

It says that shareholder is liable to pay capital gains tax and not the depository – shareholders are
the beneficial owners and not the registered owners – so only the beneficial owners are liable to pay
capital tax and not the registered owners.

A purchased 200 shares in 1995, 400 shares in 2010, 100 shares in 2013 – in 2013, A sold 300 shares
– first in first out method – first shares i.e. 200 would be sold first.

45(3)
A purchased a building in 1995 for 5 lakhs – now he becomes partner of a firm in 2010 by
transferring his building to the firm – this is transfer as per the definition of transfer – what is the
capital gain in this case? – What is the consideration and the cost of acquisition in this case?

Sale value of consideration = book value of the asset in 2010 – this is considered as the sale
consideration

Capital Gain in the hands of A = Sale Consideration minus Cost of Acquisition (indexed cost as it is a
long-term capital asset)

45(4)

It is the opposite of 45(3).

If there is a dissolution of a firm in 2011 – and after that the assets were distributed to the partners –
what is capital gain in the hands of firm?

Sale Consideration = Fair Market Value at the time of transfer (i.e. in 2011)4

Cost of Acquisition = Book Value (in the above case)

Capital Gain in the hands of firm = Sale Consideration minus Cost of Acquisition

45(5)

Compulsory Acquisition under Law

It is a charging section and independent of S. 45(1).

It is taxable in the year of receipt of compensation and not in the year of transfer.

In 2010, there was compulsory acquisition by government – compensation was fixed at Rs. 5 lakhs –
as per S. 45, this is transfer and there is a capital gain – but this compensation was received in 2012 –
but as per S. 45, capital gain is taxable in the year of transfer – this provision of s. 45(5) is why this is
an exception to S. 45 – it is taxable in the year 2012 and not 2010.

Cost of Acquisition in 1995 = 2 lakhs

Sale value = 2012 = 5 lakhs

Capital Gain = 5 lakhs in indexed value 2 lakhs

If A is not satisfied with the consideration – Court grants extra compensation in 2014 of Rs. 3 lakh
above the 5 lakh paid in 2012 – what will be the treatment of 3 lakh – this is a capital gain – it is
taxable in 2014. There is no cost of acquisition (zero) – entire 3 lakhs will be taken as capital gain –
and it is taxable.

4
Here were are not using book value as it can be manipulated.
Enhanced compensation received by the successor – he is also taxable under “Capital Gain” and not
income from other sources – even if he is not the transferor but just the beneficiary.

CASES ON SECTION 45

(1) Sunil Siddarthbhai v. CIT (1985) 156 ITR 509 SC – Definition of “transfer” – Transfer is an
inclusive definition – It is not restricted to sale, exchange or relinquishment – there are other
ways of transfer also – if it partakes the nature of “transfer”.

(2) Vania Mills Case

(3) CIT v. B S Kooka (1962) 46 ITR 86 SC – SC held that conversion of capital asset into stock-in-trade
does not amount to transfer – after this case amendment was made and S. 45(2) was inserted
and now it is considered as a “transfer”.

(4) Prakash Chandra v. ITO (1983) 17 TTJ 230 (Jaipur ITAT) – S. 45(3) was in question – capital
contribution by partner, etc. – there was a transfer of stock-in-trade (not capital asset) by the
partner – whether S. 45(3) will apply in this case or not? – Court held that S. 45(3) deals with
transfer of capital asset and not stock-in-trade – so S. 45(3) is not applicable – and it is not
taxable as capital gain.

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12-9-2013

SECTION 46 – V. Imp

Capital gains on distribution of assets by companies in liquidation

(1) Treatment in the hands of company - Such distribution of assets by companies in liquidation
shall not be regarded as a “transfer” by the company for the purposes of S. 45 – thus no capital
gain will be charged.

(2) Treatment in the hands of shareholders = He shall be chargeable to “capital gains tax” – he is
liable to capital gains tax.

Whatever A gets on liquidation minus the amount he paid for his shares = Income liable to be
charged for capital gains tax.

Capital Gains Tax = Market value of asset/money so received minus the amount assessed as
dividend

CIT v. M A Chidambaram (1984) 147 ITR 180 (Mad) – Constitutional validity of S. 46(2) on the
ground that how capital gains can be taxed in the hands of the shareholder – Capital gains is
chargeable in the hands of transferor and not the transferee – Mad HC held that S. 46 itself is a
charging section and S. 45 will not apply.
N Bhagwati v. CIT (2003) 259 ITR 678 (SC) – Asset distributed on liquidation was an agricultural land
– Bhagwati claimed exemption of agricultural land as it is not an asset and it is not taxable – SC
denied benefit of S. 2(14) and held that S. 46 applies in a special situation and it is a special provision
and it includes any asset – it may be capital asset and may not be a capital asset – the section has
used the term “any asset” and not “any capital asset” – so it is liable to tax .

CIT v. Brahmi Investment Pvt Ltd (2006) 286 ITR 66 (Guj HC) – Company went into liquidation and
subsidiary company (not an individual but company) received assets and cash – Section 47(iv) and
(v) – Limitations on S. 45 in S. 47(iv) and (v) – But S. 46(2) talks the chargeability of capital gains tax
in the hands of the transferee and not the transfer – so S. 47 is not applicable – and the transferee is
liable but not the transferor as it is exempted u/s 47.

SECTION 46A: BUYBACK OF SHARES (Inserted by Amendment Act of 2000)

If A receives any consideration by the buyback of shares – and the difference between the cost of
acquisition of shares and the consideration paid by the company for buyback of shares will be the
income chargeable to capital gains tax.

SECTION 47 – Transactions not regarded as transfer

In these cases, there is no capital gains tax.

(i) Any distribution of capital assets on partition of a HUF

Transfer of a capital asset under a gift or will or an irrevocable trust; (Gift is taxable in the hands of
the transferee u/s 56 as Income from Other Sources.

(ii) Transfer of a capital asset by company to its subsidiary company

(iii) Amalgamated company and amalgamating company

Read all the Explanations - Important

Read with Section 47A: Withdrawal of exemption u/s 47 in certain cases – Important – One
question from S. 47 and 47A in End Term.

17-9-2013

SECTION 49 – DEEMED COST OF ACQUISITION

Cost of Acquisition of Gift

SECTION 50

SECTION 50B

Slump Sale – defined in S. 2(42C)

SECTION 50C

SECTION 51

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19-9-2013

SECTION 54

Applies to individuals, HUF

From the sale of residential property – from the sale is capital gain

If re-invest the capital gain into buying any other property – then that investment can be claimed as
exemption.

Even adjustment is purchase – for example there is a family settlement – even settlement may
amount to purchase.

Either you can purchase the house property and construct. – if A purchases a property with ground
floor – and first floor is contructed – even this can be claimed – full exemption can be claimed – even
construction is included in purchase.

Even 2-3 residential properties can be purchased.

Even properties outside India can be purchased.

Within 2 years the property has to be purchased – You only have to purchase the property,
registration is not necessary.

Property can even be purchased in the name of wife – then also it can be claimed.

Cases:

CIT v. T N Aravinda Reddy (1979) 120 ITR 46 SC – Assessee (A) sold his own house and acquired a
common house from other brothers (BCD) – as a settlement from some family matter – he did not
construct any property – whether this settlement amounts to purchase (as the word used in S. 54 is
purchase or construct) – SC held that the objective of S. 54 is you have to reinvest the capital gain –
The word “purchase” includes settlement also within the family and allowed exemption u/s 54.
CIT v. R L Sood (2000) 245 ITR 727 (Del) – Requirement of registration of sale deed is not necessary
u/s 54 – Time limit within 2 years you have to purchase the property – assessee purchased it within
2 years but registration happened after2 years – Court held that the date on which the payment is
made is relevant and not registration.

Mrs. Prema P Shah v. ITI (2006) 100 ITD 60 (Mum ITAT) – Court held that exception u/s 54 does not
require that you have to purchase the property in India only – the property can be purchased
anywhere in the world – there is no restriction u/s 54 that the property has to be purchased in India
only.

Ajit Vaswani v. DCIT (2001) 117 Taxmann 123 (Del ITAT) – It was held that there need not be direct
link between the capital gain and the investment – e.g. A sold property for 20 lakh – this is to be
invested – A took home loan to purchase the house and from that loan A constructed the house –
this 20 lakh from capital gain has been used in any other business – Court held that this can be used
anywhere else also – there is no requirement of any direct link – Purchasing is important – from
where you are purchasing it is not important.

CIT v. V Natrajan (2006) 287 ITR 271 (Mad HC) – Assessee invested the capital gain for the purchase
of property and the document was registered in the name of his wife – here Court held that this
cannot be disallowed and gave him the benefit of S. 54.

SECTION 112: TAX ON LONG-TERM CAPITAL GAIN

Capital gain is taxable at different rates: Short Term Capital Gain (10-15%) and Long Term Capital
Gain (20%).

If there is a capital gain of Rs 5 lakhs and there is no other income – so this 5 lakh is taxable @ 20%
or as per the slab system?

S. 112 provides that whatever is the total capital gain, reduce this from the total income (so total
income is 0 in this case), reduce 2 lakh from 5 lakh – so on remaining 3 lakhs you are supposed to
pay tax at 20% - this come to Rs. 60,000. – You are not putting this into the slab system.

If the other income is Rs 1 lakh, and capital gain is 5 lakh, exemption limit is Rs. 2 lakhs (as per the
slab system), so deduct 1 lakh from 2 lakhs which is 1 lakh, subtract this from 5 lakhs, tax is
chargeable on 5 lakhs – 1 lakh = 4 lakhs @ 20% = 80000.

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INCOME FROM OTHER SOURCES

Section 56, 57, 58, 59

Whatever is not covered in the preceding heads, would come under “other sources”.

Only incomes and not capital is taxable.

SECTION 56(1)

SECTION 56(2)

Dividends

It is taxable in the hands of companies and not shareholders, then why is it included here? – This is
dividend from the foreign company as that is taxable in the hands of the shareholders.

Gift [56(2)(vii)) – Inserted by 2009 Amendment

A receives 5000 from B, 10000 from C, 10000 from D, 20000 from E, and 10000 from F – In
aggregate this is more than 50k – then the entire 50k is taxable.

If on bday A received 51k as cash – it is taxable.

A received from B any immovable property whose value exceeds Rs. 50k – it is taxable. Here the
aggregate is not relevant and individual transaction is important.

If A receives any gift of movable property and the aggregate value (fair market value) exceeds 50k –
then taxable for the whole amount.

These gifts are exempted if received from any relative, or the occasion of marriage or under will or
inheritance, or in contemplation of debt.......

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20-9-2013

56(2)(vii-a) – Inserted by 2010 Amendment - Gift of Property by a person to a company

If a company receives shares from other company without any consideration – then that
property/share will be taxable as per the Fair Market Value of that property/share.

If company A gifts company B (both pvt companies), then B is taxable as a donee – only if it is
without consideration.

If company A gifts company B, with some consideration but it is not adequate, if that consideration is
less than FMV, then the difference between the consideration and FMV will be taxable in the hands
of B.

If A gifts some property to B, the FMV is 5 lakhs – B paid 50000 as consideration just for the sake of
paying it – here 4.5 lakh is taxable.

SECTION 57: DEDUCTIONS

Dividends – brokerage paid, etc. can be claimed as deduction.

Family Pension is taxable u/s 56 (Pension is t

axable u/s 15) - family received the pension after death, it is taxable u/s 56 – exemptions are
available u/s 57.

SECTION 58: WHEN EXEMPTIONS ARE NOT AVAILABLE

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SECTION 70-80: SET-OFF AND CARRY FORWARD

I. Inter-Source Set Off (71)

II. Inter-Head Set off (72)
III. Carry Forward (73)
a. It can be set off only inter-source and not inter-head.

If there are 4 businesses, then the loss of A can be set off from the profit of B C D.

Exceptions:

(1) Loss arising out of speculative business – it can only be set off against the profit from the
speculative business and not from the general business.
(2) Capital Gain – If there is loss arising from the Long-Term Capital Asset (LTCA), then it can only be
set off against the long-term capital gain and not against the short-term capital gain and no
other. But if there is short-term capital loss, it can be set off against long-term capital gain or
short-term capital gain.
(3) Winning from Lotteries, Puzzles – These incomes from other sources – are not available for set
off against any other income.
(4) Income u/s 35AD (Specified Business) – if there is any loss in this business then this can be set
off against profit of this business only and no other profit.

Inter-Source Set Off (S. 70)

It is defined u/s 70.

Loss from HP can be set-off against the profit of business income.

If there is HP loss, then this can be set-off against salary income. But salary is only available for HP
loss and not against any other loss.

Business loss is not available against profit of salary.

CARRY FORWARD – S. 71B

In case of carry-forward, inter-head is not available. It can only be set-off inter-source. E.g. loss from
HP, if there is no inter-source set-off and inter-head set off, then it will be carry-forward – once it is
carry forwarded, then it can only be set off only against the HP and not against any other.
Once there is a business loss and it has to be carried forward, then next year it can only be set-off
only against the profit of that business.

Other head will not be available once it is carry-forwarded.

There is a time limit for carry-forward. E.g. for 2012-13, it is carried forward from 2011-12, there was
a loss in 2011-12, and there was no set-off inter-source or inter-head, it was carried forward to
2012-13, then it can be carried forward for upto 8 assessment years – if after 8 years it is not set off
then it would lapse. 8 assessment years would be counted from the 1st assessment years.

Same goes for business loss also – 8 assessment years.

Exception: E.g. A is running a business and holding some shares as trading assets – on these shares A
receives dividends taxable under “income from other sources” – loss from business can be set off
from the profit of dividends (even if this dividend is not business income) – this is because A is
holding the shares as trading assets.

If loss in profession, then it can be set-off against profit from business – Business and Profession are
same.

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