02 Taxation Notes - Anirudh Belle

NOTES ON
THE INCOME TAX ACT, 1961

&
AN INTRODUCTION TO
THE GOODS AND SERVICES TAX (GST)
Prepared as per the syllabus of the

Law of Taxation course
for the Bachelor of Laws (LL.B.) programme,
in the academic year 2018-19,
at the Jindal Global Law School.
ANIRUDH BELLE
LL.B. 2016 (Class of 2019),
Jindal Global Law School
TABLE OF CONTENTS
A. Introduction ................................................................................................................................... 2
B. Basic Concepts of Income Tax........................................................................................................ 4
C. Section 6 – Residential Status ....................................................................................................... 11
D. Revenue and Capital Receipts ....................................................................................................... 30
E. Scope of Total Income and Incidence of Taxation ........................................................................ 47
F. Capital Gains ............................................................................................................................... 66
G. Exemptions and Deductions ......................................................................................................... 78
H. Tax Planning, Avoidance and Evasion ................................................................................... 124
I. Basic Overview of International Tax Provisions – An Indian Perspective ................................... 132
K. Advance Ruling (Sections 245 N-V)............................................................................................ 168
L. Introduction to the Goods and Service Tax (GST) ...................................................................... 184
Income Tax Act and GST – Notes / 2018
A. Introduction
• A ‘tax’ is a financial charge imposed by the Government on income, a commodity or an activity.
• Basic features of a tax: a) Compulsory levy, b) Imposed by the Government (Central or State), c) By
way of a legislation and d) No quid pro quo
• The government imposes two types of taxes, namely, Direct taxes and Indirect taxes.
• Direct tax is a type of tax where the incidence and impact of taxation fall on the same entity. It is a
form of tax where the burden of tax is directly on the tax payer. In the case of direct tax, the burden
can’t be shifted by the taxpayer to someone else. These are taxes levied broadly on income or wealth.
Income tax, corporation tax, property tax, inheritance tax and gift tax are examples of direct tax.
• An indirect tax is a tax levied on goods and services rather than on income or profits. It is a type of
tax where the incidence and impact of taxation does not fall on the same entity. In the case of an
indirect tax, the burden of tax can be shifted by the taxpayer to someone else. Indirect tax has the
effect of raising the price of the products on which they are imposed. Customs duty, central excise,
service tax and value added tax are examples of indirect taxes.
• Taxes are collected for serving the primary purpose of providing sufficient revenues to the State.
Taxes have come to be recognised as an instrument through which the social and economic objectives
of a welfare State could be achieved.
• Taxes have the effect of providing incentives for greater productivity and earnings and more savings,
fostering industrial development by selective concessions, restraining ostentatious expenditure,
checking inflationary pressures and achieving social objectives like the redistribution of wealth and
the enlargement of opportunities to the common man.
• Income tax is one of the major sources of revenue for the Government.
• The responsibility for collection of income tax vests with the Central Government. This tax is leviable
and collected under Income Tax Act, 1961 (hereinafter referred to as “the Act”).
• The Act, in its present form, came into force on and from April 1, 1962. Before this, the Indian
Income-Tax Act, 1922 was in force. The procedural matters with regard to income tax are governed
by the Income Tax Rules, 1962 (its earlier counterpart being the Income Tax Rules, 1922).
Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

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• The Act contains provisions for the determination of taxable income, determination of tax liability,
procedure for assessment, appeal, penalties and prosecutions. It also lays down the powers and duties
of various income tax authorities.
• The Finance Act: Every year a Budget is presented before the Parliament by the Finance Minister.
One of the important components of the Budget is the Finance Bill. The Bill contains various
amendments such as the rates of income tax and other taxes. When the Finance Bill is approved by
both the Houses of Parliament and receives the assent of President, it becomes the Finance Act.
• Notifications: The Central Board of Direct Taxation (CBDT) issues notifications from time to time
for the proper administration of the Act.
• Circulars: Circulars are also issued by the CBDT to clarify doubts regarding the scope and meaning
of income tax provisions. These circulars are issued for the guidance of income tax officers and
assessees. These circulars are binding on the relevant tax authorities, and not on the assessee
(however, the assessee may take benefit of these circulars).
• Judicial Decisions: Decisions pronounced by the Supreme Court become law and they are binding
on all the courts, Appellate Tribunals, Income Tax authorities and on assessees, while High Court
decisions are binding on assessees and Income Tax Authorities which come under its jurisdiction,
unless its rulings are overruled by a higher authority (i.e. the Supreme Court). The decision of a High
Court cannot bind another High Court.

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B. Basic Concepts of Income Tax
• No precise definition of the word ‘Income’ is attempted under the Income Tax Act, 1961.
• The definition of “income” as given in Section 2(24) of the Act contains the word “includes”, and
therefore the list is intended to be inclusive, not exhaustive. Section 2(24) enumerates certain items,
including those which cannot ordinarily be considered as income but are treated statutorily as such.
• “Income” includes not only those things which the interpretation clause declares; it shall also include
all such things the word signifies according to its natural import.
• Income: In general terms, income is a periodical monetary return featuring some sort of regularity.
However, in the Income Tax Act, even certain income which does not arise regularly are treated as
income for tax purposes e.g. Winnings from lotteries, crossword puzzles, etc.
- Cash or Kind: Income may be received in cash or in kind. When income is received in kind, its
valuation will be made in accordance with the rules prescribed in the Income Tax Rules, 1962.
- Receipt basis/Accrual basis: Income arises either on receipt-basis or on accrual-basis (i.e. it may
accrue to a taxpayer without its actual receipt).
Income, in some cases, is deemed to accrue or arise to a person without its actual accrual or
receipt. Income accrues where the right to receive income arises.
- Legal or illegal source: The income tax law does not make any distinction between income
accrued or arisen from a legal source and income tainted with illegality. In CIT v. Piara Singh
(1980), the Supreme Court has held that if smuggling activity can be regarded as a business, the
confiscation of currency notes by customs authorities is a loss which springs directly from the
carrying on of the business and is, therefore, permissible as a deduction.
- Temporary/Permanent: There is no difference between temporary and permanent income under

the Act. Even temporary income is taxable in the same way as permanent income.
- Lumpsum/instalments: Income, whether received in lumpsum or in instalments, is liable to be

taxed. For example: arrears of salary or bonus received in lumpsum is income and charged to tax
as salary.
- Gifts: Gifts of a personal nature do not constitute income, subject to the gift being valued at
maximum of Rs. 50,000/- received in cash. The recipient of gifts, like for birthdays, marriages,
etc., is not liable to pay income tax as they are received in kind. However as per the Finance Act,

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2009 gifts in kind having fair value up to Rs. 50,000/- are not liable to tax, but those having a fair
value of more than Rs. 50,000/- are wholly taxable.
- Revenue or Capital receipt: Income tax, as the name implies, is a tax on income and not a tax on
every item of money received. Therefore, unless the receipt in question constitutes income as
distinguished from capital, it cannot be charged to tax.
For this purpose, income should be distinguished from capital which gives rise to income.
However, some capital receipts have been specifically included in the definition of income. The
distinction between revenue or capital receipt is given below.
• Capital Receipts and Revenue Receipts: In general, two types of receipts occur during the course
of business. Capital Receipts are described as the money brought to the business from non-
operating sources like proceeds from the sale of long-term assets, capital brought by the proprietor,
sum received as a loan or from debenture holders etc. In contrast Revenue Receipts are the result of
firm’s routine activities during the financial year, which includes sales, commission, interest on
investment.
Although the general principle of law is to tax only revenue receipts as income, there are three
exceptions to this rule under which capital receipts are also taxable as income, viz.:
(i) Any compensation received for termination of employment or modification of the terms of
employment would fall within the meaning of a profit in lieu of salary and consequently taxable as
salary income. [Section 17(3)(i)]
(ii) Any compensation received for termination of managing agency or other contractual
relationships in relation to the management of the whole, or substantially the whole, of the affairs of
a company, or the modification of the terms and conditions relating thereto, would be taxable as
income from business. [Section 28(ii)(a and b)]
(iii) Any compensation or other payment due to or received by any person for the termination or the
modification of the terms of any other agency held by him in India in relation to the business of any
other person would also be taxable as income from business regardless of the nature of the agency
business. [Section 28(ii)(c)].
• “Assessee” and “Person”: In common parlance, every tax payer is an assessee. However, the word
assessee has been defined in Section 2(7) of the Act.
Income tax is charged in respect of the total income of the previous year of every person. “Person”
is defined in Section 2(31) of the Act.

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• Charge [Section 4]: Income tax is chargeable on an annual basis at the rate applicable in the
assessment year. Rates of tax are fixed by the Finance Act of the relevant assessment year. Total
income is calculated in accordance with the provisions of the Act, as they stand on April 1st of the
assessment year (with the exception of provisions that have been given a retrospective effect).
• Gross Total Income and Total Income: As per Section 14, a person’s income is computed under
the following five heads:
1. Salaries
2. Income from house property
3. Profits and gains of business or profession
4. Capital gains
5. Income from other sources
Gross Total Income: Aggregate income under the above heads in accordance with the provisions of
the Act, calculated before making any deduction under Sections 80C to 80U.
Total Income: It is the Gross Total Income as reduced by the amount permissible as deduction under
Sections 80C to 80U.
• Exemptions – Deductions:
Exemptions (Section 10):
- Income that qualifies for exemption is not included in the computation of income.
Deductions (Chapter VIA):
- Generally given from income chargeable to tax with respect to certain eligible expenditures.
- If amount deductible is more than income, then the resulting amount will be shown as a loss.
• Assessment Year [Section 2(9)]: “Assessment year” means the period of twelve months
commencing on 1st April every year and ending on 31st March of the next year.
Income of the previous year of an assessee is taxed during the following year (i.e. the assessment
year) at the rates prescribed by the Finance Act of the assessment year.
• Previous Year [Section 3]: Income earned in any given year is taxable in the year succeeding it. The
year in which income is earned is known as previous year.

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From the assessment year 1989-90 onwards, all assessees are required to consider the period of the
financial year (i.e. April 1 to March 31) as that of the previous year. This uniform previous year has
to be followed for all sources of income.
In case of a newly set up business or profession or a source of income newly coming into existence,
the first previous year will be the period commencing from the date of setting up of
business/profession or as the case may be, the date on which the source of income newly comes into
existence and ending on the immediately following March 31.
Examples of previous year in the case of newly set-up business/profession:
Example 1
Y sets up a new business on May 15, 2013. What is the previous year for the assessment year 2014-
15.
Ans. Previous year for the assessment year 2014-15 is the period commencing on May 15, 2013 and
ending on March 31, 2014.
Example 2
A joins an Indian company on February 17, 2013. Prior to joining this Indian company he/she was
not in employment nor does he/she have any other source of income. Determine the previous year of
A for the assessment years 2013- 14 and 2014-15.
Ans. Previous years for the assessment years 2013-14 and 2014-15 will be as follows:
Previous Year Assessment Year

Feb. 17, 2013 to March 31, 2013 2013-14
April 1, 2013 to March 31, 2014 2014-15
• Computation of Taxable Income and Tax Liability of an Assessee:
Income tax is a charge on the assessee’s income. Income Tax law lays down the provisions for
computing the taxable income on which tax is to be charged. Taxable income of an assessee shall be
calculated in the following manner:
1. Determine the residential status of the person as per Section 6 of the Act.

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2. Calculate the income as per the provisions of respective heads of income. Section 14 classifies the
income under five heads:
(i) Income from salaries
(ii) Income from House Property
(iii) Profits and gains of business or Profession
(iv) Capital Gains
(v) Income from other sources
3. Consider all the deductions and allowances given under the respective heads before arriving at the
net income.
4. Exclude the income exempt under Section 10 of the Act.
5. Aggregate of incomes, computed under the 5 heads of income after applying clubbing provisions and
making adjustments of set off and carry forward of losses, is known as Gross Total Income.
6. Subtract therefrom the deductions admissible under Sections 80C to 80U. The balance is called Total
Income. The total income is rounded off to the nearest multiple of Rupees ten. (Section 288A)
7. Add agricultural income in the total income calculated in (6) above. Then calculate tax on the
aggregate as if such aggregate income is the Total Income.
8. Calculate income tax on the net agricultural income as increased by Rs. 2,00,000/2,50,000/5,00,000
as the case may be, as if such increased net agricultural income were the total income.
9. The amount of income tax determined under (8) above will be deducted from the amount of income
tax determined under (7) above.
10. Calculate income tax on capital gains under Section 112, and on other income at specified rates.
11. The balance of the amount of income tax left as per (9) above plus the amount of income tax at (10)
above will be the income tax in respect of the total income.
12. Deduct the following from the amount of tax calculated under (11) above:
- Tax deducted and collected at source.

- Advance tax paid.
- Double taxation relief.

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13. The balance of amount left after deduction of items given in (12) above, shall be the net tax payable
or net tax refundable for the assessee. Net tax payable/refundable shall be rounded off to the nearest
multiple of Ten rupees (Section 288B).
14. Along with the amount of net tax payable, the assessee shall have to pay penalties or fines, if any,
imposed on him under the Income Tax Act.
Tax Liablity Calculation: A Basic Example
Illustration: Suppose I earn 15 lakh gross salary in a year. Now how do I calculate income tax? After
exemptions and deductions, my net taxable income comes to 11 lakh. This 11 lakh is subject to the taxes.
Solution:
Step 1
From this 11 lakh, initial 2.5 lakh becomes tax free.
11,00,000 – 2,50,000 (Tax free) = 8,50,000
Tax 1 = 0
Step 2
From the remaining 8.5 lakh another 2.5 lakh is subject to 5% tax
8,50,000 – 2,50,000 (5% tax) = 6,00,000
Tax 2 = 12,500
Step 3
Now Samara has 6 lakh Rupees. From this amount the Rs. 5,00,000 is subject to 20% tax rate.

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6,00,000 – 5,00,000 (20% tax) = 1,00,000
Tax 3 = 1,00,000
Step 4
The remaining 1 lakh rupees would be subject to 30% tax.
Tax 4 = 30,000
Step 5
The income tax liability would be the addition of tax 1, tax 2, tax 3, and tax 4.
Total Tax liability = tax 1 + tax 2+ tax 3 + tax 4
=12,500+ 1,00,000+30,000
=1,42,500
The following are the applicable surcharge rates:
Surcharge: 10% of income tax, where total income exceeds Rs.50 lakh up to Rs.1 crore.
Surcharge: 15% of income tax, where the total income exceeds Rs.1 crore.
Note: Surcharge is calculated from the Total Tax Liability.

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C. Section 6 – Residential Status

• Citizenship and residential status are separate concepts.
• Residential status impacts the incidence of taxation (Section 5).
• There are different tests for different assessees.
• It is to be determined for each Previous Year – because residential status may change from year to
year.
• A person may be a resident of more than one country for any previous year. If this happens, then one
needs to look at resolving the possibility of double taxation by way of resorting to Double Taxation
Avoidance Agreements (DTAAs).
Residential Status of an Individual:
The different types of residential status of an individual are:
Ø Resident and Ordinarily Resident (ROR)

Ø Resident, but not ordinarily a resident in India (RNOR)
Ø Non-Resident (NR)
The different categories of residential status have a bearing on the ultimate income tax liability of the taxpayer
and the incidence of taxation.
Test for Residence of Individuals – Section 6(1) and Section 6(6)
An individual may either be a (i) Resident in India or (ii) Non-resident in India.
However, an individual cannot be simply called a “resident” in India. If an individual is a resident

in India, he/she will be either:
(a) Resident and Ordinarily resident in India (ROR) or
(b) Resident, but not Ordinarily a resident in India (RNOR).

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Basic Condition for an Individual to be a Resident:
Under Section 6(1) of the Income Tax Act, an individual is said to be a resident in India in any previous
year if he/she:
(a) [Section 6(1)(a)]: is in India in the previous year, for a period or periods amounting in all to
one hundred and eighty-two days (182 days) or more – i.e., he/she has been in India for at least 182
days during the previous year; or,
(b) [Section 6(1)(c)]: has been in India for at least three hundred and sixty-five days (365 days)
during the four years preceding the previous year AND has been in India for at least sixty days
(60 days) during the previous year except in following two cases, where this requirement of 60
days in Section 6(1)(c) will be substituted with 182 days:
– A citizen of India, who leaves India in any previous year as a member of the crew of an Indian
ship, OR for the purpose of employment outside India, or
– Citizen of India or Person of Indian origin being outside India (whether for rendering service
outside or not) and who comes on a visit to India in the any previous year.
Therefore, in case of a Indian citizen being a crew member of an Indian ship, or an India citizen going
abroad for employment purpose (other than for training), or an Indian citizen/Person of Indian Origin
coming on a visit to India during relevant previous years, only condition (a) only needs to be checked. If
it is satisfied, then the individual is treated as a resident, otherwise he/she will be treated as non-resident.
A person is deemed to be of Indian origin if he/she, or either of his parents or any of his grandparents, was
born in Undivided India. It may be noted that grandparents include both maternal and paternal
grandparents.
Test for Non-Resident – Section 6(1)
If an individual does not satisfy any of the above basic conditions – i.e. when none of the conditions
mentioned in Section 6(1) [182 days test along with the exceptions] are satisfied – then, he/she will be treated
as Non-Resident.
It must be noted that the fulfilment of any one of the above conditions (a) or (b), as applicable, will make
an individual resident in India for tax purposes. Further it is to be noted that these conditions are
alternative and not cumulative in their application.

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Resident and Ordinarily Resident (ROR) – Section 6(1) r/w Section 6(6)
An individual may become a resident and ordinarily a resident in India if he/she satisfies both the following
conditions given under Section 6(6), besides satisfying any one of the above mentioned conditions under
Section 6(a):
(i) he/she is a resident in India in at least any 2 out of the 10 previous years immediately preceding the
relevant previous year, or
(ii) he/she has been in India for 730 days or more during the 7 previous years immediately preceding the
relevant previous year.
Test for Resident and Not Ordinarily Resident (RNOR) – Section 6(6)
An individual is not ordinarily resident in any previous year if –
(a) he/she has been a non-resident in India in 9 out of the 10 previous years preceding that year, or
(b) he/she has during the 7 previous years preceding that year been in India for a period of, or periods
amounting in all, to 729 days or less.
Ø Important Points:
(i) The fact that an assessee is a resident in India in respect of one year does not automatically
mean that he/she would be a resident in the preceding or succeeding years as well.
Consequently, the residential status of the assessee should be determined for each year
separately. This is in view of the fact that a person resident in one year may become non-
resident or not ordinarily resident in another year and vice versa.
(ii) It must also be noted that the residential status of an individual for tax purposes is neither
based upon, nor determined by, his citizenship, nationality and place of birth or domicile.
This is because of the fact that, for tax purposes, an individual may be resident in more
than one country in respect of the same year.
(iii) The common feature in both the above conditions [of Section 6(6)] is the stay of the
individual in India for a specified period. The period of stay required in each of the
conditions need not necessarily be continuous or consecutive nor is it stipulated that the
stay should be at the usual place of residence, business or employment of the individual.
Purpose of stay is immaterial in determining the residential status.

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(iv) The stay may be anywhere in India and for any length of time at each place; in cases where
the stay in India is at more than one place, what is required is that the total period of stay
should not be less than the number of days specified in each condition.
(v) Steps to determine the residential status of an Individual:
Step 1: Determine whether the individual falls under exceptions to the basic condition
[Section 6(1)];
Step 2: If the answer in the Step 1 is in the affirmative, apply only first basic condition
[Section 6(1)(a)] which if satisfied, will render the individual in question a resident, and,
if not satisfied, will render him a non-resident.
If the answer in the Step 1 is in the negative, then apply both basic conditions in Section
6(1)(a) and the individual may be determined a resident on satisfaction of any one of the
conditions.
Step 3: Check if the individual satisfies the test of ‘Ordinary Resident’ [Section 6(6)]. If
the test is satisfied, then the individual will be called an ROR, otherwise he/she will be
called an RNOR.
(vi) “India” means the territory of India, its territorial waters, continental shelf, Exclusive
Economic Zone (up to 200 nautical miles) and airspace above its territory and territorial
waters.
(vii) Where the exact arrival and departure time, to and from India, is not available for an
individual, the day he/she comes to India and the day he/she leaves India will counted as
his stay in India.

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Solved Problems
Q1. Mr. P, an Indian Citizen, has been living in Delhi since 1960. He/she left for Japan on July 1, 2012 and
returned to India on August 7, 2016. Determine his residential status for the assessment year 2017-18.
Solution:
Section 6(1) Test – stay in India for a minimum period of 182 days in the previous year:
Mr. P has stayed in India for 237 (viz. 25 + 30 + 31 + 30 + 31 + 31 + 28 + 31) days in the previous year
2016-17. So, this test is satisfied.
So, Mr. P shall be a resident in India during the previous year 2016-17 (assessment year 2017-18). Keeping
in view the facts of the given case, Mr. P satisfies the two additional conditions also namely:
– He/she is resident in two out of ten previous years preceding the relevant previous year.

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– His stay in India is also more than 730 days in 7 previous years preceding the relevant previous year. As
he/she left for Japan on 1st July 2011.
Hence, Mr. P is resident and ordinary resident in India for the assessment year 2017-18.
-~-
Q2. Dr. Z, an Indian citizen and a Professor in IIM, Lucknow, left India on September 15, 2016 for the USA
to take up a Professor’s job at MIT, USA. Determine his residential status for the assessment year 2017-18.
Solution: Dr. Z being a citizen of India and who has gone out of the country for employment, will be governed
by 182 days test only and therefore the second condition under section 6(1), i.e. 60 days during relevant
previous year shall not be applicable.
Dr. Z stayed in India for 168 (viz. 30 + 31 + 30 + 31 + 31 + 15) days only in the relevant previous year.
Hence, Dr. Z shall be a non-resident in India for the assessment year 2017-18 as condition by stay of 182 days
in relevant previous year is not satisfied.
-~-
Q3. Mr. R is a foreign citizen. Determine his residential status for the assessment year 2017-18 on the
assumption that during financial years 2002-03 to 2016-17, he/she was present in India as follows:

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Solution:
The facts of the given case may be presented in the form of the following table:
The following facts are now available:
(i) Stay of Mr. P during the previous year 2016-17 is 185 days.

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(ii) Mr. P is resident in India in two out of ten previous years preceding the relevant previous year
(viz. resident in 2015-16 on satisfaction of 2nd basic condition [Section 6(1)(c)] and resident in 2014-
15 on satisfaction of 1st basic condition [Section 6(1)(a)]).
(iii) Stay of Mr. P in India is also more than 730 days in 7 previous years preceding the relevant
previous year.
Hence, Mr. P shall be a resident and ordinary resident for the assessment year 2017-18.
-~-
Q4. Mr. B is a foreign citizen. His father was born in Delhi in 1960 and mother was born in England in 1965.
His grandfather was born in Delhi in 1935. Mr. A is coming to India to see the Taj Mahal and visit other
historical places in India. He/she comes to India on November 1, 2016 for 200 days. He/she has never come
to India before. Determine his residential status for AY 2017-18.
Solution: Mr. B falls in exception to basic conditions as he/she is a Person of Indian Origin (as his grandfather
was born in undivided India) and he/she comes on a visit to India during relevant Previous year. Therefore,
only first basic condition of 182 days during relevant previous year would be checked.
Stay during relevant PY 2016-17 = 1st Nov, 2016 to 31st March, 2017 = 30+31+31+28+31 = 151 days
Mr. B is Non-resident in India for PY 2016-17 as he/she does not satisfy first basic condition.
-~-
Tests of Residence for Hindu Undivided Families (HUF), Firms and Other Associations of
Persons (AOP) – Section 6(2)
The test to be applied to determine the residential status of a HUF, Firm or other Association of Persons is
based upon the control and management of the affairs of the assessee concerned.
The tests based on the period of stay in India applicable to individuals cannot be applied to these assessees
for obvious reasons.

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Ø Meaning of place of control and management:
The place of control and management refers to the place(s) where the functions of decision-making
and of issuing directions are carried out, and not the place(s) from where the activity in question is
carried on as such.
In other words, control and management refers to the taking of policy decisions relating to the
business or activity in question – policy decisions concerning finance, marketing, production,
advertising, personnel etc. Policy decisions do not refer to day-to-day operations of the
concern/assessee. Control and management is situated at that place where policy decisions are
taken.
– Control and Management of HUF: It is with the Karta or its Manager.
– Control and Management of Firm/AOP: It is with Partners/Members.
A HUF, firm, or other association of persons is said to be a resident in India within the meaning of
Section 6(2) in any previous year, if during that year the control and management of its affairs is
situated wholly or partly in India. If the control and management of its affairs is situated wholly
outside India during the relevant previous year, it is considered non-resident.
Ø A HUF can be “not ordinarily resident” in India:
– If the Manager/Karta has been not ordinarily resident in India in the previous year in accordance
with the tests applicable to individuals.
– Where, during the last ten years, the Kartas of the HUF had been different from one another, the
total period of stay of successive Kartas of the same family should be aggregated to determine the
residential status of the Karta and consequently the HUF
In other words, if the Karta of resident HUF satisfies both the following additional conditions (as
applicable in case of an individual), then the resident HUF will be ROR, otherwise it will be RNOR.
Additional Conditions :
(1) Karta of Resident HUF should be a resident in at least 2 previous years out of 10 previous years
immediately preceding relevant previous year.
(2) Stay of Karta during 7 previous year immediately preceding relevant previous year should be 730
days or more.

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Note: It is immaterial whether Karta is Resident or Non-Resident during relevant previous year, for
the purpose of determining whether HUF is ROR or RNOR. If Karta satisfies both the additional
conditions, then HUF will be ROR, otherwise RNOR.
Different Categories of Residential Status of a HUF
Non-Resident: If the control and management of the affairs of HUF is situated wholly
outside India.
Resident: If the control and management of the affairs of HUF is situated wholly or partly in
India.
Not Ordinarily Resident: A resident HUF is said to be ‘Not Ordinarily Resident’ in India if
Karta or manager thereof, satisfies any of the additional conditions under Section 6(6)(b).
Firms, association of persons, local authorities and other artificial juridical persons can be either
resident (ordinarily resident) or non-resident in India but they cannot be not ordinarily resident in
India.
Ø Important Points
• Even if a negligible portion of the control and management of the affairs is exercised from India, it
will be sufficient to make the family, firm or the association resident in India for tax purposes. For
instance, if the affairs of a firm are controlled partly from India and partly from Bangladesh, the firm
would be resident in India.
• While the control and management of the affairs of the firm or family would necessarily be exercised
by the partners of the firm or members of the family, the residential status of the members or partners
is generally irrelevant for determining the residential status of the firm or family. But in cases where
the residential status of the partners materially affects or determines the place of control and

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management of the affairs of the firm, the residential status of the member or partners should also be
taken into account in determining the residential status of the firm or the family.
• The mere fact that all the partners are resident in India does not necessarily lead to the
conclusion that the firm is resident in India because there may be cases where even though the
partners are resident in India, control and management of the affairs of the firm is exercised
from outside India.
• A HUF would generally be presumed to be resident in India unless the assessee proves to the tax
authorities that the control and management of its affairs is situated wholly outside India during
the relevant accounting year.
A resident HUF would be a ROR if the Karta of the HUF also satisfies both the additional conditions
(mentioned above); otherwise the HUF would be RNOR.
Ø Rebuttable presumption for residential status:
V.V.R.N.M. Subbayya Chettiar v. Commissioner of Income Tax, Madras:
Facts: The Karta of a Hindu Joint Family lives with his wife, son and three daughters in Ceylon,
where they are domiciled. He/she carries on business under the name of General Trading Corporation
and owns a house, some immovable property and investments in British India. He/she owns shares
in firms located at Vijayapuram and Nagapatnam in the British India. For the purposes of the present
assessment, the year of account for which is 1941-42, the appellant is said to have frequently visited
British India spending a total of 101 days in the country. During these stays, he/she attended the suits
related to family lands in the Trial Court and in the Court of Appeal, income-tax proceedings related
to assessment of family income before the income-tax authorities at Karaikudi and Madras.
Issue: Whether the assessee (a Hindu undivided family) is 'resident' in British India under section
4A(b) of the Income-tax Act?
Ratio: (1) As a general rule, the control and management of a business remains in the hand of a
person or a group of persons, and the question to be asked is wherefrom the person or group of persons
controls or directs the business.
(2) Mere activity by the company in a place does not create residence, with the result that a company
may be "residing" in one place and doing a great deal of business in another.

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(3) The central management and control of company may be divided, and it may keep house and do
business in more than one place, and, if so, it may have more than one residence.
(4) In case of dual residence, it is necessary to show that the company performs some of the vital
organic functions incidental to its existence as such in both the places, so that in fact there are two
centres of management.
Merely because the assessee attended to some of the affairs of his family during his visit to British
India in the particular year, he/she doesn’t bring himself within the ambit of the rule.
Conclusion: The appellant was asked to produce evidence to show that the Control and Management
of affairs of the family was situated wholly outside the taxable territories, as the onus of proving
such fact is on the appellant to bring his case under the exception. Since the appellant failed in
adducing evidence, the normal presumption has to be given effect to and hence the dismissal of appeal
is legitimate.
The decision of the appeal must be confined to the year of assessment to which this case relates,
and it would be open to the appellant to show in future years by proper evidence that the seat of
control and management of the affairs of the family is wholly outside British India.
Ø Difference in the Control & Management test: HUF and a Company:
“In this connection it is perhaps necessary to look at the converse definition of a Hindu undivided
family, firm or other association of persons. In their case they are resident unless the control and
management of its affairs is situated wholly without the taxable territories. Therefore, whereas in the
case of a Hindu undivided family or firm or association of persons any measure of control and
management within the taxable territories would make them resident, in the case of a company any
measure of control and management of its affairs outside the taxable territories would make it
non-resident.” - Narottam and Parekh Ltd. v Commissioner of Income Tax, Bombay City (AIR
1954 Bom 67)
Solved Problems
Q1. ABC HUF’s whole affairs of business are completely controlled from India. Determine its Residential
status for AY 2017-18 (a) if Karta is ROR in India for that year (b) If Karta is NR in India but he/she satisfies
both the additional conditions (c) If Karta is RNOR in India.
Solution: HUF would be Resident in India as Control and Management is wholly situated in India.
Determination of whether HUF is ROR or RNOR:

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(a) HUF is ROR in India as Karta would be satisfying both the additional conditions (because he/she
is ROR).
(b) HUF is ROR in India as Karta is satisfying both the additional conditions. Karta’s residential
status during relevant previous year (i.e. resident/non-resident) is irrelevant.
(c) HUF is RNOR as Karta does not satisfy both the additional conditions.
-~-
Q2. AB & Co. is a partnership firm whose operations are carried out in India. However, all meetings of
partners take place outside India as all the partners are settled abroad. Determine Residential status of firm
for AY 2017-18.
Solution: AB & Co. is Non-Resident in India during relevant previous year as Control and Management
(place where policy decisions are taken, here it is the place where meetings are held) is wholly situated
outside India.
-~-
Tests for Companies – Section 6(3)
Section 6 (3): A company is said to be resident in India in any previous year, if—
(i) it is an Indian company; or
(ii) its place of effective management, in that year, is in India.
Explanation. – For the purposes of this clause “place of effective management” means a place where key
management and commercial decisions that are necessary for the conduct of the business of an entity as
a whole, are in substance made.
A company’s residential status depends on its incorporation or the situs of effective management.

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Ø Place of Effective Management Test (POEM):
Note: Please refer the CBDT's Circular No. 06 of 2017 for an excellent detailing of POEM ("Guiding
Principles for determination of Place of Effective Management (POEM) of a Company")
– Was suggested in the Direct Taxes Code and has been in force since AY 2017-2018
– CBDT had issued draft guidelines on the test in December 2015 – which have been finalized and
notified in January 2017
– Earlier test – “during that year, the control and management of its affairs is situated wholly in
India”.
– Origins of the control and management (C&M) test – UK common law test.
– De Beers case by House of Lords in 1906.
Ø DeBeers ([1906] A.C. 455):
Facts: De Beers Consolidated Mines Limited had been incorporated in the Colony of the Cape of
Good Hope (now part of South Africa) where the actual mining activities were undertaken. On the
other hand, the board meetings took place in Kimberley (South Africa) and London. A majority of
the directors were residing in London.
Holding: The company was considered to be resident in London as all important matters, such as,
negotiation of contracts, policy decisions on disposal of diamonds and other assets, application of
profits, appointment of directors were taken up there.
Place of management trumped place of the operations and place of profit making – colonial subtext.
A company is resident where its real business is carried on, which is explained as being the place
where the company’s ‘central management and control’ abides.
Ø India’s experience with the control and management test:
– The test is applied in India such that an enquiry is made into the company’s controlling and
directing power, or its head and brain, as opposed to its day-to-day management. –
– The court looks to not where the directors reside but where the board decides the key issues.

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– Some examples of key issues are ones relating to company policy, financial matters, disposal of
profits and any other significant items concerning the general and corporate affairs of a company.
– Unlike the common law test, the Indian test required control and management to be situated “wholly
in India”.
– Substance over form approach advocated by Indian Courts.
– Interpretation of the test in the context of companies feature in very few cases – more cases
involving partnership firms and Hindu Undivided Families.
Ø Radha Rani Holdings (P) Limited. V. Additional Director Of Income-tax
Facts: The Company that is the assesse was incorporated in Singapore and all the board meetings of
the organization were held in Singapore. One of the directors Mrs. Geeta Soni was an inhabitant of
India. She was holding 99% of the shares in the company. The chairman was an occupant of
Singapore. It was held by the revenue authorities that the company was a non-resident as the whole
control and administration was outside India.
Issue: Whether the assessee-company was a non-resident within the meaning of Section 6(3)(i)?
Ratio: As per section 6(3)(ii), a company is said to be a resident of India if during that year, the
control and management of its affairs is situated wholly in India. Even if slightest control and
management is exercised outside India, the company would be treated as a non-resident.
If the control and management of the company lies in its place of incorporation, then the residential
status would be in that country irrespective of the fact whether they own other companies.
Conclusion: As the provisions of Section 6(3)(ii) relating to the 'control and management' of the
company being situated wholly in India, are not satisfied in this case. Therefore, the assessee company
was a 'non-resident' in India during the year under consideration.
Ø Government’s justifications for switching to POEM:
– Under the earlier rule a company could easily avoid becoming a resident by simply holding a
board meeting outside India. This facilitates creation of shell companies which are incorporated
outside but controlled from India.
– POEM would help to deal with cases of creation of shell companies.

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– POEM is an internationally recognized concept for determination of residence of a company

incorporated in a foreign jurisdiction. POEM is recognized and accepted by OECD also.
– The modification in the condition of residence in respect of a company, by including the concept
of effective management, would align the provisions of the Act with the Double Taxation Avoidance
Agreements entered into by India with other countries and would also be in line with international
standards.
Ø Guidelines on POEM:
– Any determination of POEM will depend upon the facts and circumstances of a given case.
– POEM concept is one of substance over form.
– An entity may have more than one place of management, but it can have only one place of
effective management at any point of time.
– Since “residence” is to be determined for each year, POEM will also be required to be determined
on year to year basis.
– POEM pertains to management decisions rather than operational decisions: decision to open a
major new manufacturing facility vs. decisions by plant manager appointed by senior management to
run that facility, concerning repairs and maintenance
– The process of determination of POEM would be primarily based on the fact as to whether or not
the company is engaged in active business outside India.

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– Active Business Outside India: presumption that if majority of board meetings are outside
India it would be a non-resident (rebuttable)
– How to prove that a company has Active Business Outside India?:
- Passive Income (transactions of sale and purchase between Associated Enterprises, Royalty,
Interest, Dividend, Capital Gains) is not more than 50% of its total income.
- Less than 50% of its assets are situated / resident in India.
- Less than 50% of its employees are situated in India.
- Payroll expenses on such employees are less than 50% of the total payroll expenses.
– The average of the data of the relevant previous year and two years prior to that shall be taken
into account for determining POEM.
– If the Board of Directors are standing aside and such powers are being exercised by either the
holding company or any other person(s) resident in India, then POEM shall be considered to be a
resident in India.
– If the company’s Active Business is not outside India:
First stage would be ascertaining the person(s) who actually make the key management and
commercial decision for conduct of the company’s business as a whole; and
Second stage would be determination of place of decision making.

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– Mere formal holding of board meetings at a place would by itself not be conclusive for
determination of POEM being located at that place.
– In case of de jure /de facto delegation of power, where the Board only routinely ratifies the
decisions, POEM would be the place where senior management / other persons make decisions.
– Physical location of board meeting no longer relevant – participation through video conferencing,
etc.
– place of residence of directors may be relevant.
– Decisions made by shareholders on matters reserved for them are not relevant for determining
POEM.
– But shareholders may exercise effective management (usurpation of powers and exercise of undue
influence)
– Holistic determination rather than an assessment of picking up isolated facts such as: residence of
directors, presence of PE, foreign ownership, local management from India, preparatory and auxiliary
activities / support functions from Indian
– Where all factors mentioned are inconclusive, place of main and substantial activity and place where
accounting records are maintained can be considered.
– Further, if it is determined that during the previous year the POEM is in India and also
outside India then POEM shall be presumed to be in India if it has been mainly /predominantly
in India.
– Procedural safeguards: prior approval of Principal Commissioner / Commissioner and subsequent

approval of collegium of members.
Ø Guidelines on POEM – Clarifications:
– Companies having turnover / gross receipts less than Rs. 50 crores in a financial year are exempt
from the POEM test.
– If the board of an Indian company follows the general principles of global policy laid down by the
parent company in the domain of functions such as payroll, accounting, human resource management,
banking procedures, etc. it would not constitute a case of the board standing aside.
– A foreign company considered resident under POEM rules will have to pay tax on its worldwide
income in India at the rate of 40%. Note that Indian companies have to pay tax at 30% / 25%.

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Residential Status of Other Persons – Section 6(4)
Section 6 (4): Every other person is said to be resident in India in any previous year in every case,
except where during that year the control and management of his affairs is situated wholly outside
India.
Resident: If the control and management of the affairs of a firm or AOP or other person is situated
wholly or partly in India then such a firm or AOP or other person is said to be resident in India.
Non-Resident: If the control and management of the affairs of a firm or AOP or other person is
situated outside India then such a firm or AOP or other person is said to be non-resident in India.

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D. Revenue and Capital Receipts

Section 4 brings to charge tax on total income.
Prima facie, in order to come within the scope of the charging provision, the receipt in question should
normally be a revenue receipt. Capital receipts are normally exempt. However, certain capital receipts have
been specifically included in the definition of income, some of which are:
(a) Income by way of capital gains [Section 45];
(b) Compensation for modification/termination of services [Section 17(3)(i)];
(c) Amount due to or received whether in lump sum or otherwise by any assessee from any person
before joining his employment or cessation of his employment [Section 17(3)(iii)];
(d) Compensation or other payment due to or received by some specified person covered under
Section 28(ii)(a), (b), (c) and (d);
(e) Any sum whether received or receivable in cash or in kind under an agreement for not carrying
out any activity in relation to a business or not sharing any know-how, patent, copyright, trade mark,
license, etc. [Section 28(va)];
(f) Voluntary contributions received by a trust/institution created wholly or partly for charitable or
religious purposes or by certain other specified institutions [Section 2(24)(iia)];
(g) W.e.f. 1. 4. 2006, gift of money, though capital receipt, shall be taxable if the same is received
from unrelated persons and the aggregate sum of money received as gift from one or more person
exceeds Rs. 50,000;
(h) Gift of immovable property or gift of movable property shall be taxable in certain cases if the
same is received from unrelated persons. [Section 56(2)(vii)];
(i) Shares acquired by a firm or a closely held company without consideration or for inadequate
consideration shall be taxable in certain cases [Section 56(2)(viia)];
(j) Any consideration received for issue of shares as exceeds the fair market value of the shares
referred to in Section 56(2)( viib).
A capital receipt is generally exempt from tax unless it is expressly taxable under Section 45. [Cadell
Weaving Mills Co. P. Ltd v CIT(2001) 249 Taxman 265 (80m)].

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On the other hand, there are certain receipts which are revenue receipts, but do not form part of total income.
Tests relevant for determination of nature of receipts
1. Capital sales versus business sales: The receipt would be on capital account where the transaction
merely amounts to change of investment or is for the purposes of realisation of capital. Where,
however, such transaction is one entered into in the ordinary course of business, it would be a
revenue receipt.
Profits arising from the sale of a capital asset are chargeable to tax as capital gains under Section 45,
whereas profits arising from the sale of a trading asset, being of revenue nature, are taxable as income
from business under Section 28 provided that the same is in the regular course of assessee's business,
or the transaction constitutes an adventure in the nature of trade.
2. Nature of the initial receipt an important factor: The character of the receipt at its initial stage
plays a vital role in determining whether it is a capital or revenue receipt. This is clear from the
decision of the Court of Appeal in Morley v Tattersall TC 13R 264 in which it was held that if a
particular amount is not received as a trading receipt in the course of the business at the first
instance, it would not subsequently be regarded as a trading receipt due to change of things or
circumstances.
3. Fixed capital versus circulating capital: A receipt referable to a fixed capital is a capital receipt,
while what is referable to circulating capital or stock in-trade of an assessee would be a revenue
receipt.
What is a fixed capital for one person may be a circulating capital for another. A machinery would
be a fixed capital for a person who uses the same in his trade for manufacture of an article. While it
would be circulating capital for the machinery manufacturer. For an ordinary investor, shares would
be fixed capital, but for a dealer in shares, it would be circulating capital. Profit or realisation of fixed
capital would be on capital account, and may attract capital gain tax while the same on realisation of
circulating capital would be a revenue receipt. The Supreme Court in CIT v Vazir Sultan & Sons TC
38R 925 has applied this principle.
Where the assessee, a firm, was appointed as the sole selling agent by a company
manufacturing cigarettes for the Hyderabad State in the year 1931, and subsequently in the
year 1939 that agency was extended even in respect of the sales outside the Hyderabad State,
but in the year 1950 the said agency was restricted and confined only to the Hyderabad State
and payment was made to the assessee as compensation for the loss by way of restriction of

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the area of the agency, it was held that the agency formed the capital asset of the company
and the amount received by the assessee as compensation was a capital receipt and not income
from business. [CIT v Vazir Sultan (1959) 36 ITR 175 (SC)]. However, although it is capital
receipt it has been specifically included as income under Section 28(2)(i).
4. Test in the hands of the recipient: In deciding whether a certain receipt is income or not, the test is
its character in the hands of the recipient and not character in the hands of the payer, nor the fund
out of which the money came. What may be regarded as capital in the hands of the payer may yet be
income in the hands of payee. [CIT v Vazir Sultan & Sons (1959) 36 ITR 175 (SC)].
Where the assessee had teak trees on her land which had been planted long ago, and which had been
cut and completely removed from the land together with roots thereof for the purpose of rubber
plantation on the land, it was held that the sale proceeds of the trees was not income liable to tax but
was a capital receipt in the hands of the assessee. [Vishnudatta Antharjanam (AKT.K.M.) v CAgIT
(1970) 78 ITR 58 (SC)].
On the other hand where the trees were not removed with roots and the stumps of the trees were
allowed to remain in the land so that the trees may regenerate, it is an income liable to tax under the
Income-tax Act and is not capital receipt. [Venugopala Verma Rajah v CIT (1970) 76 ITR 460 (SC)].
5. Casual or recurring receipts: One test that is sometimes adopted is whether the receipt is a casual
receipt or whether it is a recurring receipt. If income is a casual receipt, it is capital; if income is a
recurring receipt, it is revenue. But this is not an unfailing test, for an annual or periodic receipt
may be capital, and a single receipt may yet be revenue. So also, it cannot be said that only recurring
receipts can be income and all non- recurring receipts should always be capital in nature. [Yogam
(SMDP) v CIT (1985) 154 ITR 624 (Ker)].
6. Premium receipts: Premium received by an owner in consideration of the grant by him of a licence
to realise a capital asset belonging to the owner is capital, but any sum received by the owner for his
allowing another to use the capital asset is revenue. [Maharaja Chintamani Saran Nath Sah Deo v
CIT (1961) 41 ITR 506 (SC)].
7. Payer's motive not material: In determining whether a payment amounts to a return for loss of a
capital asset or is income, profits or gains liable to tax, one must have regard for the nature and quality
of the payment, if the payment was not received to compensate for a loss of profits of business, the
receipt cannot properly be described as income, profits or gains as commonly understood. To
constitute income, profits or gains, there must be a source from which the particular receipt has arisen,
and a connection must exist between the quality of the receipt and the source. It the payment is by
another person, it must be found out why that payment has been made. It is not the motive of the
person who pays that is relevant. More relevance attaches to the nature of the receipt in the hands of
the person who receives it though in trying to find out the quality of the receipt one may have to

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examine the motive out of which the payment was made. The fact that the amount paid was large or
that it was periodic in character, or described as pay remuneration, etc., do not determine its quality
[Divecha (P.H.) v CIT (1963) 48 ITR 222 (SC)].
8. Profit motive: The existence or absence of profit motive is also neither decisive nor conclusive for
arriving at a decision whether a particular receipt is income or not because even in the absence of a
motive to earn income, the assessee may derive income and would still be chargeable to tax.
[Vishnudatta Antharfanam (A.K.T.K.M) v CAgIT (1970) 78 ITR 58 (SC)].
9. Nomenclature of transaction irrelevant: The character of the receipt either as capital receipt or as
income should not be based on the name given to the amount received by the assessee in his records
because, in law, the real nature and character of the transaction must be determined in the light of the
terms of the contract and the rights and obligations of the parties flowing therefrom unguided by the
nomenclature of the transaction. [National Cement Mines Industries Ltd. v CIT (1961) 42 ITR 69
(SC)]
However, the nomenclature of the transaction or receipt as used by the parties may be of assistance
to the Revenue to arrive at a view in regard to the intention of the party even though the nomenclature
is not decisive particularly when the transaction is between two businessmen who are conversant with
such phraseologies. [CIT v Panbari Tea Co. Ltd. (1965) 57 ITR422 (SC)].
A mere book-keeping entry cannot be income, unless income has actually resulted. [CIT v Shoorji
Vallabhdas & Co. (1962) 46 ITR 144 (SC)].
10. Entry in the books of account of a hypothetical income does not result ill income subject to tax:
Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time
at which the liability to tax is attracted, viz, the accrual of the income or its receipt; but the substance
of the matter is the income. If income does not result at all, there cannot be a tax, even though in book
keeping, an entry is made about a "hypothetical income", which does not materialise. Where income
has, in fact, been received and is subsequently given up in such circumstances that it remains the
income of the recipient, even though given up, the income may be taxable. Where, however, the
income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income,
even though an entry to that effect might, in certain circumstances, have been made in the books of
account. Where the company provided for additional remuneration to the directors subject to the
approval of the Central Government but made no application for the approval and the directors forgo
the additional remuneration prior to the end of the previous year, it was held that the additional
remuneration does not accrue and is hence not taxable. [Seth Madan Lal Modi v CIT(2003) 261 ITR
49 (Del)].
Under the Income tax Act, income is to be computed not of the basis of accounting treatment but on
the well-established principles of law interpreted by the Courts on the basis of law of income-tax.

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The company credited a certain percentage of the deposits collected from customers under a finance
scheme as administrative and process charges in the profit and loss account. Later it filed a revised
computation during the assessment proceedings claiming that the sum credited is part of the deposit
received which is erroneously credited in the profit and loss account. It claimed that the receipt is
capital in nature. It was held that the Court is compelled to go by the true nature of the receipts and
not go by the entry in the books of account and therefore held that the entire receipt of collection from
the depositor is a loan sum being capital in nature despite being shown in the profit and loss account
as income. [CIT v Sahara Investment India Ltd. (2004) 136 Taxman 61 (All)].
11. Treatment as income by the assessee is not conclusive: A receipt which in law cannot be regarded
as income cannot become so merely because the assessee has erroneously credited it to the profit and
loss account. [CIT v Stewarts & Lloyds of India Ltd. (1987) 165 ITR 416 (Cal); CIT v India Discount
Co. Ltd. (1970)75 ITR 191 (SC)].
12. Disallowance in the hands of payer: That the expenditure had been disallowed in payer's hands
cannot be the basis for determining that it is not a revenue receipt in the hands of the recipient. The
same should be viewed only from the recipient's angle. [Lakshmi Rajyam v CIT(1960) 40 ITR 340
(Mad)].
13. Lump sum receipt versus receipt ill instalments: A revenue receipt may be received in single lump
sum or a capital receipt may ensue through several instalments payments. [CIT v Panbari Tea Co.
Ltd. (1961) 57 ITR 422 (SC)].
Where the assessee, who had served a company as director for a very long time desired to resign his
directorship but was persuaded by the company not to resign and in consideration of the assessee
acceding to the request, the company made lump sum payment to him, it was held that the lump sum
amount received by the assessee was not a capital receipt but income in his hands being profit arising
to him from his directorship. [Cameron v Prendergast (Inspector of Taxes) (1940) 8 ITR Suppl
(HL)].
14. Revenue receipts (Whether sums awarded by courts are income?) The Courts may give varied
names to sum awarded like compensation but the courts have declined to be bound by labels and have
always tried to look through it and to solve the question of substance by reference to the true character
of the award. [While v G & M Davies (1979) Simons TC 415 (Ch D)].
(a) Compensation, for land whether capital or revenue receipt: Compensation received for
immobilisation, sterilisation, destruction or loss, total or partial, of a capital asset is a capital
receipt. Where compensation is recovered for an injury inflicted on a man's trading, so to
speak, a hole in his profits, the compensation would fill that hole and would be a trading
receipt. On the other hand, where the injury is inflicted on the capital assets of the trade,
making, so to speak, a hole in them, the compensation recovered is meant to be used to fill

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that hole and is a capital receipt. [CIT v Bombay Burmah Trading Corporation (1986) 161
ITR 386 (SC)] Whether a particular receipt by way of compensation was capital or a revenue
receipt had to be decided on a consideration of the legal basis of the claim. The fact that the
measure or basis for the compensation was in relation to the assessee's profits, was not
decisive of the nature of the receipt [Associated Oil Mills Ltd. v CIT (1960) 40 ITR 118
(Mad)]. Nor can the matter of taxability or otherwise of a receipt be decided on the basis of
the entries which the assessee may choose to make in his accounts; that has to be decided in
accordance with the provisions of law [Cf CIT v Mogul Line Ltd. (1962) 46 TC 590 (80m)].
(b) Compensation received in respect of loss of a trading asset or stock-in trade: A company
entered into an agreement to develop some land belonging to a college. It undertook to erect
houses on the lands, on completion of which the college was to grant to the company or its
nominees leases of the lands at nominal rents for 99 years. A clause in the agreement enabled
the college to vary the plan of development on due notice and to withdraw any plot from the
scheme. Accordingly, the college served a notice withdrawing 87 plots and when the company
objected that it was not a valid notice, the college paid £ 5,000 to the company to induce it to
withdraw its objection. It was held that the sum of £ 5,000 so received by the company was a
trading receipt, as the right to build on the plots was a trading asset or the stock-in-trade and
not a capital sum, and further, that any sum received as compensation for such right ought to
come into the trading account. [Shadbolt v Salmon Estate 25 TC 52].
The assessee firm which carried on the business of mining, held six mining leases. It
transferred one of the mining leases for a certain consideration. The amount was not described
as premium before the mining or Income-tax Authorities. Even after the transfer of the lease,
the assessee's business had continued. It was held that the amount received constituted a
business receipt. [CIT v Lakshminarayana Mining Co. (1987) 165 ITR 326 (Kar)].
(c) Compensation received for loss of profits: Compensation received for loss of profits has the
same characteristics as the type of receipts discussed immediately above. A company
purchased the licence for producing certain dramatic plays in certain territories for a specified
term and the licensor agreed that in those territories no talking film of the plays would be
made. Subsequently, it was discovered that the film rights in those territories had already been
sold by the licensor; thereupon, the licensee-company brought an action for damages which
was awarded in a certain sum. It was held that the damages were income chargeable to
income-tax and, further, that the damages were really the loss of profits which the assessee
suffered by the breach. [Vaughan v Archie Parnel & Alfred Zeitlin Ltd. 23 TC 505: (1942)
101 ITR Supp 17].
Where the assessee, a cloth dealer, was awarded damages for the supply to it of a smaller
quantity of cloth than the quota allotted to it, it was held that the damages were for the injury

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inflicted on his trading and hence for loss of profits. [Trikamlal v CIT (1982) 134 ITR 450
(MP)].
(d) Compensation for termination of agreement: Where the agreement to run, manage and
administer the hotel was entered into by the, assessee-company in the ordinary course of
business, the compensation received on the termination of the agreement would be a trading
receipt. [CIT v Oberoi Hotels (India) Pvt. Ltd. (1994) 209 ITR 732 (Cal)].
(e) Compensation received by purchaser from vendor for cancellation of contract to sell by
the vendor: The cancellation of a agreement leaves unaffected the structure of the business,
and what all takes place in consequence of the cancellation is that the assessee loses a
profitable contract which has yet to run for a certain period of time, the assessee being able to
carry on the same business (though, of course, by making alternative arrangements), the
compensation paid represents profits which would have been earned in pursuance of the
contract had it not been cancelled. It does not represent the purchase price of the contract
itself. Hence, such compensation is income and not capital. [Bush, Beach & Gent Ltd. v Road
(1940) 8 lTR Supp 36].
(f) Compensation received by the developer from the land owner on termination of
development agreement: Compensation received from the land owner on termination of
development agreement was the deprivation of potential income and loss of future profits as
mentioned in the settlement agreement and not for divesting the assessee of its earning
apparatus, as restrictive covenant in the said agreement only prohibited the assessee from
undertaking a similar project in the vicinity of the existing project without consent of the land
owner for the limited duration of three years, and therefore; the compensation was a revenue
receipt. [Ansal Properties & Industries Ltd. v CIT (2011) 238 CTR 126 (Del)]
(g) Compensation received by vendor from purchaser for cancellation of contract to buy by
the purchaser: A firm of ship-builders had entered into a contract to build ships for a
purchaser. The purchaser was unable to complete the contract and, in order to free himself
from the obligation to buy, made a lump sum payment to the ship builders as compensation
for cancellation of the contract. It was held that it was a revenue receipt. [Short Bros v IRC
12 TC 955 (CA)].
15. Sales tax receipts and refunds: It is now settled law that sales tax charged and collected from
customers as part of the bills is in the nature of a trading receipt assessable to income-tax. In the case
of an assessee who maintains his accounts on the mercantile system, sales tax collected but not paid
to Government pending adjudication of dispute over his liability to pay sales-tax is a revenue receipt
of the year in which it is collected. [CIT v Naggi Reddy (T.) (1993) 202 ITR 253 (SC)].

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16. Tax payable by assessee collected from customers: The assessee, a dealer in grains and grocery,
was under an obligation to pay mandi tax. The assessee collected the amount of tax from its customers
and credited it in the balance sheet in that account. It was held that the assessee was not following the
mercantile system of accounting and, as such, the mandi tax collected by him from the customers was
liable to be taxed as its income. [Dhariwal Sales Enterprises v CIT (1988) 171 ITR 212 (MP)].
17. Mesne profits: The mesne profits received by the assessee under the consent decree granted by the
Apex Court was capital receipt not chargeable to tax. [Narang Overseas Pvt. Ltd. v ACIT(2008) 111
ITD 1 (Mum) (SB)].
Receipts on Capital Account
1. (Liquidated damages received in connection with a capital asset are capital receipts: The
damages received by the assessee were directly and intimately linked with the procurement of a
capital asset viz, the cement plant. The amount received by the assessee towards compensation for
sterilization of the profit earning source, not in the ordinary course of business was a capital receipt.
[CIT v Saurashtra Cement Ltd. (2010) 325 ITR 422 (SC)].
2. Lump sum payment made gratuitously or by way of compensation or otherwise to widow/other

heirs of an employee: The Board has clarified lump sum payment made gratuitously or by way of
compensation or otherwise to the widow or other legal heirs of an employee, who dies while still in
active service, is not taxable as income under the Income-tax Act, 1961. [Circular No. 573, dated
21.8. 1990: (1990) 185 ITR St. 31].
3. Payment in lieu of alimony: Where, under a decree, the assessee received, from her ex-husband, a
lump sum together with a monthly alimony, it was held, that while the monthly alimony would be a
taxable, the lump sum would be a capital receipt being in lieu of a capital asset viz. a right to get
maintenance from her husband. [Maheshwari Devi of Pratapgarh (Princess) v CIT (1984) 147 ITR
258 (Born)].
4. Amount received for surrendering leasehold rights: The amount received by a lessee for
surrendering his leasehold rights for the remaining period of the lease is in the nature of compensation
and is, therefore, a capital receipt. The mere fact that the amount had been agreed to be received in
monthly instalments cannot, by itself, be the sole criteria to hold that the receipt was a revenue receipt.
[CIT v Vardhini & Co. (1987) 165 ITR 342 (Kar)].
5. Compensation for deprivation of use and possession of the land: The land of the assessee was
unauthorizedly occupied and the civil suit instituted by the assessee for recovery of possession was
decreed in his favour. During the pendency of the appeal, the parties arrived at a compromise where
under the assessee was paid a sum which included what was styled as interest of a certain amount. It

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was held that the receipt was essentially in the nature of damages for use and occupation paid to the
owner. It was compensation received by the owner for the deprivation of the use and possession of
the land, and the receipt could not be included in the total income of the assessee. [CIT v ltalia (J.D.)
(1983) 141 ITR 948 (AP)].
6. Surrender of tenancy rights: Amount received by way of consideration for relinquishment or

surrender of tenancy rights is a capital receipt. However, such capital receipt is now chargeable to
capital gains.
7. Transfer fees received by a co-operative housing society: Normally the lease deed executed by a
member of a co-operative society in favour of society stipulates that whenever a member makes a
transfer of his flat or plot in favour of another person, he/she will have to pay to the society certain
part of the premium received by him. In generic language, this is termed as transfer fees. The question
is whether the amount which is received by the society pursuant to such stipulation is assessable to
tax as its income. In the under noted case such receipt has been held taxable. [CIT v Presidency Co-
operative Housing Society Ltd. (1995) 216 ITR 321 (80m)]. However, later in the case of Sind Co-
operative Housing Society v ITO (2009) 182 Taxman 346 (80m), it was held that the amount received
from outgoing and incoming members are not chargeable to tax, as it is surplus from mutual activity.
8. Compensation for termination of distributorship agreement is capital receipt: Compensation for

termination of a distributorship agreement would have the character of capital receipt, even if it were
receivable in instalments. Where the termination of the agreement resulted in substantial loss and that
this agreement coupled with the obligation on the part of the assessee, that it would not compete in
the same line of business would mean that it would not be a revenue receipt. It was pointed out by
the High Court that substantial loss had been incurred by the assessee as a result of the termination,
so that the compensation should be treated as loss of a source. [CIT v T. I. & M. Sales Ltd. (2003)
259 ITR 116 (Mad) following the decision of the Supreme Court in P.H. Divecha v CIT (1963) 48
ITR 222 (SC)]. However, it shall be subject to the provisions of Section 28(ii) if applicable.
9. Amount forfeited on account of non-payment of call money on debentures is capital receipt:

Where the assessee issues partly convertible debentures and forfeits application moneys for non-
payment of call moneys, such forfeited amount would be on capital account, so that there can be no
inference of a revenue element therein. [Deepak Fertilisers and Petro Chemicals Corporation Ltd.
v Deputy CIT (2008) 304 ITR (AT) 167 (Mumbai). See also Prism Cement Ltd. v JClT (2006) 285
ITR AT 43 (Mum)].
10. Forfeiture of application money is a capital receipt: Similarly share application money forfeited
and credited to the capital reserve shall not be taxable. [DCIT v Brijlaxmi Leasing & Finance Ltd.
(2009) 309 ITR (AT) 211 (Ahd)].

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11. Compensation for denial of job on basis of gender discrimination: Where the amount was
received by way of compensation for denial of job on basis of gender discrimination, it was held that
such amount is not in nature of "profit in lieu of salary". Such amount received shall be capital receipt
thus not taxable. [CIT v Rani Shankar Mishra (2010) 320 ITR 542 (Del).
12. Compensation for termination of technical know-how agreement: Compensation for termination
of technical know agreement received from the foreign collaborator 'M' by the assessee does not
represent a capital asset in the hand of the assessee. It was a case where only a limited right for limited
period to use patent and trade mark was given to the assessee by M without parting with any of its
assets, patent or trade mark. Object of the agreement was to grant benefit of technical assistance to
the assessee only for running the business' of manufacture and sale of tyres and tubes. It did not create
any right in favour of the assessee in any tangible asset so as to form a capital asset of enduring nature.
Thus, the amount received by assessee from M consequent upon termination of the agreement was
not against any price for relinquishment of any right in capital asset or for parting with any asset of
enduring nature. It was a sum paid in the ordinary course of business to adjust the relations between
assessee and M so that the agreement comes to an end amicably. Therefore, amount received by
assessee upon termination of the agreement constituted a revenue receipt. [S Kumars Tyre
Manufacturing Company Ltd. v Commissioner of Income Tax (2009) 30 DTR (MP) 233].
13. Interest on deposit of margin money for import of machinery before commencement of
business: Interest on deposit of margin money for opening of letter for credit for import of machinery
at the stage of setting up of industrial unit of the assessee is a capital receipt and the same is to be set
off against preoperative expenses. [CIT v Arihant Threads Ltd. (2011) 49 DTR 251 (P&H)].
14. Income received on account of affirmative voting on a resolution is capital receipt: Amount
received by assessee for affirmative voting on a resolution was not a business receipt, but received as
bounty or wind fall for voting affirmatively and supporting a resolution and was a capital receipt.
Amount received by Assessee as casual receipt in the nature of windfall and not repetitive in character
would not amount to income and therefore, not liable to tax. [CIT v David Lopes Menezes (2010)
195 Taxman 131: (2010) Vol 112 (10) Born LR 4655].
15. Difference on account of exchange rate fluctuation on remittance of share capital raised abroad
is capital receipt: Where a company raised share capital abroad by way of global depository receipts
and remitted the proceeds to India only on requirement, the entire difference on account of exchange
rate fluctuation was in the nature of capital receipt and not chargeable to tax. [CIT v Jagatjit
Industries Ltd. (2011) 337 ITR 21 (Del)].
16. Subsidy received with reference to capital investment, is a capital receipt: Subsidy received for
setting up agro based industrial unit in backward area was determined with reference to capital
investment, is a capital receipt. [CIT v Siya Ram Garg (HUE) (2011) 49 DTR 126 (P&H)].

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CIT v. Vazir Sultan & Sons
IN THE SUPREME COURT OF INDIA
Assessment Year: 1951-1952
Decided On: 20.03.1959
Appellants: Commissioner of Income Tax, Hyderabad-deccan Vs.
Respondent: Vazir Sultan & Sons
Hon'ble Judges/Coram:
B.P. Sinha, J.L. Kapur and N.H. Bhagwati,
The facts leading up to this appeal may be stated as follows :
1. The assesses is a registered firm consisting of five brothers and the wife of a deceased brother
having equal shares in the profit and loss of the partnership. The firm was appointed (without
drawing a written agreement) the sole selling agents and sole distributors for the Hyderabad
State for the cigarettes manufactured by M/s. Vazir Sultan Tobacco Co., Ltd.in 1931, and that
they were allowed a discount of 2% on the gross selling price." In 1939 another arrangement
was arrived at between the assesses and the company whereby the assesses was given a
discount of 2% not only on the goods sold in the Hyderabad State but on all the goods sold in
the Hyderabad State and outside Hyderabad State. It does not appear that the board of directors
passed any resolution in support of this new arrangement nor was any agreement drawn up
between the parties incorporating the said new arrangement.
2. On June 16, 1950, the board of directors passed the following resolution reverting to the old
arrangement embodied in the resolution dated January 6, 1931, and resolved that payment of
a sum of Rs. 2,26,263 be made to Vazir Sultan & Sons by way of compensation. Since Vazir
Sultan &Sons,wastopayRs6920to D. B. Akki & Co., out of that amount also by way of
compensation, the sum of Rs. 2,19,343 was accordingly received by the assesses.
3. The Income-tax Officer included this sum in the assessee's total income and taxed it as a
revenue receipt.
4. On appeal the Appellate Assistant Commissioner held that the sum of Rs. 2,19,343 was not a
revenue receipt but a capital receipt being compensation for the loss of the agency and as such
not liable to tax.
5. The Income-tax Officer thereupon preferred an appeal to the Income-tax Appellate Tribunal,
Bombay, which held that the said sum received by the assesses was a revenue receipt and
liable to tax.

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6. The assesses then applied to the Appellate Tribunal for a reference to the High Court under
section 66(1) of the Income-tax Act and the Tribunal accordingly referred the following
question of law to the High Court : "Whether the sum of Rs. 2,19,343 received by the assesses
firm from Vazir Sultan Tobacco Co., Ltd., is a revenue receipt or a capital receipt?"
7. The High Court answered the question in favor of the assesses stating the question in a
different form “Whether the sum of Rs. 2,19,343 received by the assesses firm from Vazir
Sultan Tobacco Co., Ltd., is liable to be taxed under the Indian Income-tax Act ?"
8. The appellant thereafter applied to the High Court for a certificate of fitness which was
granted by the High Court on February 21, 1955, and hence this appeal.
9. The question that needs to be determined is whether the sum mentioned in the resolution by
way of "compensation" for the loss of the agency was a revenue receipt (trading receipt or an
income receipt) as contended by the Revenue or a capital receipt as contended by the assesses
ie the court has got to determine what is the true character of the receipt in this case.
JUDGMENT : Bhagwati, J. and Sinha
10. This appeal with a certificate from the High Court of Judicature at Hyderabad raises the
question whether the sum of Rs. 2,19,343 received by the assesses in the year of account
relevant for the assessment year 1951-52 was a revenue receipt or a capital receipt.
11. It was urged on behalf of the appellant that the sole selling agency which was granted by the
company to the assesses in the year 1931 was merely expanded as regards territory in 1939
and what was done in 1951 was to revert to the old arrangement, and the structure or the
profit- making apparatus of the assessee's business was not affected thereby. The expansion
as well as the restriction of the assessee's territory were in the ordinary course of the assessee's
business and were mere accidents of the business which the assesses carried on and the sum
of Rs. 2,19,343 received by the assesses as and by way of compensation for the restriction of
the territory was a trading or an income receipt and was therefore liable to tax.
12. It was, on the other hand, contended on behalf of the assesses that it did not carry on business
of acquiring and working agencies, that the agency acquired in 1931 was a capital asset of the
assessee's business of distributing Charminar cigarettes in the Hyderabad State, that the
expansion of territory outside the Hyderabad State in 1939 was an accretion to the capital
asset already acquired by the assesses, that the resolution of 1950 was in substance a
termination or cancellation of the agency qua territory outside the Hyderabad State and
resulted in the sterilisation of the capital asset qua that territory, that the sum of Rs. 2,19,343
received by the assesses in the year of account was by way of compensation for the
termination or cancellation of the agency outside Hyderabad State and being therefore
compensation for the sterilisation pro tanto of a capital asset of the assessee's business was a
capital receipt and was therefore not liable to tax.
13. As to whether a particular receipt in the hands of an assesses is a capital receipt or a revenue
receipt, the court had occasion to consider the same in Commissioner of Income-tax v. South
India Picture Ltd. The assesses there carried on the business of distribution of films. In some

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instances the assesses used to produce or purchase films and then distribute the same for
exhibition in different cinema halls and in other cases used to advance monies to producers
of films produced with the help of monies so advanced. In the course of such business it
advanced monies to the Jupiter Pictures for the production of these films and acquired the
rights of distribution of the three films under three agreements in writing dated September,
1941, July, 1942, and May, 1943. In the accounting year ending March 31, 1946, and in the
previous years the assesses had exploited its rights of distribution of the three pictures. On
October 31, 1945, the assesses and the Jupiter Pictures entered into an agreement canceling
the three agreements relating to the distribution rights in respect of the three films and in
consideration of such cancellation the assesses was paid Rs. 26,000 in all by the Jupiter
Pictures as compensation. It was held by the majority of this court that the sum received by
the assesses was a revenue receipt (and not a capital receipt) assessable under the Indian
Income-tax Act in as much as :
(1) the sum paid to the assesses was not truly compensation for not carrying on its
business but was a sum paid in the ordinary course of business to adjust the relation
between the assesses and the producers of the films,
(2) one could not say that the cancelled agreements constituted the frame work or
whole structure of the assessee's profit-making apparatus.
14. The criteria laid down by the majority judgment for determining whether the particular payment
received by the assesses was income or was to be regarded as a capital receipt were :
(i) whether the agreements in question were entered into by the assesses in the course
of carrying on its business of distribution of films, and
(ii) whether the termination of the agreements in question could be said to have been
brought about in the ordinary course of business;
15. so that money received by the assesses as a result of or in connection with such termination of
agreements could be regarded as having been received in the ordinary course of its business and
therefore a trading receipt.
16. Therefore, when a question arises whether a payment of compensation for termination of an agency
is a capital or a revenue receipt, it would have to be considered whether the agency was in the nature
of capital asset in the hands of the assesses, or whether it was only part of his stock-in- trade. In Barr
Crombie & Sons Ltd. v. Commissioners of Inland Revenue, the agency was found to be practically
the sole business of the assesses, and the receipt of compensation on account of it was accordingly
held to be a capital receipt, while in Kelsall's case the agency which was terminated was one of several
agencies held by the assesses and the compensation amount received therefore was held to be a
revenue receipt, and that was also the case in Commissioner of Income-tax v. South India Pictures
Ltd.
17. In the case before us the agency agreement in respect of territory outside the Hyderabad State was as
much an asset of the assessee's business as the agency agreement within the Hyderabad State and
though expansion of the territory of the agency in 1939 and the restriction thereof in 1950 could very

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well be treated as grant of additional territory in 1939 and the withdrawal thereof in 1950, both these
agency agreements constituted but one employment of the assesses as the sole selling agents of the
company. There is nothing on the record to show that the acquisition of such agencies constituted the
assessee's business or that these agency agreements were entered into by the assesses in the carrying
on of any such business. The agency agreements in fact formed a capital asset of the assessee's
business worked or exploited by the assesses by entering into contracts for the sale of the Charminar
cigarettes manufactured by the company to the various customers and dealers in the respective
territories. This asset really formed part of the fixed capital of the assessee's business. It did not
constitute the business of the assesses but was the means by which the assesses entered into the
business transactions by ways of distributing those cigarettes within the respective territories. It really
formed the profit-making apparatus of the assessee's business of distribution of the cigarettes
manufactured by the company. If it was thus neither circulating capital nor stock-in- trade of the
business carried on by the assesses it could certainly not be anything but a capital asset of its business
and any payment made by the company as and by way of compensation for terminating or cancelling
the same would only be a capital receipt in the hands of the assesses.
18. If both the agency agreements, viz., one for the territory within the Hyderabad State and the other for
the territory outside Hyderabad State, had been terminated or cancelled on payment of compensation,
the whole profit-making structure of the assessee's business would have been destroyed. Even if one
of these agency agreements was thus terminated, it would result in the destruction of the profit-
making apparatus or sterilisation of the capital asset pro tanto and if in the former case the receipt in
the hands of the assesses would only be a capital receipt, equally would it be a capital receipt if
compensation was obtained by the assesses for the termination or cancellation of one of these agency
agreements which formed a capital asset of the assessee's business.
19. The facts of the present case are closely similar to those which obtained in the Commissioner of
Income-tax v. Shaw Wallace & Co. In that case also the assesses had for a number of years prior to
1928 acted as distributing agents in India of the Burma Oil Company and the Anglo-Persian Oil
Company, but had no formal agreement with either company. In or about the year 1927 the two
companies combined and decided to make other arrangements for the distribution of their products.
The assessee's agency of the Burma Company was accordingly terminated on December 31, 1927,
and that of the Anglo-Persian Company on June 30, following. Some time in the early part of 1928
the Burma Company paid to the assesses a sum of Rs. 12,00,000 "as full compensation for cessation
of the agency" and in August of the same year the Anglo-Persian Company paid them another sum
of Rs. 3,25,000 as "compensation for the loss of your office as agents to the company". On the facts
and circumstances of the case the Privy Council came to the conclusion that the sums could only be
taxable if they were the produce, or the result of, carrying on the agencies of the oil companies in the
year in which they were received by the assesses. But when once it was admitted that they were sums
received, not for carrying on that business, but as some sort of solatium for its compulsory cessation,
the answer seemed fairly plain. Whatever be the criticism in regard to the concept of income adopted
in this case noted earlier in this judgment, the decision could just as well be supported on the grounds
which we have hereinbefore discussed and was quite correct, the payments having been received by
the assesses as and by way of compensation for the termination or cancellation of the agency
agreements in question which were in fact the capital assets of the assessee's business.

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20. The Appellate Assistant Commissioner as well as the High Court were thus justified in the conclusion
to which they came, viz., that the sum of Rs. 2,19,343 received by the assesses from the company,
was a capital receipt.
21. The result, therefore, is that the appeal fails and will stand dismissed with costs throughout.
JUDGMENT : Kapur, J. (Dissenting)
22. I have had the advantage of perusing the judgment prepared by my learned brother Bhagwati, J., but
with great respect I am unable to agree and my reasons are these.
23. The sole question for determination in this case is as to whether a sum of Rs. 2,26,263 received by
the assesses from Vazir Sultan Tobacco Co. Ltd. as compensation for the termination of their agency
for the distribution of Charminar cigarettes in areas of India other than Hyderabad State is or is not
taxable in the hands of the assesses. The answer to this question depends on whether the amount has
been received by the assesses as a capital or a revenue receipt. In 1931 the assesses were appointed
distributing agents for Hyderabad State only and for the rest of India in 1939, the agency commission
in each case being a discount of 2% on the gross selling price. The agency of 1939 was terminated
by a resolution dated June 16, 1950, on payment of the compensation amount already mentioned but
the assesses continued to be distributors for Hyderabad State. It must here be mentioned that the
agency in question was terminable at will, and that any compensation paid for it would prima facie
be revenue.
24. During the accounting year the amount of income, profits and gains of the assesses from the cigarette
distribution business and from another source, i.e., Acid Factory within the State of Hyderabad, was
Rs. 4,53,159. The order of the Income-tax Officer or the Appellate Tribunal does not show how much
of this sum was attributable to the cigarette distribution business and how much to the other source.
There is no finding as to how and to what extent, if any, the business outside that State.
25. The question now arises did the assesses receive the compensation in lieu of the commission they
otherwise might or would have earned if the agreement had continued or did they receive it as
compensation for the destruction of a profit making asset. The answer to this question would again
be dependent upon whether the receipt in question is attributable to a fixed capital asset or to
circulating capital. These two terms have been used in a number of cases but as applied to agencies
compensation will be a capital receipt if it is brought to sale. On the other hand it is revenue receipt
if it is paid in lieu of profits or commission. In Van Den Berghs Ltd. v. Clark Lord Macmillan
described circulating capital as "capital which is turned over and in the process of being turned over
and in the process of being turned over yields profit or loss. Fixed capital is not involved directly in
that process and remains unaffected by it". As was said by Lord Macmillan in the same case, it is not
possible to lay down any single test as infallible or any single criterion as decisive in the determination
of the question. Ultimately it must depend upon the facts of a particular case.
26. One test is whether the agreement related to the whole structure of the recipient's profit-making
apparatus and affected the whole conduct of his business or was the loss of a part of the fixed
framework of the business. If it is, it is capital (Van Den Berghs' case). But compensation for
temporary and variable elements of the recipient's profit-making apparatus would be revenue
(MacDonald's case). If the agreement affects the whole structure and character of the recipient's

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business then it is capital but not if the structure of the business is so designed as to absorb the shocks
as by the cancellation of one agency (Kelsall Parsons' Case). So the decision as to whether
compensation was capital or revenue would depend upon whether the cessation of the agency destroys
or materially cripples the whole structure of the recipient's profit-making apparatus or whether the
loss is of the whole or part of the framework of business.
27. If we apply these tests to the agreement which has been terminated in the present case, it does not fall
in any of the class of cases of destruction of a capital asset.
28. Also the learned Judge observed that compensation paid on the cancellation of a trading contract
differs in character from compensation paid for cancellation of an agency contract therefore
considerations applicable to agency contracts were different to trading contracts, because the two
classes of contracts were essentially different. The receipt from trading contracts were revenue and
not essentially but receipts from agency contract may take any character ie capital or revenue. The
fact is that an agency contract which has the character of a capital asset in the hands of one person
may assume the character of a trading receipt in the hands of another. The court there observed that
when the assesses holds a number of agencies, the compensation paid for cancellation of any of them
could be regarded as revenue receipt. This is inconsistent with the conclusion that an agency contract
must always be regarded as a capital asset.
29. As a matter of fact there are three kinds of cases of agencies shown by the decided cases :(1) Kelsall
Parsons' case where the recipient was carrying on several agencies and the test laid down was whether
the business structure could absorb a shock of the termination of one. (2) The other is where the
compensation is for a temporary and variable element of assessee's profit making apparatus :
MacDonald' case
30. The third class of cases is represented by Fleming & Co.'s case where the rights and advantages
surrendered were such as to destroy or materially cripple the whole structure of the profit making
apparatus.
31. The agreement which is now before us and which was surrendered was terminable at will. The amount
of profit which the assesses made from working the agency contract in Hyderabad State alone was
much more than the amount which the assesses received for the termination of the whole of their
agency outside the State. Thus it is clear that the termination did not affect the trading activities of
the assesses and therefore the termination of the contract viewed against the background of the
assesses' business organisation and profit-making structure appears to be no more than compensation
for the loss of future profit and commission. The true effect of the facts of this case appears to be this
that in 1939 the assesses' area of distribution was increased from the State of Hyderabad to the whole
of India and in 1950 it was again reduced to the original area of 1931. The assesses never lost their
agency. As a result of this contraction of area they at the most have lost some agency commission.
The compensation therefore was in the nature of surrogatum and in this view of the matter it is
revenue and not capital.
32. I would therefore allow this appeal with cost throughout.
ORDER

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33. In accordance with the majority judgment of the court, the appeal is dismissed with costs throughout.

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E. Scope of Total Income and Incidence of Taxation
Meaning and Scope of Total Income:
Section 4 of the Act imposes a charge of tax on the total or taxable income of the assessee.
The meaning and scope of the expression of total income is contained in Section 5.
The total income of an assessee cannot be determined unless we know his residential status in India during
the previous year. The scope of total income, and consequently the liability to income-tax, depends upon the
following facts:
14. whether the income accrues or is received in India or outside,
15. the exact place and point of time at which the accrual or receipt of income takes place, and
16. the residential status of the assessee.
Scope of Total Income has been defined on the basis of Residential Status:
(A) Resident and Ordinarily Resident Assessee
According to Sub-section (1) of Section 5 of the Act the total income of a resident and ordinarily resident
assessee would consist of:
(i) income received or deemed to be received in India during the accounting year by or on behalf
of such person;
(ii) income which accrues or arises or is deemed to accrue or arise to him in India during the
accounting year;
(iii) income which accrues or arises to him outside India during the accounting year.
It is important to note that under clause (iii) only income accruing or arising outside India is included. Income
deemed to accrue or arise outside India is not includible.

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(B) Resident but Not Ordinarily Resident In India
According to Proviso to sub-section (1) of Section 5 the total income in case of resident but not ordinarily
resident in India would consist of:
(i) income received or deemed to be received in India during the accounting year by or on behalf of such
person;
(ii) income which accrues or arises or is deemed to accrue or arise to him in India during the accounting year;
(iii) income which accrues or arises to him outside India during the previous year if it is derived from a
business controlled in or a profession set up in India.
(C) Non-Resident
Sub-section (2) of Section 5 provides that the total income of a non-resident would comprise of:
(i) income received or deemed to be received in India in the accounting year by or on behalf of such
person;
(ii) income which accrues or arises or is deemed to accrue or arise to him in India during the previous
year.
Explanation 1. – Income accruing or arising outside India shall not be deemed to be received in India within
the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared
in India.
Explanation 2. – For the removal of doubts, it is hereby declared that income which has been included in the
total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to
him shall not again be so included on the basis that it is received or deemed to be received by him in India.
Place and Date of Receipt of Income:
The place and date of receipt of income are two important factors for levying tax. When the amount is
received in cash and directly from the debtor, there is no difficulty in deciding the place and date of receipt.
But when the payment is made by cheque or by post, the place and date of receipt is determined as follows:
(i) Date of receipt when receipt is by cheque

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If the payment is made by the drawee on presentment of the cheque, the date of receipt of the cheque and
not the date of its encashment shall be the date of receipt.
(ii) Place of receipt when payment is made by cheque and by post
In this case, if the Post Office is the agent of the creditor, the place of posting by the debtor shall be regarded
as the place of receipt by the creditor. If, on the other hand, there is no specific understanding that the
payment is to be made by post, the place of receipt by the creditor would be the place of receipt.
(iii) Place of receipt when receipt is through a Postal Money Order, or by Insured Post
In this case, the place of receipt is to be determined on the basis of who (creditor or debtor) bears the
postal expenses. If the postal expenses are borne by the creditor, the place of debtor would be place of
receipt. If, on the other hand, the debtor bears the postal expenses, the place of creditor would be the place
of receipt.
(iv) Date and place of receipt in case of articles sent by V.P.P.
In this case the place of the delivery by the Post Office would be the place of receipt and the date of receipt
would be the date of payment by the buyer.
(v) Payment by transfer of immovable property
Whenever any immovable property is accepted in satisfaction of a claim, the date of receipt would not be
the date when possession is given but the date of receipt would be when a conveyance is executed.
(vi) Issuing receipt in advance
When a receipt is issued in advance but the payment is not received during the accounting year, it cannot be
treated as receipt during the accounting year when the receipt is issued.
Income Received in India:
Income received in India is taxable regardless of the assessee’s residential status.
Receipt (first occasion on which the recipient gets money under his own control) is distinguished from
remittance / subsequent dealings by the assessee of the amount in question.
(i) The receipt contemplated for this purpose refers to the first receipt of the amount in question
as the income of the assessee.

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For instance, if A receives his salary at Delhi and sends the same to his father, the salary income of
A is a receipt for tax purposes only in the hands of A; his father cannot also be said to have received
income when he/she receives a part of the income of A. In the hands of A’s father it is only a receipt
of a sum of money but not a receipt of income.
(ii) Method of Accounting: Although receipt of income is not the sole test of its taxability, the
receipt of income would be the primary basis for determining the taxability of the amount in cases
where the assessee follows the cash system of accounting; however, where the assessee follows the
mercantile system of accounting, the income would become taxable as the income of the
accounting year in which it falls due to the assessee regardless of the date or place of its actual
receipt.
(iii) While considering the receipt of income for tax purposes both the place and the date of its
receipt must be taken into account. The income in question should be not only received during
the accounting year relevant to the assessment year but must also be received in India in order to
constitute the basis of taxation. Thus, if an item of income is first received outside India and after a
few years is brought into India, the subsequent receipt of the same amount in India should not be
taken as the basis of taxing the same since the same income cannot be received twice and it will be
known as Remittances.
(iv) For the purpose of taxation, both actual and constructive receipt must be taken into account.
Receipt by some other person on behalf of the assessee should be treated as receipt by the assessee
for being taxed in his hands.
(v) The question of taxability of a particular income received by the assessee depends upon the
nature of income. For instance, income from salaries and interest on securities would attract liability
to tax immediately when it falls due to the assessee, regardless of its actual receipt by or on behalf
of the assessee.
Income deemed to be received in India:
In addition to the income actually received by the assessee or on his behalf, certain other incomes not
actually received by the assessee and/or not received during the relevant previous year, are also
included in his total income for income tax purposes. Such incomes are known as income deemed
to be received. Some of the examples of such income are:
(i) All sums deducted by way of taxes at source (Section 198).
(ii) Incomes of other persons which are included in the income of the assessee under Sections 60 to
64.

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(iii) The amount of unexplained or unrecorded investments (Section 69).
(iv) The amount of unexplained or unrecorded moneys, etc. (Section 69A).
(v) The annual accretion in the previous year to the balance standing at the credit of an employee
participating in a Recognised Provident fund to the extent provided in Rule 6 of Part A of the Fourth
Schedule [Section 7(i)]. The contributions made by the employer to Recognised Provident Fund in
excess of 12% of the employees salary and the interest credited to the Provident Fund account of the
employee in excess of the prescribed rate shall be included in the salary income of the employee. This
amount is known as annual accretion.
(vi) The transferred balance in a Recognised Provident Fund to the extent provided in Rule 11(4) of
Part A - Fourth Schedule [Section 7(ii)].
When provident fund is recognised for the first time in a particular year, the existing balance to the
credit of an employee on the date of recognition, which is carried into the recognised provident fund,
is called the transferred balance. The amount of the transferred balance, less the employees own
contributions included therein, is deemed to be the income of the year in which recognition takes
place. The amount contributed by the employer to the provident fund and the interest on his
contribution is included in the income under the head Salaries and the interest on the contributions
made by the employee is included in the income under the head “Income from other sources”.
(vii) Any dividend declared by a Company or distributed or paid by it within the meaning of Section
2(22) [Section 8(a)].
(viii) Any interim dividend unconditionally made available by the Company to the member who is
entitled to it [Section 8(b)].
(ix) The Supreme Court verdict in Standard Triumph Motor Co. Ltd. v. CIT (1993) 201 ITR 391,
seems to have made the lot of non-residents, in particular, more vulnerable. The Court in that case
held that a credit entry in the books of the buyer of goods or services in favour of the supplier of
goods or services tantamount to receipt of money by the latter. By equating credit entry with receipt
itself the judgment exposes non-residents to Indian tax liability where they were not all along liable
on the basis of mere credit entry. Because a resident is in any case liable to tax on his world income
and therefore this judgment affects a non-resident more than it affects a resident.
Income accrued in India:
The accrual of income is different and distinct from the receipt of income discussed above. Sometimes in the
context of accrual or arisal the word earned is used. A person may be said to have earned his income in the

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sense that he/she has contributed to the production by rendering of goods or services. But in order that the
income may be said to have accrued to him, an additional element is necessary, that is, he/she must have
created a debt in his favour.
Income is said to accrue when it comes into existence for the first time or at the point of time when the
right to receive the income arises although the right may be exercised or exercisable at a future date.
Income is said to be received when it reaches the assessee. When the right to receive the income becomes
vested in the assessee, it is said to accrue or arise.
Income is said to accrue only to that person who is lawfully entitled to that income.
Income accrues at the place where the source of the income is situated, which may or may not be the same
as the place from which the business activities are carried on. Normally, income accrues at the place where
the contract yielding the income is entered into and for this purpose the contract should be taken to have been
entered into at the place where the offer is accepted.
Determining the place of accrual:
v Composite business which comprises manufacturing, sale, export and import activities –
apportionment and attribution.
v In a transaction involving sale of goods the place of accrual is where property in the goods passes
from seller to buyer
v If the seller maintains control over the goods sold by taking bill of lading in his name and stipulates
that the property in the goods would only pass at the destination (which happens to be outside India),
where do the profits accrue or arise?
As already stated, the total income in the case of any non-resident assessee consists of:
(a) income received or deemed to be received in India, regardless of the place of its accrual, and
(b) income which accrues or is deemed to accrue in India regardless of the place of its receipt.
Thus, the accrual of income as the basis of taxation is more important in the case of non-residents
than all other classes of assessees. Accordingly, a non-resident partner of a resident partnership firm
carrying on its business outside India is taxable in India on the entire amount of his share of the firms
income from its foreign business; such a partner cannot claim tax exemption in respect of even a part
of his share of the firm’s income corresponding to the firms foreign income. This is because of the
fact that, so far as the partner is concerned, the source of his income (i.e., his share in firms profits)
is situated in India (as the firm is resident in India) and the income consequently arises in India.

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Income deemed to accrue or arise in India:
According to Section 9 of the Act, certain incomes are deemed to accrue or arise in India which are discussed
below:
(a) Income by virtue of business connection
– Income arising through or from business connection to any assessee is deemed to accrue or arise
in India where a business connection actually exists whether with or without a regular agency, branch
or other type of commercial association.
– For purposes of deeming income to accrue or arise in India, the expression ‘business connection’
must be taken to have wider scope than what is commonly understood by it. It is entirely different
from the carrying on of a business although business connection may have some direct or indirect
relationship with the business carried on.
– The Supreme Court has held that business does not necessarily mean trade or manufacture only, it
is being used as including within its scope professions, vocations and callings [Barendra Prasad Ray
and Others v. I.T.O. (1981) ITR, p. 295].
– If income accrues to any person outside India by virtue of his business connection in India, whether
directly or indirectly, that income must be deemed to accrue or arise in India for purposes of income-
tax assessment.
– In cases where all the operations or activities of a business are not carried on in India, but, income
arises by virtue of a business connection in India, the income which is deemed to accrue or arise in
India should be taken to be only that part which could reasonably by attributed to the operations
carried on in India. Rule 10 of the Income-tax Rules contains the basis on which the income
attributable to the operations carried out in India could be deemed to accrue or arise in India.
– However, where a substantial part of a non-resident’s output is sold in the Indian market through
brokers to various customers in India, or is merely engaged in rendering of services outside India to
a person carrying on business in India, it does not amount to a business connection in India.
– Similarly, where an Indian exporter selling goods through non-resident selling agents, receives sale
price in India, credits commission on sales to non-resident agents in his books of account and remits
the amount to them later, such commission to non-residents is neither received or deemed to be
received in India nor deemed to accrue or arise in India [C.I.T. v. Toshoku Ltd. (1980) 125 ITR p.
525 (S.C.)].

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The Meaning of Business Connection:
The expression business connection includes:
(i) the maintenance of a branch office, factory, agency, receivership, management or other
establishment for the purchase or sale of goods or for transacting any other business;
(ii) the erection of a factory where the raw products purchased locally are processed or converted
into some form suitable for export outside India;
(iii) appointing an agent or agents in India for the systematic and regular purchase of raw materials
or other commodities or for the sale of the non-residents goods, or for any other purpose;
(iv) the formation of a close financial association between a resident and a non-resident company
which may or may not be related to one another as a holding and subsidiary company;
(v) the formation of a subsidiary company to sell or otherwise deal with the products of the non-
resident parent company;
(vi) the grant of a continuing licence to a non-resident for the purpose of exploitation for profit of
an asset belonging to the non-resident even though the transaction in question may be treated
as an out and out sale by the parties concerned.
No Business connection in India in following cases of Non-Resident:
(1) Tax Exemption for encouraging Export:
– For the purpose of encouraging exports, a specific tax concession has been given by providing that
no income shall be deemed to accrue or arise in India to a non-resident through or from his operations
which are confined to the purchase of goods in India for the purpose of export.
– This exemption is available to anon-resident even though he/she keeps an office agency for the
purpose of buying and export. This exemption is, however, not available to residents or not ordinarily
residents.
– In order to qualify for tax exemption, it is essential that the operations of the non- residents,
although arising from business connection, should be confined to the purchase of goods for the
purpose of export outside India.
– Consequently, the exemption would not be available if the goods purchased in India are sold in
India or are not exported outside India.
– Further, if the non-resident works up the raw-materials into finished or semi-finished products, the
exemption would be withdrawn and he/she would become chargeable on such portion of the profits
as is attributable to his manufacturing it in India.

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(2) Operations confined to collection of news and views for transmission outside India by or on behalf
of Non Resident who is engaged in the business of running news agency or of publishing newspapers,
magazines or journals;
(3) Operations confined to shooting of cinematograph films in India if such Non-Resident is:
(a) an Individual – he/she should not be a citizen of India; or
(b) a firm – the firm should not have any partner who is a citizen of India or who is resident in India;
or
(c) a company – the company does not have any shareholder who is a citizen of India or who is
resident in India
Principles of Business Connection
There are various factors, which need to be kept under consideration while determining whether a
BC exists in a particular situation, or not. The landmark judgment of the Andhra Pradesh High
Court(G V K Industries Ltd v ITO reported in [1997] 228 ITR 564)compiles the ratios of various
other judgments and lays down the following principles of BC:
(i) Whether there is a BC between an Indian person and a non-resident is a mixed question of fact
and law which has to be determined on the facts and circumstances of each case;
(ii) The expression 'BC' is too wide to admit of any precise definition; however it has some well
known attributes;
(iii)The essence of 'BC' is the existence of close, real, intimate relationship and commonness of
interest between the non-resident and the Indian person;
(iv) Where there is control or management or finances or substantial holding of equity shares or
sharing of profits by the non-resident of the Indian person, the requirement of principle (iii) is
fulfilled;
(v) To constitute 'BC' there must be continuity of activity or operation of the nonresident with the
Indian party and a stray or isolated transaction is not enough to establish a BC.
Anglo French Textile Co Ltd v CIT reported in [1953] 23 ITR 101 (SC)
A Ltd, a company incorporated in the UK, owned a spinning and weaving mill at Pondicherry. A Ltd
had appointed another company in Madras as its constituted agent for the purpose of its business in
India. In a particular assessment year, A Ltd had not made any sales of yard or cotton manufactured
by it in India, but all purchases of cotton required for the factory at Pondicherry were made by the
agents in Madras and no purchases were made through any other agency. The question under

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consideration was whether A Ltd could be said to have a BC in India. In this case, the Supreme Court
held that:
The activity performed by the Madras entity for A Ltd was not in the nature of an isolated transaction
of purchase of raw materials. In this case, a regular agency was established in Madras for the purchase
of the entire raw materials required for the manufacture abroad and the agent was chosen by reason
of his skill, reputation and experience in the line of trade. The terms of the agency fully establish that
the entity in Madras was carrying on an activity almost akin to the business of a managing agency in
India of the foreign company and the latter certainly had a connection with the agency.
When there is a continuity of business relationship between the person in Madras who helps to make
the profits and the person outside Madras who receives or realizes the profits, such relationship does
constitute a business connection. [EMPHASIS PROVIDED].
CIT v. R. D. Aggarwal & Co., 56 ITR 20 (SC)
R Ltd, a company located in Amritsar, carried on business as importers and commission agents of
non-resident exporters. R Ltd communicated orders canvassed by them from dealers in Amritsar to
the non-residents for acceptance. If a contract resulted and price for goods purchased was paid by the
Amritsar dealer to the non-resident exporters, the assessees became entitled to commission varying
between 1.5% to 2.5% of the price. R Ltd carried out its activities as sole agents of certain non-
resident exporters and as representatives for certain other non-resident exporters. The issue was
whether the relationship between R Ltd and the non-resident exporters could be regarded as a BC.
In this case it was held that none of the activities of the non-resident exporters, such as procuring raw
materials, manufacturing, sale or delivery of goods took place in India. R Ltd merely procured orders
from merchants in Amritsar for purchase of goods from the non-residents. R Ltd did not have the
authority to even accept the offers on behalf of the non-residents.
Some commercial activity was undoubtedly carried on by the assessees in the matter of procuring
orders, which resulted in contracts for sale by the non-residents of goods to merchants at Amritsar.
Hence, this could in no way result in a BC of R Ltd with the non-residents within India.
(b) Income arising from any asset or property in India:
– Income arising in a foreign country from any property situated in India would be deemed to accrue
or arise in India.
– In this context, the term property does not refer to house property alone but it refers to all tangible
properties whether movable or immovable. For instance, the rent or hire charges for the use of
buildings or machinery of the assessee which, under an agreement are payable only outside India,
would be deemed to accrue or arise in India.

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– Income arising through or from any asset or source of income in India would also be deemed to
accrue or arise in India.
– In this context, the term source means not a legal concept but something which a practical man
would regard as a real source of income.
– The term property does not refer to the property dealt with by Sections 22 and 23, but it includes
any tangible movable or immovable property. The term asset would, however, include all intangible
rights and, consequently, interests, dividends, patents and copyrights, royalties, rents etc. will be an
Income from assets.
(c) Capital asset:
– Capital gains arising to an assessee from the transfer of a capital asset situated in India would be
deemed to accrue or arise in India irrespective of the fact whether the capital asset in question
represents a movable or immovable property or a tangible or intangible asset.
– It is also immaterial whether the consideration for the transfer of the capital asset is actually paid
or payable in India or outside.
– The place of registration of the document of transfer of property is equally immaterial.
– However, if the capital asset, prior to the transfer, is situated outside India, the provisions of
Section9(1) would not apply to deem the capital gains arising on the transfer as accruing or arising in
India for purposes of its taxation in India.
(d) Income from salaries:
– Income which is chargeable under the head Salaries is deemed to accrue or arise in India in all
cases when earned in India. For this purpose income is said to be earned in India if the services are
rendered in India.
– The actual place of accrual of the salaries, the residential status of the employer, the citizenship or
nationality of the employee and whether the employee is a Government servant or an employee of
private enterprise are immaterial.
– However, under Sub-section (2) of Section 9, any pension payable outside India to a person
residing permanently outside India should not be deemed to accrue or arise in India if the pension is

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payable to civil servants and retired judges provided they were appointed before the 15th August,
1947 and continued to serve after the constitution came into operation.
– Barring this exception, non-residents and not ordinarily residents entitled to receive salary or
pension earned by them in India would be deemed to receive income which has accrued in India even
though the income may be actually accruing and received outside India.
– Income from salaries payable by the Government to a citizen of India outside India for his services
rendered outside India, is deemed to accrue or arise in India even though the income is actually
accruing outside India and is also received outside India. Thus, under this provision, salary income
of all Government servants, working outside India is deemed to accrue in India. In the absence of this
provision they would not be chargeable to tax in respect of such income as they would, after some
time, become non-residents.
– This provision to deem income as accruing in India applies only in respect of their income from
salary but not in respect of the allowances and perquisites to which they are entitled to while serving
in a foreign country.
– Section10(7) of the Income Tax Act, 1961 contains a specific provision to exempt government
servants from tax on their services in a foreign country partly to meet the higher cost of living in that
country.
– Salaries paid by the Indian Government in a foreign country to citizens of the foreign country
should not, however, be deemed to accrue in India since this provision applies only to Indian citizens
employed by the Government who are rendering service outside India.
(e) Taxability of Interest: Interest payable in following cases will be deemed to accrue or arise in India and
will be taxable in the hands of recipient irrespective of his residential status (i.e. ROR, RNOR or NR).
Interest payable by:
i. Government; or
ii. A Resident in India, except where interest is payable in respect of moneys borrowed and used for the
purpose of business or profession carried outside India or earning any income from any source outside
India (i.e. Interest payable by a Resident for loan used in India for any purpose, whether for business
or profession or otherwise);

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iii. A Non-Resident in India provided interest is payable in respect of moneys borrowed and used for a
business or profession carried on in India (i.e. Interest payable by a Non-Resident for loan used for
only business or profession in India)
(f) Taxability of Royalty: Royalty payable in following cases will be deemed to accrue or arise in India and
will be taxable in the hands of recipient irrespective of his residential status (i.e. ROR, RNOR or NR).
Royalty payable by:
(i) Government; or
(ii) A Resident in India except where it is payable in respect of any right/information/property used for the
purpose of a business or profession carried on outside India or earning any income from any source outside
India (i.e. Royalty payable by a Resident for right/information/property used for any purpose in India whether
business or profession or for earning other incomes);
(iii) A Non-Resident in India provided royalty is payable in respect of any right/information/property used
for the purpose of the business or profession carried on in India or earning any income from any source in
India (i.e. Royalty payable by a Non-Resident for right/information/property used for any purpose in
India whether business or profession or for earning other incomes)
(g) Taxability of Fees for Technical Services: Fees for technical services payable in following cases will
be deemed to accrue or arise in India and will be taxable in the hands of recipient irrespective of his residential
status (i.e. ROR, RNOR or NR).
Fees for technical services payable by:
(i) Government; or
(ii) A Resident in India except where services are utilized for the purpose of a business or profession
carried on outside India or earning any income from any source outside India (i.e. Fees for technical
services payable by a Resident for services utilised for any purpose in India whether business or
profession or for earning other incomes);
(iii) A Non-Resident in India provided fee is payable in respect of services for the purpose of a
business or profession carried on in India or earning any income from any source in India (i.e.
Fees for technical services payable by a Resident for services utilised for any purpose in India
whether business or profession or for earning other incomes);

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(h) Taxability of Dividend:
– Dividend paid by any Indian company outside India is deemed to accrue or arise in India and the
income is consequently chargeable to income-tax irrespective of the fact whether the dividend is
interim dividend or a final dividend and whether it is an actual dividend or a notional dividend.
– The place of declaration of the dividend is immaterial and the date of payment is equally immaterial
for deeming the income to accrue in India.
– Normally, dividend income arises at the place where the source of income is situated, i.e., where
the shares yielding the income are kept. Shares are said to be situated at the place where the share
register of the company is kept. While the share register of a company should ordinarily be kept at
the place where its registered office is located, even if the share register is kept outside India and the
dividends are declared outside India, the dividend would still be deemed to accrue in India because
the company is an Indian company. It is another matter that dividend paid/payable by Indian
companies has been exempted vide Section 10(34) with the introduction of the system of distribution
tax which has shifted the incidence of tax on dividend to the company from the shareholder.
– Dividends declared by foreign companies outside India would not, however, be deemed to accrue
or arise in India even in cases where the foreign company is resident in India because of the control
and management of its affairs being situated wholly in India.
– In order to deem the dividend income as arising in India, the residential status of the shareholder
as also the status of the assessee, whether he/she is an individual, company or local authority, are
irrelevant.
Indian and Foreign Income
Whether Income Whether income accrues or Status of income

received or deemed to arises or is deemed to accrue
be received in India or arise in India during the
during the relevant PY? relevant PY?
Yes Yes Indian Income
Yes No Indian Income
No Yes Indian Income
No No Foreign Income

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ROR NOR Non-Resident
Indian Income Taxable in India Taxable in India Taxable in India
Foreign Income
1. Business Income Taxable in India Taxable in India Wholly: Taxable in India

where business is
controlled wholly or Partly: Not Taxable in India
partly in India
2. Business Income Taxable in India Not taxable in India Not taxable in India
where business is
controlled outside India
3. Income from Taxable in India Taxable in India Not taxable in India

profession set up in India
4. Income from Taxable in India Not taxable in India Not taxable in India
profession set up outside
India
5. Other foreign income Taxable in India Not taxable in India Not taxable in India
such as salary, rent,
interest, etc.
Tax Incidence for any other tax payer
RESIDENT IN INDIA NON-RESIDENT
Indian Income Taxable in India Taxable in India
Foreign Income Taxable in India Not taxable in India

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Solved Problems
Q1. Mr. X earns the following income during the previous year ended 31st March, 2017. Determine the
income liable to tax for the assessment year 2017-18 if Mr. X is (a) resident and ordinarily resident in India,
(b) resident and not ordinarily resident in India, and (c) non-resident in India during the previous year ended
31st March, 2017.
– Profits on sale of a building in India but received in Holland- Rs. 20,000
– Pension from former employer in India received in Holland- Rs. 14,000
– Interest on U.K. Development Bonds (1/4 being received in India) - Rs. 20,000
– Income from property in Australia and received in U.S.A. - Rs. 15,000
– Income earned from a business in Abyssinia which is controlled from Zambia (` 30,000 received in India)
- Rs. 70,000
– Dividend on shares of an Indian company but received in Holland [not qualifying for exemption under
Section 10(34)] - Rs. 10,000
– Profits not taxed previously brought into India- Rs. 40,000
– Profits from a business in Nagpur which is controlled from Holland- Rs. 27,000

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Solution:
Computation of income liable to tax:
-~-
Q2. A had the following income during the previous year ended 31st March, 2017:
– Salary Received in India for three Months – Rs. 9,000
– Income from house property in India- Rs.13,470
– Interest on Saving Bank Deposit in State Bank of India- Rs.1,000
– Amount brought into India out of the past untaxed profits earned in Germany- Rs. 20,000
– Income from agriculture in Indonesia being invested there- Rs.12,350 – Income from business in
Bangladesh, being controlled from India- `10,150
– Dividends received in Belgium from French companies, out of which Rs. 2,500 were remitted to India-
Rs.23,000

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You are required to compute his total income for the assessment year 2017-18 if he/she is: (1) a resident; (ii)
a not ordinarily resident, and (iii) a Non-resident.
Solution:
Computation of total income of A is given below:
-~-
Q3. Mr. Y earns the following income during the previous year ended on 31st March, 2017. Determine the
income liable to tax for the assessment year 2017-18 if Mr. Y is (a) resident and ordinary resident (b) resident
and not ordinary resident, and (c) non-resident in India during the previous year ended on 31st March, 2017.
(i) Honorarium received from Government of India (Travelling and other incidental expenses of Rs.
7,000 were incurred in this connection)- Rs. 20,000
(ii) Profits earned from a business in Tamil Nadu controlled from Pakistan – Rs. 50,000
(iii) Profits earned from a business in U.K. controlled from Delhi- Rs. 30,000

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(iv) Profits earned from a business in U.S.A. controlled from Pakistan and amount deposited in a bank
there- Rs. 40,000 (v) Income from a house property in France, received in India- Rs. 10,000
(v) Past untaxed foreign income brought into India during the year- Rs. 25,000
(vi) Dividends from a German company credited to his account in Pakistan- Rs. 35,000
(vii) Dividends declared but not received from an Indian company- `20,000(ix) Agricultural income
from Burma not remitted to India- Rs. 40,000
(viii) Pension for services rendered in India, but received in Pakistan- Rs. 30,000
Solution:
Computation of Income liable to tax of Mr. Y is given below:

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F. Capital Gains
- When we buy any kind of property for a lower price and then subsequently sell it at a higher price,
we make a gain.
- The gain on sale of a capital asset is called capital gain. This gain is not a regular income like
salary, or house rent.
- It is a one-time gain; in other words the capital gain is not recurring, i.e., they do not occur again
and again periodically.
- Opposite of gain is called loss; therefore, there can be a loss under the head capital gain.
- We do not use the term capital loss, as it is incorrect.
- Capital Loss means the loss on account of destruction or damage of capital asset.
- Thus, whenever there is a loss on sale of any capital asset it will be termed as loss under the head
capital gain.
Ø The capital gain is chargeable to income tax if the following conditions are satisfied:
1. There is a capital asset.
2. Assessee should transfer the capital asset.
3. Transfer of capital assets should take place during the previous year.
4. There should be gain or loss on account of such transfer of capital asset.

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Ø CAPITAL ASSET
Capital Asset
Capital asset, as per section 2(14) of the Act, means property of any kind except the following:
a) Stock-in-trade, consumable stores or raw-materials held for the purpose of business or profession.
b) Personal effects, i.e., movable property (including wearing apparel and furniture, held for personal use by
the assessee or any member of his family dependent on him; But excludes: -
• Jewellery, which means,
i. Ornaments made of gold, silver, platinum or any other precious metal or any alloy containing one or
more of such precious metals, whether or not containing any precious or semi-precious stone, and
whether or not worked or sewn into any wearing apparel;
ii. Precious or semi-precious stones, whether or not set in any furniture, utensil or other article or worked
or sewn into any wearing apparel.
• Archaeological Collections
• Drawings
• Paintings
• Sculptures or
• Any work of arts
c) Agricultural land in India other than the following lands specified here:
• In any area which is comprised within the jurisdiction of a municipality (by whatever name
known) or a cantonment board and which has a population of not less than 10,000 according
to the last preceding census; or
• Land situated in any area around the above referred bodies upto a distance of 8 kilometers
from the local limits of any municipality or cantonment board referred to in item (a) above,
as the Central Government may, having regard to the extent of, and scope for, urbanisation of
that area and other relevant considerations, specify in this behalf.
d) the following bonds issued by the Central Government,
• 6 ½ per cent Gold Bonds, 1977,
• 7 per cent Gold Bonds,1980,
• National Defence Gold Bonds, 1980, and

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• Special Bearer Bonds, 1991,
e) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 notified by the Central Government.
Ø Will an agricultural land be treated as capital asset, in case it is located within 8 kilometers
from the local limits of a City Municipal Corporation, even though the same is not notified by
the Central Government under section 2(14)(iii)(b)?
CIT v. Madhukumar N. (HUF) (2012) 208 Taxman 394 (Kar.)
On this issue, the Karnataka High Court observed that, as per section 2(14), an agricultural land is not a
capital asset except in the following cases -
(a) when it is located within the jurisdiction of a municipality, etc., which has a population not less than
10,000 or
(b) when it is located within 8 kilometers from the local limit of a municipality, etc., mentioned in (a) above,
which is notified by the Central Government in this regard.
For an agricultural land to become a capital asset by virtue of (b) above, two conditions have to be satisfied
namely, the population of the municipality etc, should not be less than 10,000 and the same should be notified
by the Central Government.
Therefore, in case an agricultural land is situated within 8 kilometers from the local limit of a municipality,
etc. whose population is more than 10,000 but the same is not notified by the Central Government, the said
land would not be a capital asset and no capital gain tax would be attracted on its sale.
Ø Would sale of a plot of land held as stock-in-trade by an assessee engaged in the business of real
estate and construction of plots, be treated as sale of capital assets, to attract the provisions of
section 50C?
CIT v. Kan Construction and Colonizers (P) Ltd (2012) 208 Taxman 478 (All.)
On this issue, the Allahabad High Court observed that for applicability of section 50C, the essential
requirement is that the building and land transferred should be a capital asset.
Further, as per section 2(14), capital asset does not include stock-in-trade held for the purpose of an assessee’s
business or profession.
The Assessing Officer treated the sale of plot of land held by the assessee as sale of capital asset and
accordingly, applied the provisions of section 50C.

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The High Court held that since the assessee is a builder and construction of buildings is its business,
investment in purchase and sale of plots by it is ancillary and incidental to its business activity. Therefore, it
was held that the assessee has held the land as stock-in-trade and not as a capital asset.
Hence, section 50C will not apply in this case and the profit on sale of land will be treated a business income.
Ø TYPES OF CAPITAL ASSET:
There are two types of Capital Assets:
1. Short Term Capital Assets (STCA): An asset, which is held by an assessee for less than 36 months,
immediately before its transfer, is called Short Term Capital Assets. In other words, an asset, which is
transferred within 36 months of its acquisition by assessee, is called Short Term Capital Assets.
2. Long Term Capital Assets (LTCA): An asset, which is held by an assessee for 36 months or more,
immediately before its transfer, is called Long Term Capital Assets. In other words, an asset, which is
transferred on or after 36 months of its acquisition by assessee, is called Long Term Capital Assets.
The period of 36 months is taken as 12 months under following cases:
• Equity or Preference shares,
• Securities like debentures, government securities, which are listed in recognised stock exchange,
• Units of UTI
• Units of Mutual Funds

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• Zero Coupon Bonds
Long Term Capital Asset?
A simple definition for Long-term capital asset in relation to Taxation of Capital Gains is "A capital asset,
which is not a Short-Term Capital Asset".
Ø Types of Capital Gain:
The profit on transfer of STCA is treated as Short Term Capital Gains (STCG)while that on LTCA is known
as Long Term Capital Gains (LTCG).
While calculating tax the STCG is included in Total Income and taxed as per normal rates while LTCG is
taxable at a flat rate @ 20%.
Ø TRANSFER
Capital gain arises on transfer of capital asset; so it becomes important to understand what is the meaning of
word transfer. The word transfer occupies a very important place in capital gain, because if the transaction
involving movement of capital asset from one person to another person is not covered under the definition
of transfer there will be no capital gain chargeable to income tax. Even if there is a capital asset and there is
a capital gain.
The word transfer under income tax act is defined under section 2(47). As per section 2 (47) Transfer, in
relation to a capital asset, includes sale, exchange or relinquishment of the asset or extinguishments of any
right therein or the compulsory acquisition thereof under any law.
In simple words Transfer traditionally included:
• Sale of asset
• Exchange of asset
• Relinquishment of asset (means surrender of asset)
• Extinguishments of any right in asset (means reducing any right on asset)
• Compulsory acquisition of asset
• in a case where the asset is converted by the owner thereof into, or is treated by him as, stock-in-trade
of a business carried on by him, such conversion or treatment; or

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• the maturity or redemption of a zero-coupon bond; or
• any transaction involving the allowing of the possession of any immovable property to be taken or
retained in part performance of a contract of the nature referred to in section 53A of the Transfer of
Property Act, 1882 (4 of 1882); or
• any transaction (whether by way of becoming a member of, or acquiring shares in, a co-operative
society, company or other association of persons or by way of any agreement or any arrangement or
in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of,
any immovable property.
The definition of transfer included only above said five ways before 2012. It was retrospectively amended
by the Finance Act of 2012 and the definition was further broadened.
Explanation 2 : For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed
to have always included disposing of or parting with an asset or any interest therein, or creating any interest
in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or
involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise,
notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or
flowing from the transfer of a share or shares of a company registered or incorporated outside India.

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Ø Computation of Capital Gains:
The capital gain can be computed by subtracting the cost of capital asset from its transfer price, i.e.,
the sale price. The computation can be made by making a following simple statement:
Statement of Capital Gains
Particulars Amount
Full Value of Consideration ----------

Less: Cost of Acquisition*(COA) -----------
Cost of Improvement*(COI) -----------
Expenditure on transfer -----------
Capital Gains -----------
Less: Exemption U/S 54 -----------
Taxable Capital Gains -----------
* To be indexed in case of LTCA -----------
Ø Full Value of Consideration:
Full value of consideration means & includes the whole/complete sale price or exchange value or
compensation including enhanced compensation received in respect of capital asset in transfer. The following
points are important to note in relation to full value of consideration.
• The consideration may be in cash or kind.
• The consideration received in kind is valued at its fair market value.
• It may be received or receivable.
• The consideration must be actual irrespective of its adequacy.
Ø Cost of Acquisition:
Cost of Acquisition (COA) means any capital expense at the time of acquiring capital asset under transfer,
i.e., to include the purchase price, expenses incurred up to acquiring date in the form of registration, storage
etc. expenses incurred on completing transfer.

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In other words, cost of acquisition of an asset is the value for which it was acquired by the assessee. Expenses
of capital nature for completing or acquiring the title are included in the cost of acquisition. The Cost Inflation
Index (CII) has a major role to play in the calculation of COA.
Indexed Cost of Acquisition = COA x [CII of Year of transfer / CII of Year of acquisition]
Indexed Cost of Improvement = Cost of Improvement x [CII of Year of Transfer / CII of Year of
Improvement]
Ø If capital assets were acquired before 1.4.81, the assessees have the option to have either actual cost
of acquisition or fair market value as on 1.4.81 as the cost of acquisition. If assessees chooses the
value as on 1.4.81 then the indexation will also be done as per the CII of 1981 and not as per the year
of acquisition.
Ø How does CII help in capital gains computation?
Capital gain arises when the net sale consideration of a capital asset is more than the cost. Since “cost
of acquisition” is historical, the concept of indexed cost allows the taxpayer to factor in the impact of
inflation on cost.
Consequently, a lower amount of capital gains gets to be taxed than if historical cost had been
considered in the computations.

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Ø Inflation Index is reported in terms of Financial Year, not Assessment Year. In India the year for
financial transactions start from 1 st April and ends on 31st March following year. For example, for
any transaction between 1st April 2010 to 31st Mar 2011 the Indexation for year 2010-2011 i.e 711
would be used.
Financial Year CII Financial year CII
1981‐82 100 1997‐98 331

1982‐83 109 1998‐99 351
1983‐84 116 1999‐00 389
1984‐85 125 2000‐01 406
1985‐86 133 2001‐02 426
1986‐87 140 2002‐03 447
1987‐88 150 2003‐04 463
1988‐89 161 2004‐05 480
1989‐90 172 2005‐06 497
1990‐91 182 2006‐07 519
1991‐92 199 2007‐08 551
1992‐93 223 2008‐09 582
1993‐94 244 2009‐10 632
1994‐95 259 2010‐11 711
1995‐96 281 2011‐12 785
1996‐97 305 2012‐13 852
Ø Expenditure on Transfer
Expenditure incurred wholly and exclusively for transfer of capital asset is called expenditure on
transfer.
It is fully deductible from the full value of consideration while calculating the capital gain.
Examples of expenditure on transfer are the commission or brokerage paid by seller, any fees like
registration fees, and cost of stamp papers etc., travelling expenses, and litigation expenses incurred
for transferring the capital assets are expenditure on transfer.

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Note: Expenditure incurred by the buyer at the time of buying the capital assets like brokerage,
commission, registration fees, cost of stamp paper etc. are to be added in the cost of acquisition before
indexation.
Ø Exemption from Capital Gains
Exemption means a reduction from the taxable amount of capital gain on which tax will not be levied
and paid. The exemptions are given under Section 54, these exemptions are of various types but here
we will discuss only one of the exemptions relating to the house property.
Exemption under Section 54
The exemption u/s 54 relates to the capital gain arising out of transfer of residential house. The
exemption is available to only individual assessee.
The exemption relates to the capital gains arising on the transfer of a residential house.
Conditions: Exemption is available if: - 1. House Property transferred was used for residential
purpose; 2. House Property was a long-term capital asset; 3. Assessee has purchased another house
property within a period of one year before or two years after the date of transfer or has constructed
another house property within three years of date of transfer – i.e. the construction of the new house
property should be completed within three years. The date of starting of construction is irrelevant.
Where any capital gain arises to an assessee, individual or HUF, on the transfer of a long-term
residential house (either self-occupied or let out), the income of which is chargeable under the head,
‘Income from house property’, and where the assessee (or in case of his death, his legal
representative) has (i) purchased a residential house within a period of one year before such transfer
or within a period of two years after such transfer, or (ii) constructed a residential house within three
years after such transfer, the capital gain arising on such transfer is to be treated in the following
manner:
(i) The capital gain arising on the transfer of such residential house is exempt to the extent it is re-
invested in the purchase or construction of another residential house within the period as
aforesaid. If the entire capital gain is re-invested, it is fully exempt from income-tax and not
includible in the total income of the asessee. If only a part thereof is re-invested, the balance is
chargeable to income-tax. The allotment of flats under self-financing scheme of Delhi
Development Authority is treated as a new construction for the purposes of capital gain exemption
(under Section 54).
(ii) The new residential house so purchased or constructed should not be transferred within a period
of three years of its purchase or construction as the case may be. If it is transferred within such

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period of three years, the cost of the new house so purchased or constructed is to be reduced by
the amount of old exempted capital gain. In other words, the old exempted capital gain and new
capital gain, if any arising on the transfer of the new residential house, both are chargeable to tax
as the income of the previous year in which the new residential house is transferred. If the transfer
of the new house is effected after the expiry of three years of its purchase or construction, the cost
of the new house so purchased or constructed is not to be reduced by the amount of old exempted
capital gain. In other words, the old exempted gain is not taxable in such cases.
(iii) Where the amount of capital gain which is not appropriated or utilised by the assessee for the
purchase of a residential house within one year before the date of the transfer or which is not
utilised by him/her for the purchase or construction of a new residential house before the date for
furnishing the return of income (under Section 139), the unutilised amount has to be deposited
on or before the due date for furnishing the return of income in an account in any bank or
institution specified by the Central Government. The return of income should be furnished along
with proof of such deposit. The amount already utilised for the purchase or construction of the
new residential house together with the amount so deposited shall be deemed to be the amount
utilised for the purchase or construction of the new residential house. Thus, the assessee is allowed
exemption in respect of capital gain so utilised or deposited.
The assessee has to utilise the amount so deposited for the purchase or construction of the new
residential house within the specified period as aforesaid [under Section 54(1)]. When the deposited
amount is not so utilised either wholly or partly for the purchase or construction of the new residential
house, the unutilised amount is treated as capital gain of the relevant previous year in which the period
of three years from the date of such transfer expires.
Important Concepts:
Ø Asset: Means any property which can be realized into cash or some other valuable item, e.g., land,
building, car, jewelry, T.V., computer etc.
Ø Debentures: Debentures are financial document of title, which states that the person whose name is
written on it has given a certain some of money to the company as loan and he/she is entitled to get
interest on that money till maturity.
Ø Bearer Bonds: Against debentures, bearer bonds do not have any name on it, any person who will
hold these document will be eligible to get the money and interest. These bonds do not exist now
days these have already matured.
Ø Equity Shares: Equity shares are also financial document of title, which states that the person whose
name is written on it (not in case of demat shares) has contributed to the capital fund of the company
and will be eligible for dividend.

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Ø Preference Shares: preference shares are also like equity shares with the difference that the dividend
in their case is fixed and it is paid first to preference shareholders, and later to equity shareholders.
Ø Recurring: Means to recur to occur again and again, e.g., salary, rent etc. occurs again and again,
while non-recurring means something which does not occur again and again which occur once in a
while, although it can occur again but there is no certainty of its occurrence again e.g., loss on account
of road accident, gain on sale of house etc.

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G. Exemptions and Deductions
Tax is calculated on the income earned in the Previous Year. For providing relief to the tax payers from
payment of tax, income tax law provisions feature the concepts of exemption and deduction.
Exempted income refers to income which is not charged to tax. Under the Income Tax Act, Section 10
provides for income which is exempted from the levy of income tax (e.g., scholarships).
Deduction refers to an amount which requires to be included in the computation of income, in the first
instance, and is then allowed to be deducted, in full or in part, on the fulfilment of certain conditions (e.g.,
deduction for payment of donations under Section 80G of the Income Tax Act).
General Exemptions
Under Section 10 of the Income Tax Act, various items of income are totally exempt from Income Tax.
Therefore, incomes falling under this category are not included in the total income of an assessee.
Section 10 provides that in computing the total income of a Previous Year of any person, income which falls
within its ambit shall not be included in the computation of total income, provided that the assessee proves
that a particular item of income is exempt and falls within that provision – the onus is on the assessee, i.e.
the assssee must to prove that his or her income falls within the ambit of Section 10 to avail the exemption
that attends the provision.
The items of ‘exemptions’ specified in Section 10, are explained as follows:
A. AGRICULTURAL INCOME [SECTION 10(1)]
Agricultural income as defined in Section 2(1A) is exempt from income tax in the case of all assesses.
This exemption has been granted on account of the constitutional provisions relating to the powers
of the Central and the State Governments for levying tax on agricultural income.
Under the Constitution, only State Governments are empowered to levy tax on agricultural income.
Hence, the Central Government, while imposing income tax on incomes of various types, must
exclude agricultural income from the purview of income tax (as income tax is levied by the Central
government).
This exemption would, however, be available only in cases where the income in question constitutes
agricultural income within the meaning of Section 2(1A).

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Definition of Agricultural Income: Section 2(1A) of the Income Tax Act
Conditions to be satisfied for Agricultural Income:
According to the definition of Agricultural Income as per Section 2(1A) of the Act, income which
satisfies following conditions is treated as agricultural income.
a. Rent or revenue derived from land:
– The word rent denotes the payment of money, either in cash or in kind, by one person to another
(owner of the land) in respect of the grant of right to use land.
– The recipient of rent or revenue should be the owner of the land.
– The expression “revenue” is used in the broader sense of return, yield or income, and not in the
sense of land revenue.
– Income is said to be derived from land only if the land is the immediate and effective source of
the income and not the secondary and indirect source. Thus interest on arrears of rent payable in
respect of agricultural land is not agricultural income because the source of income (interest) is
not from land but it is from rent which is a secondary source of income and is taxable under the
head Income from other sources. [CIT v. Kamakshya Narain Singh [(1948) 16 ITR 325].
b. Land must be situated in India:
Land must be situated in India, however it is immaterial whether the agricultural land in question
has been assessed to land revenue or local taxes or assessed and collected by the Officers of the
Government in India.
c. Land must be used for agricultural purposes:
The land must be used for agricultural purposes. There must be some measure of cultivation on
the land, some expenditure of skill and labour upon it, to have been used for agricultural purposes
within the meaning of the Act. [Mustafa Ali Khan v. CIT (16 ITR 330)].
Also, the land is said to be used for agricultural purposes where the following two types of
operations are being carried on [CIT v. Raja Benoy Kumar Sahas Roy (1957) 32 ITR 466]:

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(i) Basic operation:
These include tilling of the land, sowing of seeds, planting or an operation of a similar
kind (digging pits in the soil to plant a sapling).
(ii) Subsequent Operations:
These include weeding, digging the soil around the growth, nursing, pruning, cutting,
Protection of Crops from insects and pets etc.
Note: Here agriculture connotes all the products of vegetable kingdom (food for human beings and animals,
fruits, commercial crops, flowers, medicines, bamboo, timber, fuel material) but it does not include the
products of animal kingdom (dairy farming, butter and cheese making, poultry farming, breeding of livestock
etc.).
Concept of Agricultural Income:
Agricultural Income means and includes
I. Rent received from the land used for agricultural purposes [Section 2(1A)(a)]:
When a person (landlord or tenant) lets out a piece of land, which is situated in India, for agricultural
purposes, the rent received either in cash or kind from the tenant is considered as agricultural income.
II. Revenue income derived from agriculture:
When the landlord or tenant cultivates the farm, raises the product and sells it or appropriates it for
his individual needs, the difference between the cost and selling price (including the value of self-
consumption on the basis of average market rate for the year) is the income derived from agriculture.
III. Income from making the produce fit to be taken to market:

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The crop as harvested might not find a market. If, in order to make the product a saleable commodity,
the cultivator or receiver of rent-in-kind performs some operation (manual or mechanical) and
enhances the value of the produce, the enhancement of value of the produce is also agriculture
income. Such income to be regarded as agricultural income, the following conditions must be
satisfied:
1. The operation must be one which is ordinarily employed by the cultivator to make the produce
fit for the market – i.e., threshing, winnowing, cleaning, drying, etc.
2. There is no market (ready and willing, and not a theoretical market) for the produce as
received from the farm.
3. (The process to make it marketable has been performed either by the cultivator or receiver of
rent-in-kind.
4. The produce must not change its original character.
Example:
(a) There is no ready market for raw coffee in the green state. It has to be dried-up and cured before
it can be sold. In the same way, the conversion of the green tobacco leaves into fluecured tobacco is
a must before sale. On the other hand, there is a ready market of kapas or unginned cotton. If the
farmer sells the ginned cotton, the additional income (difference between the selling price of ginned
cotton and unginned cotton) is not agricultural income and is therefore liable to tax.
(b) Similarly, where a farmer grew mulberry leaves and fed the same to silk-worms, it was not a
process employed by the cultivator of mulberry leaves to make them marketable by way of producing
silk cocoons, and the income derived from rearing of silk-worms was not agricultural income because
the silk cocoons produced by silk-worms did not bear any character of an agricultural produce or as
a marketable form of mulberry leaves. [K. Lakshmansa & Co. v. CIT (1981) 128 ITR, p. 283 (Kar.)].
IV. Income from sale of produce:
When the cultivator or receiver of rent-in-kind sells the produce either after performing certain activities to
make it fit for market (discussed in III above) or without doing any such activity, the income is agricultural
income. It is immaterial that he has sold the produce to the wholesaler in the market or through his own retail
shop directly to the consumers.
V. Income from Building:
In the following cases the income from building or house property is treated as agricultural income:
(a)
(i) If the land-lord receives rent in cash, it is owned and occupied by him; or
(ii) If the land-lord receives rent-in-kind, it is occupied by him -whether owned or not;
or
(iii) if it is occupied by the cultivator - whether owned by him or not;
(b) If it is on or in the immediate vicinity of the agricultural land;
(c) If it is required as a dwelling-house or as a store house or as an out-house by the land-lord or
cultivator;

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(d) If it is required by reason of the land-lords or cultivators connection with the land, i.e., either
the building is required to make the produce fit to be taken to the market or there is a sufficient
quantity of produce which requires a store house or there are numerous tenants and it is
necessary to stay there to collect the rent or it is necessary for the cultivator to be there to look
after the farm.
(e)
(i) The land is assessed to land revenue in India; or
(ii) The land is subject to land revenue or local rate assessed and collected by the
officers of the Government - either Central or State for the benefit of local bodies.
Where the land is not so assessed, the building should not be situated:
a. in an area of municipality (whether known as Municipal Corporation, Notified

Area Committee, Town Area Committee, or by any other name or Cantonment
Board whose population according to the latest census figures published is
10,000 or more; or
b. in a notified area within such limits of a Municipality, etc., as may be notified
by Government.
However, the distance of notified area cannot exceed 8 kilometres from the local limits. The department has
issued various circulars from time to time specifying the notified areas.
VI. Ownership of Land is not essential:
In the case of rent or revenue, it is essential that the assessee has an interest in the land (as an owner or a
mortgagee) to be eligible for tax-free income. However, in the case of agricultural operations, it is not
necessary that the cultivator be the owner of the land. He could be a tenant or a sub-tenant. In other words,
all tillers of land are agriculturists and enjoy exemption from tax. In certain cases, further processes may be
necessary to make a commodity marketable out of agricultural produce. The sales proceeds in such cases are
considered agricultural income because the producer’s final objective is to sell his products.
--~--
Computation of Tax Liability:
While determining the tax-liability, due consideration is to be given to the following rules to arrive at the tax
on non-agricultural income:
1. Compute the net agricultural income as if it were income chargeable to income-tax under the
head: “Income from other sources”.
2.
3. Aggregate agricultural and non-agricultural income of the assessee and calculate income-tax
on the aggregate income as if such aggregate income were the total income.

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4. Increase the net agricultural income by the first slab of income on which tax is charged at nil
rate and calculate income-tax on net agricultural income, so increased, as if such income were
the total income of the assessee.
5. Theamountofincome-taxdeterminedat(2)willbereducedbytheamountofincome-
taxdeterminedat(3).
6. The amount so arrived at will be the total income-tax payable by the assessee.
From the amount of tax determined as above, the following tax reliefs/tax rebates are deductible:
– Rebate under Section 86 in respect of share of profit from an association of persons. – Relief under
Section 90/91 in respect of doubly taxed income.
– Rebate under Section 87(A) if applicable.
The sum so arrived at will be the income-tax in respect of the total income.

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Sample Problems and Solutions:

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--~--
B. MONEY RECEIVED BY AN INDIVIDUAL AS A MEMBER OF H.U.F. [SECTION 10(2)]
Any sum received by an individual in his capacity as a member of H.U.F. is wholly exempt from income-tax
where such sum has been paid out of the income of the family, or out of the income of an impartible estate
belonging to the family, because that has been taxed in hand of H.U.F.
This exemption is, however, subject to the provisions of section 64(2), where the income from self-
acquired assets which are converted into property of the H.U.F. are to be clubbed with the income of
the person who makes the conversion subject to certain conditions. For the purpose of this exemption,
it is immaterial whether the H.U.F. has been subject to tax in respect of the income. It is also
immaterial whether the member who has received the share of income from the family is a coparcener
or not but he must be a member of that family at the time of receiving the money.

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C. SHARE OF PROFIT FROM PARTNERSHIP FIRM [SECTION 10(2A)]
Share in profit of firm received by a partner of that firm (including limited liability partnership firm)
if not taxable in the hands of the partner.
D. INTEREST INCOME OF NON-RESIDENTS [SECTION 10(4)]
(i) In the case of non-residents any income from interest on such securities or bonds as the Central
Government may by notification in the Official Gazette specify in this behalf including income by
way of premium on the redemption of such bonds.
(ii) In the case of an individual [being a Non-Resident as per (FEMA)], any income by way of interest
on moneys standing to his credit in a Non-resident (External) Account in any bank in India in
accordance with the Foreign Exchange Management Act, 1999 and the Rules made thereunder.
E. INTEREST INCOME OF NON-RESIDENTS FROM SPECIFIED SAVINGS

CERTIFICATES [SECTION 10(4B)]:
In the case of an individual being a citizen of India or a person of Indian origin, who is a non-resident,
any income from interest on notified savings certificates issued before the 1st day of June, 2002 by
the Central Government will be exempt provided he subscribes to such certificates in foreign currency
or other foreign exchange remitted from a country outside India in accordance with the provisions of
the Foreign Exchange Management Act, 1999 and any rules made thereunder. It is important to note
that the exemption will be available only to the original subscribers to the savings certificates.
F. TRAVEL CONCESSION OR ASSISTANCE TO A CITIZEN OF INDIA [SECTION 10(5)]:
The value of any travel Concession or assistance provided by the employer or the former employer
to an assessee for himself and his family in connection with his proceeding to any place in India on
leave or after retirement from service or after termination of his service is exempt subject to such
conditions as may be prescribed having regard to travel concession or assistance granted to the
employees of the Central Government. Provided that the amount exempt under this clause shall in no
case exceed the amount of expenses actually incurred for the purpose of such travel.
The exemption is admissible in respect of actual expenditure incurred for journeys performed not
only by himself (assessee) but also by his family.
For the purpose of this clause “family” means:

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(i) the spouse and children of the individual; and
(ii) the parents, brothers and sisters of the individual or any of them, wholly or mainly dependent
on him.
Rule 2B, provides that the value of travel concession or assistance received by or due to the individual
from his employer or former employer for himself and his family, in connection with his proceeding:
a) on leave to any place in India;

b) to any place in India after retirement from service or after the termination of his service
The exemption can be availed only in respect of two journeys performed in a block of four calendar
years. For this purpose, first four year block commenced from calendar year 1986 and the blocks
work out as 1986-89, 1990-93, 1994-97, 1998-2001 and so on.
If travel concession or assistance is not availed during any of the four year block period, exemption
can be claimed provided he avails the concession or assistance in the calendar year immediately
following that block. This is popularly known as the ‘carry-over’ concession. In such cases, the
exemption so availed will not be counted for purposes of regulating the future exemptions allowable
for the succeeding block of four years.
Note:
Quantum of exemption is however subject to the following limits, depending upon the mode of transport
used or available.
1. For journey performed by air , air economy fare of the national carrier (Indian Airlines or Air
India) by the shortest route to the place of destination.
2. Where place of origin of journey and destination are connected by rail and the journey is
performed by any mode of transport other than by air, air-conditioned first class rail fare by
the shortest route to the place of destination.
3. Where place of origin of journey and destination or part thereof are not connected by rail, the
maximum amount shall be:
(i) where a recognised public transport system exists, the first class or deluxe class
fare on such transport by the shortest route to the place of destination.
(ii) where no recognised public transport system exists, the air- conditioned first class
rail fare, for the distance of the journey by the shortest route as if the journey has
been performed by rail.

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G. EXEMPTIONS TO AN INDIVIDUAL WHO IS NOT A CITIZEN OF INDIA [SECTION

10(6)]
(i) Remuneration of Diplomats etc. [Section10(6)(ii)]: The remuneration received by him as an official,
by whatever name called, of an embassy, high commission, legation, commission, consulate or the
trade representation of a foreign State, or as a member of the staff of any of these officials, for service
in such capacity.
However, the remuneration received by him as a trade commissioner or other official representative in
India of the Government of a foreign State (not holding office as such in an honorary capacity), or as
a member of the staff of any of those officials, shall be exempt only if the remuneration of the
corresponding officials or, as the case may be, members of the staff, if any, of the Government of India,
resident for similar purposes in the country concerned enjoys a similar exemption in that country.
Further such members of the staff are subjects of the country represented and are not engaged in any
business or profession or employment in India otherwise than as members of such staff.
(ii) Remuneration received by foreign individual [Section 10(6)(vi)]: [The remuneration received by
a foreign individual in his capacity as an employee of a foreign enterprise for the services rendered
by him during his stay in India would be exempt if the following conditions are fulfilled:
(a) The foreign enterprise is not engaged in any trade or business in India.
(b) The total period of stay of the individual in India during the previous year does
not exceed 90 days.
(c) Such remuneration is not liable to be deducted from the income of the
employer chargeable to tax in India under the Income-tax Act.
(iii) Non-resident employee on a foreign ship[Section 10(6)(viii)]: Income chargeable under the head
‘Salaries’ received by or due to any non-resident individual as remuneration for the services
rendered by him in connection with his employment on foreign ship is exempt from tax where
the total period of his stay in India does not exceed a period of 90 days during the previous year.
(iv) Remuneration of employee of foreign Government during his training in India

[Section10(6)(xi)]:
The remuneration received by an individual being a foreign citizen as an employee of the

government of a foreign State during his stay in India in connection with his training in any
establishment or office of, or in any undertaking owned by:
a. The government; or
b. Any company in which the entire paid-up capital is held by the Central Government, or
any State Government or Governments; or partly by the Central Government and partly
by one or more State Governments; or

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c. Any company which is a subsidiary of a company referred to in (b); or
d. Any corporation established by or under a Central, State or Provincial Act; or
e. Any society registered under the Societies Registration Act, 1860, or under any other
corresponding law for the time being in force and wholly financed by the Central
Government, or any State Government or partly by the Central Government and partly
by one or more State Governments.
H. ALLOWANCE PAYABLE OUTSIDE INDIA [SECTION 10(7)]
Allowances or perquisites paid or allowed as such outside India by the Central Government to a
citizen of India for his services rendered outside India, would be wholly exempt from income-tax.
Context: Section 9(1)(iii) states that income chargeable under the head salaries is deemed to accrue
in India if it is payable by the government to an Indian citizen for rendering service outside India.
I. PAYMENT RECEIVED UNDER A LIFE INSURANCE POLICY [SECTION 10(10D)]
Any sum received under a life insurance policy, including the sum allocated by way of bonus on such
policy, other than –
a. any sum received under Sub-section (3) of Section 80DD or Sub-section (3) of Section 80DDA; or
b. any sum received under a Keyman insurance policy; or
c. any sum received under an insurance policy issued on or after the1st day of April, 2003 but on or
before 31st March 2012 in respect of which the premium payable for any of the years during the term
of the policy exceeds twenty per cent of the actual capital sum assured; or
d. any sum received under an insurance policy issued on or after the 1st day of April, 2012 in respect of
which the premium payable for any of the years during the term of the policy exceeds ten per cent of
the actual capital sum assured.
Shall be exempt
However, provisions of this sub-clause (c) or (d) shall not apply to any sum received on the death of
a person:
Provided further that for the purpose of calculating the actual capital sum assured under this sub-
clause, effect shall be given to the Explanation to Sub-section (3) of Section 80C or the Explanation
to Sub-section (2A) of Section 88, as the case may be.

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Provided also that where the policy, issued on or after the 1st day of April, 2013, is for insurance on
life of any person, who is – (i) a person with disability or a person with severe disability as referred
to in section 80U; or (ii) suffering from disease or ailment as specified in the rules made under section
80DDB,
the provisions of this sub-clause shall have effect as if for the words “ten per cent”, the words “fifteen
per cent” had been substituted.
Note:
“Keyman insurance policy” means a life insurance policy taken by a person on the life of another person
who is or was the employee of the first-mentioned person or is or was connected in any manner whatsoever
with the business of the first-mentioned person and includes such policy which has been assigned to a person,
at any time during the term of the policy, with or without any consideration.
For the purposes of this sub-section, “actual capital sum assured” in relation to a life insurance policy shall
mean the minimum amount assured under the policy on happening of the insured event at any time during
the term of the policy, not taking into account –
(i) the value of any premium agreed to be returned; or
(ii) any benefit by way of bonus or otherwise over and above the sum actually assured, which is to
be or may be received under the policy by any person.
J. SCHOLARSHIPS [SECTION 10(16)]
Scholarships granted to meet the cost of education would be exempt in every case regardless of the residential
status or citizenship of the scholar and the person from whom the scholarships are received.
K. INCOME OF MINOR CHILD [SECTION 10(32)]
Where the income of an individual includes any income of his minor child in terms of Section 64(1A), such
individual shall be entitled to exemption of the amount includible under Section 64(1A) of each minor child
or ` 1,500 for each minor child whichever is less.
L. FAMILY PENSION [SECTION 10(19)]
Family pension received by the widow or children or nominated heirs, as the case may be, of a member of
the armed forces (including paramilitary forces) of the Union, where the death of such member has
occurred in the course of operational duties, in such circumstances and subject to such conditions, as may
be prescribed, shall be exempt from tax. However, family pension received by others is exempt up to least
of Rs. 15,000 or 1/3rd of family pension and the remaining is taxable under the head other sources.

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M. ANY INCOME BY WAY OF DIVIDENDS REFERRED TO IN SECTION 115-O [SECTION

10(34)]
Any income by way of dividends referred to in Section 115-O shall be exempt from income tax. As per
section 115-O the company paying or declaring any dividend have to pay tax @15% plus surcharge as
applicable plus education cess @3% on such dividend. Hence, such dividend shall be exempt in the hands
of shareholders. Provided further nothing in this clause shall apply to any Income by way of dividend
chargeable to tax in accordance with the provisions of section 115BBDA. [Amendment vide Finance Act,
2016 w.e.f. 1-4-2017].
N. INCOME FROM MUTUAL FUNDS AND CERTAIN UNITS [SECTION 10(35)]
Any income by way of, –
(a) income received in respect of the units of a Mutual Fund specified under Clause (23D); or (b) income
received in respect of units from the Administrator of the specified undertaking; or (c) income received in
respect of units from the specified company
shall be exempt from income tax.
Provided that this clause shall not apply to any income arising from transfer of units of the Administrator of
the specified undertaking or of the specified company or of a mutual fund, as the case may be.
Explanation. – For the purposes of this clause, –
(a) “Administrator”meanstheAdministratorasreferredtoinclause(a)ofSection2oftheUnitTrustofIndia
(Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002);
(b) “specified company” means a company as referred to in clause (h) of Section 2 of the Unit Trust
of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002);

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Deductions
The deductions are available only to the assessees where the gross total income is positive. If, however, the
gross total income is nil or negative, the question of any deduction from the gross total income does not arise.
For this purpose, the expression ‘gross total income’ means the total income of the assessee computed in
accordance with the provisions of the Income-Tax Act, before making any deduction under Chapter VIA,
i.e., the aggregate income computed under each head, after giving effect to the provisions for clubbing of
income and set off of losses, is known as “Gross Total Income”. Sections 80A to 80U of the Income- tax Act
lay down the provisions relating to the deductions allowable to assessees from their gross total income. The
income arising after deduction under section 80A to 80U is called Total Income.
v Introduction:
The scheme of the Income-tax Act is to provide for various tax exemptions and concessions in three forms,
namely –
(i) Incomes which are wholly exempt from tax by virtue of their exclusion from the scope of total income
under Sections 10 to 13A;
(ii) Incomes which are includible in the total income for rate purposes but are entitled for rebate under
Section 86; and
(iii) Deductions from gross total income which are allowed for the purposes of computing total income in
respect of payments, investment and incomes.
At the outset, it must be noted that the deductions from gross total income are available only to the assessees
where the gross total income is a positive figure. If however, the gross total income is nil or is a loss, the
question of any deduction from the gross total income does not arise. For this purpose, the expression ‘gross
total income’ means the total income of the assessee computed in accordance with the provisions of the
Income- tax Act before making any deduction under Chapter VIA. The aggregate of income computed under
each head, after giving effect to the provisions for clubbing of income and set off of losses, is known as
“Gross Total Income”. Sections 80A to 80U of the Income-tax Act lay down the provisions relating to the
deductions allowable to assessees from their gross total income. However, the aggregate amount of the
deductions shall not exceed the gross total income of the assessee.
Note:
These deductions are allowed from gross total income after reducing the following incomes from gross total
income:
– Long-term Capital Gains
– Short-term Capital Gains under Section 111A
– Income from Lotteries
– Income under Sections 115A, 115AB, 115AC, 115ACA, 115AD, 115BBA, 115D

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v How do Deductions Play Out?:
Net income of the assessee is based on an aggregation of computation of income from each of the five heads
of income. The aggregate of income under the five heads is known as “gross total income”. Certain
deductions which are not deductible under any particular head of income are allowed out of gross total
income to arrive at the total income liable to tax.
Total income is accordingly computed as under:

1. Income from Salaries ___
2. Income from House property ___
3. Profits and Gains of Business and Profession ___
4. Income from Capital Gains ___
5. Income from other sources ___
Gross Total Income = ______________
Less deduction under Chapter VI-A(80C TO 80U)(-) _______
Net Income ______________
v Basic Rules of Computation:
Ø The aggregate amount of deductions under sections 80C to 80U cannot exceed gross total income
(gross total income after excluding long term capital gains, short term capital gain on equity shares
[Sec 111A], winnings from lottery, crossword puzzles and income earned under Sec.115A, 115AB,
115AC, 115ACA, 115AD, 115BBA and 115D)
Ø These deductions are to be allowed only if the assessee claims these and gives proof of such
investments/ expenditure/ income.
Ø Deduction is allowed when the saving is invested but normally any withdrawal is treated as income
in the year of withdrawal.
Ø There are some monetary thresholds on the allowable deductions under the different sections.
Ø Deductions are of two types, on account of certain : (a) payments and investments covered under
Section 80C to 80 GGC and (b) incomes which are already included under gross total income covered
under Section 80-IA to 80U.
v DEDUCTION ON LIFE INSURANCE PREMIA, CONTRIBUTION TO PROVIDENT

FUND, ETC. (SECTION 80C)
A new Section 80C has been inserted from the AY 2006-07 onwards. Section 80C provides for deduction in
respect of certain expenditure/ investments (which are specified in this section) paid or deposited by the
assessee in the previous year.
Eligibility: (a) an individual; (b) a Hindu undivided family.

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Entitlement: Deduction from the Gross Total Income of an amount equal to the investments made, subject
to a maximum amount of ` one lakh and fifty thousand.
Monetary threshold: Whole of the amount paid or deposited in the previous year (gross qualifying amount),
as does not exceed Rs.1,50,000. Basically – gross qualifying amount or Rs.1,50,000, whichever is lesser.
Aggregate cap: The aggregate cap on investments under Section 80C, 80CCC and 80CCD is Rs.1,50,000.
Nature of Investments:
(a) Life Insurance policy (premium) taken on the life of an individual assessee or spouse and any child of such
individual, and any member of the Hindu Undivided Family. But deduction is not allowed where the premium
paid on Life Insurance Policy exceeds 10% of the capital sum assured. However, where the policy, issued on
or after the 1st day of April, 2013, is for insurance on life of any person, who is –
(a) a person with disability or a person with severe disability as referred to in section 80U, or
(b) suffering from disease or ailment as specified in the rules made under section 80DDB deduction for
premium shall be allowed only when such amount shall not exceed 15% of the capital sum assured.
---
"actual capital sum assured" in relation to a life insurance policy shall mean the minimum amount assured
under the policy on happening of the insured event at any time during the term of the policy, not taking into
account-
I. the value of any premium agreed to be returned; or
II. any benefit by way of bonus or otherwise over and above the sum actually assured, which is to be or
may be received under the policy by any person.
---

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(b) Amounts paid to effect or to keep in force a contract for a non-cumulative deferred annuity not being an
annuity plan referred to in clause (j) below on the life of: (i) in the case of an individual, the individual,
spouse or any child of such individual and ‘
However, such contract should not contain a provision for exercise of an option by the insured to receive
cash payment in lieu of the payment of the annuity.
(c) Deduction from the salary payable by or on behalf of the Government to any individual, in accordance with
the conditions of his service, for securing to him a deferred annuity or making provision for his wife or
children, to the extent of one-fifth of salary.
(d) Any contribution made by an individual only to any provident fund to which the Provident Funds Act, 1925,
applies; a Recognised provident fund; an approved superannuation fund.
(e) Any contribution to (i) any provident fund set-up and notified by the Central Government in the Official
Gazette, [public provident fund has been notified for this purpose] or (ii) a ten-year account or a fifteen- year
account under the Post Office Savings Bank (Cumulative Time Deposits) Rules, 1959, as amended from time
to time, where such sums are deposited/contributions are made to an account standing in the name of: in the
case of an individual, the individual himself or a minor of whom he is the guardian; any member of the Hindu
Undivided Family in the case of a HUF and in the case of an association of persons or body or individuals,
such association or body.
(f) As subscription in the name of any person specified in sub-section 4 to the notified securities of the Central
Government.
(g) Any contribution to a PPF by individual or HUF.
(h) Subscription to other notified savings certificates defined in Section 2(c) of the Government Savings
Certificates Act, 1959 [For this clause, National Savings Certificates (VIII) issue has been notified] and
interest accured deemed to be reinvested also qualifies.
(i) Contributions made by an individual or HUF, for participation in the Unit-Linked Insurance Plan, 1971,
deemed to have been made under Section 19(8)(a) of the Unit Trust of India Act, 1963. [For this clause,
Dhanaraksha-1989 plan of LIC Mutual Fund has been notified].
(j) Contributions made in the name of an individual or HUF for participation in any notified Unit-Linked
Insurance Plan of the LIC Mutual Fund.
(k) Any contribution to effect or keep in force any notified annuity plan of the LIC or any other insurer.
(l) Any subscription, to any units of any Mutual Fund or the Unit Trust of India under any notified plan
formulated by the Central Government.
(m) Any contribution to any pension fund setup by any Mutual Fund as notified by the Central Government.

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(n) Subscription to the notified deposit scheme of or contribution to any such pension fund set up by the National
Housing Bank established under Section 3 of the National Housing Bank Act, 1987. [For this clause, Home
Loan Account Scheme of National Housing Bank has been notified].
As inserted by Finance (No. 2) Act, 1991 w.e.f. assessment year 1992-93 any such deposit scheme as notified
by the Central Government and floated by:
(a) a public sector company which is engaged in providing long-term finance for construction or purchase
of houses in India for residential purposes, or
(b) any authority constituted in India by or under any law enacted either for the purpose of dealing with and
satisfying the need for housing accommodation or for the purpose of planning, development or
improvement of cities, towns and villages or for both;
(o) Only tuition fees (excluding any payment towards any development fees or donation or payment of similar
nature), whether at the time of admission or thereafter, – (for full time education of any 2 children) to any
university, college, school or other educational institution situated within India;
(p) For purchase or construction of a residential house property, the income of which is chargeable to tax under
the head “Income from House Property”, where such payments are made towards or by way of:
(i) Any instalment or part payment of the amount due under any self-financing or other scheme of
any development authority, housing board or other authority engaged in the construction and sale
of house property on ownership basis; or
(ii) any instalment or part payment of the amount due to any company or co-operative society of
which the assessee is a shareholder or member towards the cost of the house property allotted to
him; or
(iii) re-payment of the amount borrowed by the assessee from: (1) the Central Government or any
State Government; or (2) any bank, including a co-operative bank, or (3) the Life Insurance
Corporation, or (4) the National Housing Bank, or (5) any public company formed and registered
repayment of principal part only not interest in India with the main object of carrying on the
business of providing long-term finance for the construction or purchase of houses in India for
residential purposes, eligible for deduction under Section 36(1)(viii), or (6) any company in which
the public are substantially interested or any co-operative society, where such company or co-
operative society is engaged in the business of financing the construction of houses; or (7) the
assessee’s employer where such employer is a public company or a public sector company or a
university established by law or a college affiliated to such university or a local authority or a
cooperative society; (8) the assessee’s employer where such employer is an authority or a board
or a corporation or any other body established under a Central or State Act (w.e.f. A.Y. 2006-07).
(iv) stamp duty, registration fee and other expenses for the purpose of transfer of such house property
to the assessee.
However, no deduction is allowed in respect of any payment towards or by way of –

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(A) the admission fee, cost of share and initial deposit which a share holder of a company or a member of a
cooperative society has to pay for becoming such shareholder or member; or
(B) the cost of any addition or alteration to, or renovation or repair of, the house property which is carried
out after the issue of completion certificate in respect of the house property by the authority competent to
issue such certificate or after the house property or any part thereof has either been occupied by the assessee
or any other person on his behalf or has been let out; or
(C) any expenditure in respect of which deduction is allowable under the provisions of Section 24.
(q) Subscription to equity shares or debentures or units forming part of any eligible issue of capital, i.e. issue
made by a company registered in India or a public financial institution or an approved mutual fund for the
purpose of developing, maintaining and operating an infrastructure facility as defined in the explanation to
Sub-section (4) of Section 80-IA or for generation, or for generation and distribution of power or for
providing telecommunication services whether basic or cellular.
(r) Fixed deposits for a minimum period of 5 years in any Scheduled Banks (w.e.f. A.Y. 2007-08).
(s) As subscription to such bonds issued by the National Bank for Agriculture and Rural Development, as the
Central Government may, by notification in the Official Gazette specify in this behalf.
(t) In an account under the Senior Citizens Savings Scheme Rules, 2004.
(u) As five year time deposit in an account under the Post Office Time Deposit Rules, 1981.
(v) Under section 80C(2) (xviii) deposit under a notified deposit scheme would be qualified for deduction within
the overall ceiling of Rs. 1,50,000. For this purpose Sukanya Samriddhi Account Scheme has been notified
vide Notification No. 9/2015, dated January 21, 2015.
In case of any single premium policy, if such policy is surrendered within two years of the date of commencement
of insurance, the amount of deduction of income-tax allowed earlier shall be deemed to be the tax payable in the
year of surrender.
Consequences of default/failure to pay premium:
Where, in any previous year, an assessee –
(i) terminates his contract of insurance under the Life Insurance Policy, either by notice to that effect
or, where the contract ceases to be in force by reason of failure to pay any premium, by not
reviving the contract of insurance, before premiums have been paid for two years; or
(ii) terminates his participation in any unit-linked insurance plan of U.T.I. or L.I.C. Mutual fund, by
notice to that effect or where he ceases to participate by reason of failure to pay any contribution,
by not reviving his participation, before contributions in respect of such participation have been
paid for five years; or

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(iii) transfers the house property referred to at Sl. No. ‘l’ as aforesaid, before the expiry of five years
from the end of the financial year in which possession of such property is obtained by him, or
received back, whether by way of refund or otherwise, any amount specified therein, then –
(i) no deduction shall be allowed with reference to any of the sums eligible for deduction and
(ii) the deductions of income-tax allowed in respect of the previous year or years preceding such
previous year, shall be deemed to be tax payable by the assessee in the assessment year relevant
to such previous year and shall be added to the tax on the total income of the assessee with which
he is chargeable for such assessment year.
(iv) If any shares or debentures or units emanating out of an eligible issue of capital to promote
infrastructure is transferred within three years of their acquisition the tax rebate allowed on this
account shall be deemed to be the tax liability of the pervious year in which such premature
transfer took place.
Sub-section (3) provides that the provisions of Sub-section (2) shall apply only to so much of any
premium or other payment made on an insurance policy other than a contract for a deferred annuity as is
not in excess of twenty per cent of the actual capital sum assured.
Explanation. – In calculating any such actual capital sum, no account shall be taken –
(i) of the value of any premiums agreed to be returned, or
(ii) of any benefit by way of bonus or otherwise over and above the sum actually assured, which is to
be or may be received under the policy by any person.
v DEDUCTION FOR CONTRIBUTION TO PENSION FUND (SECTION 80CCC)
An individual who deposits out of his taxable income to any pension fund of the Life Insurance Corporation
of India or any insurer, shall get a deduction from his gross total income of the amount so deposited not
exceeding Rs. 1,50,000.
Conditions for claiming deduction:
• during the PY, the individual has paid/deposited a sum under an annuity plan of the LIC or any other
insurer for receiving pension.
• deduction should not have been claimed under Section 80C
Amount of deduction - If the aforesaid conditions are satisfied, then the amount deposited or Rs. 1,00,000,
whichever is lower, is deductible.
Tax treatment of pension received - pension amount received by the assessee or his nominee as pension
will be taxable in the year of the receipt.

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v DEDUCTION IN RESPECT OF CONTRIBUTION TO PENSION SCHEME OF CENTRAL

GOVERNMENT [SECTION 80CCD]
A new pension scheme has been introduced by Finance (No. 2) Act, 2004 which is applicable to new
employees of the Central Government employed on or after 01.01.2004 or being an individual employed by
any other employer. According to this section, it is mandatory for such employee to contribute 10% of salary
every month towards the pension account. A matching contribution is required to be made by the Central
Government in this account.
Thus, Section 80CCD makes provision for deduction in respect of contribution to pension scheme of Central
Government. Deduction is allowed upto 10% of salary for own contribution and upto 10% of salary for
contribution made by the Central Government. Pension/amount received from pension fund, shall be taxable
as income in the year in which such amount is received by the assessee or his nominee.
Where under the deduction is claimed under this section, no rebate shall be granted in respect of such
contribution under Section 88 for any assessment year ending before April 1, 2006. Also, no deduction with
reference to such amount shall be allowed under Section 80 for any assessment year beginning on or after
April 1, 2006. Salary includes dearness allowance, if terms of employment so provide, but excludes all other
allowances and perquisites. The assessee shall be deemed not to have received any amount in the previous
year if such amount is used for purchasing an annuity plan in the same previous year. The following
amendments have been made to the scheme of section 80CCD from the assessment year 2016- 2017 –
1. The ceiling of Rs. 1,00,000 as provided by section 80CCD (1A) has been removed.
2. A new sub-section (1B) has been inserted in section 80CCDsoastoprovideforanadditionaldeduction in
respect of any amount paid (up to Rs. 50,000) for contribution made by any individual assessee under the
NPS. On this additional contribution, the ceiling of Rs. 1,50,000 under section 80CCE will not be applicable.
Provided that the amount received by the nominee, on the death of the assessee, under the
circumstances referred to in clause (a), shall not be deemed to be the income of the nominee [Finance
Act, 2016, w.e.f. 1- 4-2017].
v DEDUCTION IN RESPECT OF MEDICAL INSURANCE PREMIA (SECTION 80D)
Conditions to be satisfied:
• Taxpayer is an individual or a HUF
• Insurance premium is paid by the taxpayer in accordance with the scheme framed in this behalf by
the General Insurance Corporation of India and approved by the Central Government or any other
insurer who is approved by the Insurance Regulatory and Development Authority
• Mediclaim policy is taken on the health of the taxpayer, on the health of spouse, dependent parents
or dependent children of the taxpayer. In case of HUF on the health of any member of the family.

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• Aforesaid premium should have been paid by cheque (for preventive health check-up, cash could
have been paid).
Amount of Deduction:
- If all the aforesaid conditions are satisfied, then the
a) insurance premium paid or
b) deduction up to Rs. 20,000/- for senior citizens and up to Rs. 15,000/ in other cases for
insurance of self, spouse and dependent children
c) From AY 2013-14, within the existing limit a deduction of upto Rs. 5,000 for preventive
health check-up is available.
whichever is lower, is deductible.
- A person is a senior citizen if he is resident and at least of 60 years of age at any time during the
previous year. The limit is Rs.15,000/- in all other cases. From AY 2013-2014, age limit was
reduced from 65 to 60.
- Therefore, the maximum deduction available under this section is to the extent of Rs. 40,000/-.
(1) In computing the total income of an assessee, being an individual or a Hindu undivided family, there shall
be deducted such sum, as specified in sub-section (2) or sub-section (3), payment of which is made by any
mode as specified in the previous year out of his income chargeable to tax.
(2) Where the assessee is an individual, the sum referred to in sub-section (1) shall be the aggregate of the
following:
(a) the whole of the amount paid to effect or to keep in force an insurance on the health of the assessee
or his family or “any contribution made to the Central Government Health Scheme” or such other
scheme as may be notified by the Central Government in this behalf or any payment made on account
of preventive health check-up of the assessee or his family and the sum does not exceed in the
aggregate `25,000; and
(b) the whole of the amount paid to effect or to keep in force an insurance on the health of the parent
or parents of the assessee or any payment made on account of preventive health check-up of the
assessee or his family as does not exceed in the aggregate Rs. 25,000.
(c) the whole of the amount paid on account of medical expenditure incurred on the health of the
assessee or any member of his family as does not exceed in the aggregate `30,000.
(d) thewholeoftheamountpaidonaccountofmedicalexpenditureincurredonthehealthofanyparentof the

assesse, as does not exceed in the aggregate Rs. 30,000.

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Explanation: family means the spouse and dependent children of the assessee. Payment shall be made by
any mode, including cash, in respect of any sum paid on account of preventive health check-up and by any
mode other than cash in all cases other than preventive health check up.
(3) Where the assessee is a Hindu undivided family, the sum referred to in sub section (1), shall be aggregate
of the following namely:-
(a) whole of the amount paid to effect or to keep in force an insurance on the health of any member
of that Hindu undivided Family as does not exceed in the aggregate twenty- five thousand rupees;
and
(b) whole of the amount paid on account of medical expenditure incurred on the health of any member
of the
Hindu undivided family as does not exceed in the aggregate thirty thousand rupees:
Provided that the amount referred to in clause(b) is paid in respect of a very senior citizen and no amount has
been paid to effect or to keep in force and insurance on the heath of such a person:
Provided Further that the aggregate of the sum specified under the clause (a) and clause(b) shall not exceed
thirty thousand rupees.
(4) In case of a senior citizen or very senior citizen the amount shall not exceed RS. 30,000.
Explanation: For the purposes of this sub section, 1. Senior citizen means an individual resident in India
who is of the age of sixty years or more at any time during the relevant previous year. 2. Very senior citizen
means an individual resident in India who is of the age of eighty years or more at any time during the relevant
previous year.
v DEDUCTION IN RESPECT OF MAINTENANCE INCLUDING MEDICAL TREATMENT

OF A DEPENDANT WHO IS A PERSON WITH DISABILITY [SECTION 80DD]
(1) Where an assessee, being an individual or a Hindu undivided family, who is a resident in India, has,
during the previous year, –
(a) incurred any expenditure for the medical treatment (including nursing), training and rehabilitation
of a dependant, being a person with disability; or
(b) paid or deposited any amount under a scheme framed in this behalf by the Life Insurance
Corporation or any other insurer or the Administrator or the specified company subject to the
conditions specified in Sub-section (2) and approved by the Board in this behalf for the maintenance
of a dependant, being a person with disability,
the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of
a sum of rupees seventy five thousand rupees from his gross total income in respect of the previous year.

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Provided that where such dependant is a person with servere disability, the provisions of this sub-section
shall have effect as if for the words “seventy-five thousand rupees”, the words “one hundred and twenty-five
thousand rupees” had been substituted.
(2) The deduction under clause (b) of Sub-section (1) shall be allowed only if the following conditions are
fulfilled, namely: –
(a) the scheme referred to in clause (b) of Sub-section (1) provides for payment of annuity or lump
sum amount for the benefit of a dependant, being a person with disability, in the event of the death
of the individual or the member of the Hindu undivided family in whose name subscription to the
scheme has been made;
(b) the assessee nominates either the dependant, being a person with disability, or any other person
or a trust to receive the payment on his behalf, for the benefit of the dependant, being a person with
disability.
(3) If the dependant, being a person with disability, predeceases the individual or the member of the Hindu
undivided family referred to in Sub-section (2), an amount equal to the amount paid or deposited under
Clause (b) of Sub- section (1) shall be deemed to be the income of the assessee of the previous year in which
such amount is received by the assessee and shall accordingly be chargeable to tax as the income of that
previous year.
(4) The assessee, claiming a deduction under this section, shall furnish a copy of the certificate issued by the
medical authority in the prescribed form and manner, along with the return of income under Section 139, in
respect of the assessment year for which the deduction is claimed:
Provided that where the condition of disability requires reassessment of its extent after a period stipulated in
the aforesaid certificate, no deduction under this section shall be allowed for any assessment year relating to
any previous year beginning after the expiry of the previous year during which the aforesaid certificate of
disability had expired, unless a new certificate is obtained from the medical authority in the form and manner,
as may be prescribed, and a copy thereof is furnished along with the return of income.
Explanation. – For the purposes of this section, –
(a) “Administrator” means the Administrator as referred to in clause (a) of Section 2 of the Unit
Trust of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002);
(b) “dependant” means –
(i) in the case of an individual, the spouse, children, parents, brothers and sisters of the individual, or
any of them;
(ii) in the case of a Hindu undivided family, a member of the Hindu undivided family, dependant
wholly or mainly on such individual or Hindu undivided family for his support and maintenance, and

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who has not claimed any deduction under Section 80U in computing his total income for the
assessment year relating to the previous year;
(c) “disability” shall have the meaning assigned to it in clause (i) of Section2 of the Persons with
Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995 (1 of 1996);
(d) “Life Insurance Corporation” shall have the same meaning as in Clause (iii) of Sub-section (8)
of Section 88;
(e) “medical authority” means the medical authority as referred to in clause (p) of Section 2 of the
Persons with Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995
(1 of 1996);
(f) “person with disability” means a person as referred to in Clause (f) of Section 2 of the Persons
with Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995 (1 of
1996);
(g) “person with severe disability” means a person with eighty per cent or more of one or more
disabilities, as referred to in Sub-section (4) of Section 56 of the Persons with Disabilities (Equal
Opportunities, Protection of Rights and Full Participation) Act, 1995 (1 of 1996);
(h) “specified company” means a company as referred to in Clause (h) of Section 2 of the Unit Trust
of India (Transfer of Undertaking and Repeal) Act, 2002 (58 of 2002).
---
llustration:
During the P.Y. 2012-13, the gross total income of Mr. X is Rs 4,00,000. During the P.Y. he pays the
following premiums on Mediclaim insurance policy by cheque. Calculate the amount of tax benefit under
Section 80 D.
Amount (in Rs)

1. Mr. X 6,000
2. Mrs. X 4,000
3. Son (not dependent) 3,000
4. Daughter (dependent) 2,000
5. Father (not dependent, age 69 years & resident in India) 1,500
6. Mother (dependent) (age 68 years & resident in India) 2,000

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Solution:
The insurance premium paid for son will not qualify for deduction under section 80 D as he is not dependent
upon Mr. X. As for his father, who is also a non dependent, a deduction is enjoyable.
Amounts qualifying for deduction are:-
Amount (in Rs)
Mr. X 6,000
Mrs. X 4,000
Daughter 2,000
Total 12,000
(limited to 15,000)
Additional deduction for Father and Mother 3500 (1500+ 2,000)
(limited to 20,000)
Hence, total deduction under section 80 D is Rs (12,000 + 3,500) = Rs.15,500
---
v DEDUCTION IN RESPECT OF MEDICAL TREATMENT, ETC. (SECTION 80DDB READ

WITH RULE 11DD)
Deduction is available if the following are satisfied:
• The assessee has actually paid for the medical treatment of specified disease or ailment, for himself
or any dependent [definition of ‘dependent same as the above provision] or in case of HUF any
member of the family.
• The assessee furnishes a certificate, in the prescribed form from a specialized doctor, along with the
return of income.
What is the amount that can be availed of as a deduction?:
• The amount paid or Rs. 40,000, whichever is less
• Where the amount is paid in relation to a senior citizen the deduction will be allowed for amount paid
or Rs. 60,000, whichever is less.
• The deduction shall be reduced by the amount received, if any, under an insurance from an insurer
for the medical treatment of person mentioned in this section or reimbursed by the employer.
---

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Where an individual or HUF who is resident in India has, during the previous year, actually paid any amount
for the medical treatment of such disease or ailment as may be specified in the rules made in this behalf by
the Board –
(a) for himself or a dependant, in case the assessee is an individual; or
(b) for any member of a Hindu undivided family, in case the assessee is a Hindu undivided family,
the assessee shall be allowed a deduction of the amount actually paid or a sum of forty thousand rupees,
whichever is less, in respect of that previous year in which such amount was actually paid:
Provided that no such deduction shall be allowed unless the assessee obtains the prescription for such medical
treatment from a neurologists, an oncologist, a urologist, a haematologist, an immunologist or such other
specialist, as may be prescribed.
Provided further that the deduction under this section shall be reduced by the amount received, if any, under
an insurance from an insurer, or reimbursed by an employer, for the medical treatment of the person referred
to in Clause (a) or Clause (b);
Provided also that where the amount actually paid is in respect of the assessee or his dependant or any
member of a Hindu undivided family of the assessee and who is a senior citizen, the provisions of this section
shall have effect as if for the words “forty thousand rupees”, the words “sixty thousand rupees” had been
substituted.
Provided also that where the amount actually paid is in respect of the assessee or his dependant or any
member of a Hindu undivided family of the assessee and who is a very senior citizen, the provisions of this
section shall have effect as if for the words “forty thousand rupees”, the words “eighty thousand rupees” had
been substituted. [Amendment vide Finance Act, 2015 w.e.f. 1st April, 2016]
(i) “dependant” means –
(a) in the case of an individual, the spouse, children, parents, brothers and sisters of the
individual or any of them,
(b) in the case of a Hindu undivided family, a member of the Hindu undivided family,
dependant wholly or mainly on such individual or Hindu undivided family for his support and
maintenance;
(ii) “Government hospital” includes a departmental dispensary whether full-time or part-time

established and run by a Department of the Government for the medical attendance and treating of a
class or classes of Government servants and members of their families, a hospital maintained by a
local authority and any other hospital with which arrangements have been made by the Government
for the treatment of Government servants;

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(iii) “insurer” shall have the meaning assigned to it in Clause (9) of Section 2 of the Insurance
Act,1938 (4 of 1938);
(iv) “senior citizen” means an individual resident in India who is of the age of sixty years or more
at any time during the relevant previous year.
(v) “very senior citizen” means an individual resident in India who is of the age of eighty years or
more at any time during the relevant previous year.
v DEDUCTION IN RESPECT OF REPAYMENT OF LOAN TAKEN FOR HIGHER

EDUCATION (SECTION 80E)
The deduction of an amount actually paid by an individual during the previous year out of his income
chargeable to tax by way of an interest on loan, taken by him from any financial institution or any approved
charitable institution for the purpose of pursuing his higher education. The deduction will be available in
computing the total income in respect of initial assessment years and the seven assessment years immediately
succeeding the initial assessment year or until the interest thereon is paid by such individual in full, whichever
is earlier.
The expression “higher education” is being defined to mean any course of study pursued after passing the
Senior Secondary Examination or its equivalent from any school, board or university recognised by the
Central Government or State Government or local authority or by any other authority authorised by the
Central Government or State Government or local authority to do so. The expression “financial institution”
is being defined to mean a banking company to which the “Banking Regulation Act, 1949 applies (including
any bank or banking institution referred to in Section 51 of the Act) or any other financial institution which
the Central Government may, by notification in the Official Gazette, specify in this behalf. The expression
“approved charitable institution” is being defined to mean an institution specified in, or as the case may be,
an institution established for charitable purposes and notified by the Central Government under Section
10(23C) or an institution referred to in Section 80G(2)(a). The expression “initial assessment year” means
the assessment year relevant to the previous year, in which the assessee starts paying the interest on the loan.
“Relative”, in relation to an individual, means the spouse and children of that individual or the student for
whom the individual is the legal guardian.
When is the deduction available?:
• Assessee is an individual who has taken a loan from any financial institution or an approved charitable
institution for himself or his relative (spouse and children)
• The loan must have been taken in relation to pursuit of higher education
• During the PY he has repaid some amount as interest on such loan
• Such amount is paid out of his income chargeable to tax.

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“Higher education” means any course of study pursued after passing the Senior Secondary Examination or
its equivalent from any school, board or university recognized by the Central Government or State
Government or local authority or by any other authority authorized by the Central Government or State
Government or local authority to do so
Period of Deduction - deduction shall be allowed for the PY in which the assessee starts repaying the loan
or interest thereon and seven previous years immediately succeeding it or until the loan together with interest
thereon is paid by the assessee in full ,whichever is earlier.
v DEDUCTION IN RESPECT OF RENT PAID (SECTION 80GG)
Who can avail of this deduction? - an individual in respect of rent paid by him for an accommodation used
for his residential purposes provided the following conditions are fulfilled:
• Assessee is either a self-employed person or a salaried employee, not in receipt of HRA
• Actual rent paid is in excess of 10% of his total income
• He / his spouse / minor children / HUF, of which he is a member, does not own any residential
accommodation at the place where the assessee resides, performs the duties of his office or
employment or carries on his business or profession. Where, however, the assessee owns any
residential accommodation at any other place and claims the concessions of self-occupied house
property for the same, he will not be entitled to any deduction u/s 80GG even if he does not own any
residential accommodation at the place where he ordinarily resides, performs the duties of his office
or employment or carries on his business or profession.
• The assessee files a declaration in Form No. 10BA regarding the payment of rent.
What is the deduction available under this Section? - The allowable deduction is the least of these
amounts:
• excess of actual rent paid over 10% of total income (GTI – LTCGs – STCGs under Sec 111A –
deductions under Secs.80 C- 80U – income under 115A);
• 25% of his total income; and
• Rs. 2,000 p.m.
---
Deductions admissible under this Section are:
– Actual rent paid less 10% of ‘Adjusted Total Income’.

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– 25% of such ‘Adjusted Total Income’.
– Amount calculated at Rs. 2,000 p.m.
whichever is least.
Adjusted Total Income means the Gross total income as reduced by long term capital gain if included in the
gross total income and income referred to in section 115A to 115D and the amount of deduction under section
80C other than deduction under this section.
However, certain conditions as given below are required to be fulfilled/satisfied for claiming deduction u/s
80GG
– The assessee should not be receiving any house rent allowance exempt u/s 10(13A) or rent free
accommodation.
– The accommodation should be occupied by the assessee for the purpose of his own residence.
– The assessee fulfils such other conditions or limitations as may be prescribed having regard to the
area or place in which such accommodation is situated and other relevant consideration.
– The assessee or his spouse or his minor child or an HUF of which he is a member does not own
any accommodation at the place where he ordinarily resides or performs duties of his office or
employment or carries on his business or profession.
– If the assessee owns any accommodation at any place other than that referred to above, such
accommodation should not be in the occupation of the assessee and its annual value is not required
to be determined under Section 23(2)(a)(i) or Section 23(2)(b).
– Allowed only to an individual assessee after furnishing Form 10BA along with return of income.
In order to provide relief to the individual tax payers, Section 80GG has been amended so as to
increase the maximum limit of deduction from existing Rs. 2000 per month to Rs. 5000 per month.
This amendment effective from 1st April, 2017 and accordingly apply in relation to assessment year
2017-18 and subsequent assessment years.
---
v DEDUCTION IN RESPECT OF INTEREST ON DEPOSITS IN SAVINGS ACCOUNT

(SECTION 80TTA)
This deduction was inserted into the law w.e.f. 1st April 2012 (AY 2013-2014)
Who can avail this deduction? - Individual or HUF

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Deduction from gross total income up to a maximum of Rs.10,000, in respect of interest on deposits in
savings account (not time deposits) with a bank, co-operative society or post office
---
(1) Where the gross total income of an assessee, being an individual or a Hindu undivided family, includes
any income by way of interest on deposits (not being time deposits) in a savings account with –
(a) a banking company to which the Banking Regulation Act, 1949 (10 of 1949), applies (including
any bank or banking institution referred to in section 51 of that Act);
(b) a co-operative society engaged in carrying on the business of banking (including a co-operative
land mortgage bank or a co-operative land development bank); or
(c) a Post Office as defined in clause (k) of section 2 of the Indian Post Office Act, 1898 (6 of 1898),
deduction upto Rs. 10,000 shall be allowed in computing the total income of the assessee.
(2) Where the income referred to in this section is derived from any deposit in a savings account held by, or
on behalf of, a firm, an association of persons or a body of individuals, no deduction shall be allowed under
this section in respect of such income in computing the total income of any partner of the firm or any member
of the association or any individual of the body.
"Time deposits" means the deposits repayable on expiry of fixed periods.
v DEDUCTION IN CASE OF A PERSON WITH DISABILITY (SECTION 80U)
What are the conditions to avail of this deduction?
• The assessee is a resident individual
• He is a person with disability.
• He is certified by the medical authority to be a person with disability, at any time during the previous
year.
• He furnishes a certificate issued by the medical authority in the prescribed form along the return of
income
What is the amount of deduction? It is a fixed deduction, per the following details:
• Rs. 50,000 in case of a person with disability

• Rs. 1,00,000 in case of a person with severe disability (having a disability over 80%)
---

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(1) Amount of deduction:
(A) In computing the total income of an individual being a resident, who, at any time during the previous
year is certified by the medical authority to be a person with disability, there shall be allowed a deduction a
sum of Rs. 75,000.
Provided that where such individual is a person which severe disability, the provisions of this sub-section
shall have effect as if for the words “Rs. 75,000” the words “Rs. 1,25,000” has been substituted.
(B) Every individual claiming a deduction under this section shall furnish a copy of the certificate issued by
the medical authority in the form and manner, as may be prescribed, along with the return of income under
Section 139, in respect of the assessment year for which the deduction is claimed:
Provided that where the condition of disability requires reassessment of its extent after a period stipulated
in the aforesaid certificate, no deduction under this section shall be allowed for any assessment year relating
to any previous year beginning after the expiry of the previous year during which the aforesaid certificate of
disability had expired, unless a new certificate is obtained from the medical authority in the form and manner,
as may be prescribed, and a copy thereof is furnished along with the return of income under Section 139.
(a) “disability” shall have the meaning assigned to it in clause (i) of Section 2 of the Persons with
Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995 and includes
“autism”, “cerebral palsy” and “multiple disabilities” referred to in clauses (a), (c) and (h) of Section
2 of the National Trust for Welfare of Persons with Autism, Cerebral Palsy, Mental Retardation and
Multiple Disabilities Act, 1999;
(b) “medical authority” means the medical authority as referred to in clause (p) of Section 2 of the
Persons with Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995,
or such other medical authority as may, by notification, be specified by the Central Government for
certifying “autism”, “cerebral palsy”, “multiple disabilities”, “person with disability” and “severe
disability” referred to in clauses (a), (c), (h), (q) and (o) of Section 2 of the National Trust for Welfare
of Persons with Autism, Cerebral Palsy, Mental Retardation and Multiple Disabilities Act, 1999;
(c) “person with disability” means a person referred to in clause (t) of Section 2 of the Persons with
Disabilities (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995, or clause (j)
of Section 2 of the National Trust for Welfare of Persons with Autism, Cerebral Palsy, Mental
Retardation and Multiple Disabilities Act, 1999;
(d) “Person with severe disability” means:
(i) a person with eighty per cent or more of one or more disabilities, as referred to in Sub-
section (4) of Section 56 of the Persons with Disabilities (Equal Opportunities, Protection of
Rights and Full Participation) Act, 1995; or

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(ii) a person with severe disability referred to in clause (o) of Section2 of the National Trust
for Welfare of Persons with Autism, Cerebral Palsy, Mental Retardation and Multiple
Disabilities Act, 1999.
v DEDUCTION IN RESPECT OF ROYALTY ON PATENTS (SECTION 80RRB)
Who can avail of the deduction? - Individual resident in India
What are the conditions?:

• The assessee must be an individual resident of India who is a patentee receiving royalty income in
respect of a patent registered on or after 1st April, 2003
• The assessee must furnish a certificate in the prescribed form duly signed by the prescribed authority
What is the deduction? - up to Rs. 3,00,000 or the income received, whichever is less.
---
(1) Where in the case of an assessee, being an individual, who is –
(a) resident in India;
(b) a patentee;
(c) in receipt of any income by way of royalty in respect of a patent registered on or after the 1st day
of April, 2003 under the Patents Act, 1970, and
his gross total income of the previous year includes royalty, there shall, in accordance with and subject to the
provisions of this section, be allowed a deduction of 100% of such income or ` 300,000, whichever is less.
Provided that where a compulsory licence is granted in respect of any patent under the Patent Act, 1970, the
income by way of royalty for the purpose of allowing deduction under this section shall not exceed the
amount of royalty under the terms and conditions of a licence settled by the Controller under that Act:
Provided further that in respect of any income earned from any sources outside India, so much of the income,
shall be taken into account for the purpose of this section as is brought into India by, or on behalf of, the
assessee in convertible foreign exchange within a period of six months from the end of the previous year in
which such income is earned or within such further period as the competent authority may allow in this
behalf.
(2) Certificates to be furnished:
(a) No deduction under this section shall be allowed unless the assessee furnishes a certificate in the
prescribed form (Form No. 10CCD), duly signed by the prescribed authority, along with the return
of income setting forth such particulars as may be prescribed.

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(b) No deduction under this section shall be allowed in respect of any income earned from any source
outside India, unless the assessee furnishes a certificate in the prescribed form (Form No. 10H), from
the authority or authorities, as may be prescribed, along with the return of income.
(3) No Double deduction: Where a deduction for any previous year has been claimed and allowed in respect
of any income referred to in this section, no deduction in respect of such income shall be allowed, under any
other provision of this Act in any assessment year.
(a) “Controller” shall have the meaning assigned to it in clause (b) of Sub-section (1) of Section 2
of the Patents Act, 1970;
(b) “lump sum” includes an advance payment on account of such royalties which is not returnable;
(c) “patent” means a patent (including a patent of addition) granted under the Patents Act, 1970;
(d) “patentee” means the person, being the true and first inventor of the invention, whose name is
entered on the patent register as the patentee, in accordance with the Patents Act, 1970, and includes
every such person, being the true and first inventor of the invention, where more than one person is
registered as patentee under that Act in respect of that patent;
(e) “patent of addition” shall have the meaning assigned to it in clause (q) of Sub-section (1) of
Section2 of the Patents Act, 1970;
(f) “patented article” and “patentedprocess”shallhavethemeaningsrespectivelyassignedtothemin

clause (o) of Sub-section (1) of Section 2 of the Patents Act, 1970;
(g) “royalty”, in respect of a patent, means consideration (including any lump sum consideration but
excluding any consideration which would be the income of the recipient chargeable under the head
“Capital gains” or consideration for sale of product manufactured with the use of patented process or
of the patented article for commercial use) for –
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent;
or
(ii) the imparting of any information concerning the working of, or the use of, a patent; or
(iii) the use of any patent; or
(iv) the rendering of any services in connection with the activities referred to in Sub-clauses
(i) to (iii)
(h) “true and first inventor” shall have the meaning assigned to it in Clause (y) of Sub-section (1) of Section
2 of the Patents Act, 1970.

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v DEDUCTION IN RESPECT OF DONATIONS TO CERTAIN FUNDS, CHARITABLE

INSTITUTIONS, ETC. (SECTION 80G)
There are various funds created by Governments to take care of natural calamities like earthquake, floods,
etc. Similarly certain funds have been created to promote social and economic welfare and education.
To incentivize contribution into these funds, deduction has been provided in Section 80G for donations given
by assessee to these funds.
Who can avail of the deduction?: All assessees
What are the conditions for availing a deduction?:
• Donation should be monetary – not in kind
• Donation should be made to the stipulated funds / institutions
What should be the mode of payment?: Donation can be given in cash, or cheque or draft. No deduction
shall be allowed under Section 80G in respect of donation made in cash of an amount exceeding Rs 10,000
from AY 2013-2014.
For the sake of convenience, the donations have been divided into four categories depending on the quantum
of deduction:
Quantum of deduction:
(A) 100% Deduction without any qualifying limit:
(i) National Defense fund.
(ii) Prime Minister’s National relief fund.
(iii) Prime Minister’s Earthquake relief fund.
(iv) Africa fund.
(v) National Trust for welfare of persons with autism, cerebral palsy, mental retardation and multiple
disabilities.
(vi) National cultural fund set up by the Central Government.
(vii) The Chief Minister’s relief fund or the lieutenant Governor’s relief fund.
(viii) National Illness Assistance fund.

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(ix) The Andhra Pradesh Chief Minister’s Cyclone Relief Fund, 1996.
(x) The Army/Air force Central welfare fund or the Indian Naval Benevolent fund.
(xi) Any fund set up by a State Government to provide medical relief to poors.
(xii) The National/State Blood transfusion Council.
(xiii) Zila Saksharta Samiti constituted in any district.
(xiv) Any fund set up by the State Government of Gujarat, exclusively for providing relief to the
victims of earthquake in Gujarat.
(xv) Maharashtra Chief Minister’s Earthquake Relief Fund.
(xvi) University/Educational Institute of National Eminence approved by the prescribed authority.
(xvii) National foundation for communal harmony.
(xviii) Fund for technology development and application, set up by the Central Government.
(xix) National sports fund set up by the Central Government.
(xx) National Children’s Fund.
(xxi) the Swachh Bharat Kosh, setup by the Central Government , other than the sum spent by the
assessee in pursuance of Corporate Social Responsibility under sub-section (5) of section 135 of the
Companies Act, 2013 (18 of 2013);
(xxii) the Clean Ganga Fund, set up by the Central Government, whereas such assessee is a resident
and such sum is other than the sum spent by the assessee in pursuance of Corporate Social
Responsibility under sub-section (5) of section 135 of the Companies Act, 2013
(xxiii) the National Fund for Control of Drug Abuse constituted under section 7A of the Narcotic
Drugs and Psychotropic Substances Act, 1985 (61 of 1985);
(B) 50% Deduction without any qualifying limit:
(i) Jawaharlal Nehru Memorial Fund.
(ii) Indira Gandhi Memorial Trust.
(iii) Rajiv Gandhi Foundation.
(iv) Prime Minister’s Drought Relief Fund.

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(C) 100% Deduction subject to qualifying limit:
(i) Any sum to Government or any approved local authority, institution or association to be utilized
for promoting family planning.
(ii) Any sum paid by the assessee, being a company, in the previous year as donation to Indian
Olympic Association or to any other association established in India and notified by the Central
Government for:
I. Development of infrastructure for sports and games or
II. Sponsorship of sports and games in India.
(D) 50% Deduction subject to qualifying limit:
(i) Donation to Government or any approved Local Authority , Institution or Association to be

utilized for any Charitable purpose other than promoting family planning.
(ii) Any other Fund or Institution, which satisfies the conditions of Section 80G(5).
(iii) Notified Temple, Mosque, Gurudwara, Church or any other place notified by the Central
Government to be of historic, as chorological or artistic importance, for renovation or repair of such
place.
(iv) Any corporation established by the Central or State Government specified under Section
10(26BB) for promoting interests of the members of a minority community.
(v) Any authority constituted in India by or under any law for satisfying the need for housing
accommodation or for the purpose of planning development or improvement of cities, towns and
villages or for both for applying qualifying limit, all donations made to funds/institutions covered
under (C) and (D) above shall be aggregated and the aggregate amount shall be limited to 10% of
adjusted Gross Total Income :
– Adjusted Gross total income means the “Gross Total Income” as reduced by:
I. Long-term Capital gains, if any which have been included in the “Gross Total Income”.
II. All deductions permissible under Sections 80C to 80U excepting deduction under Section
80G.
III. Exempted Income.
IV. Income of NRIs and Foreign Companies under Sections 115A, 115AB, 115AC, 115ACA or
115AD.
- Quantum of deduction: Aggregate of deduction permissible under clauses (A), (B), (C) & (D).

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No deduction shall be allowed under this section in respect of donation of any sum exceeding ten
thousand rupees unless such sum is paid by any mode other than cash.
The quantum of deduction is as follows :-

• Category A- 100 % of amount donated
• Category B - 50 % of the amount donated in the funds
• Category C – 100% of the amount donated in the funds subject to maximum limit of 10% of Adjusted
GTI.
• Category D – 50% of the amount donated in the funds subject to maximum limit of 10% of Adjusted
GTI.
The total of these deductions under categories A,B,C, & D is the quantum of deduction under this section
without any maximum amount.
Adjusted Gross Total income means Gross Total Income minus long-term capital gain, short term capital
gain taxable u/s 111A, and all deductions u/s 80C to 80U (except any deduction under Sec 80G) and income
referred to under Section 115A to 115AD (income of NRIs and foreign companies taxable at a special rate
of tax).
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Deductions from Gross Total Income – Sample Problems

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H. Tax Planning, Avoidance and Evasion

Tax Planning is an exercise undertaken to minimize tax liability through the best use of all available
allowances, deductions, exclusions, exemptions, etc., to reduce income and/or capital gains. Tax
management involves compliance of law regularly and timely as well as the arrangement of the affairs of the
business in such manner that it reduces the tax liability. It includes the following functions: filing of tax
return, payment of tax on time, appearing before the appellate authority etc.
The Concept of Tax Planning
Tax Planning is an exercise undertaken to minimize tax liability through the best use of all available
allowances, deductions, exclusions, exemptions, etc., to reduce income and/or capital gains.
Tax planning can be defined as an arrangement of one’s financial and business affairs by legitimately taking
full benefit of all deductions, exemptions, allowances and rebates, such that tax liability reduces to minimum.
In other words, all arrangements by which tax is saved by ways and means which comply with legal
obligations and requirements – and are not colourable devices or tactics that meet the letters of the law, but
not the spirit behind the law – would constitute tax planning.
The Supreme Court in McDowell & Co. v. CTO (1985) 154 ITR 148 had observed that “tax planning may
be legitimate provided it is within the framework of the law. Colourable devices cannot be part of tax
planning and it is wrong to encourage or entertain the belief that it is honourable to avoid payment of tax by
resorting to dubious methods.” Tax planning should not be done with intent to defraud the revenue
authorities. Even though all transactions entered into by an assessee could be legally correct, on the whole,
these transactions may be devised to defraud the revenue authorities. All such devices where the statute is
followed in strict words, but where the actual spirit behind the statute is disregarded, would be termed as
colourable devices; such devices do not form part of tax planning. All transactions in respect of tax planning
must be in accordance with the true spirit of the statute and should be correct in form and substance.
Various judicial pronouncements have laid down the principle that form and substance of the transactions
shall be seen in totality to determine the net effect of a particular transaction. Th Supreme Court in the case
of CIT v. B M Kharwar (1969) 72 ITR 603 had held that, “The tax authority is entitled and is indeed bound
to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a
device the legal relation, it is open to the tax authorities to unravel the device and determine the true character
of relationship. But the legal effect of a transaction cannot be displaced by probing into substance of the
transaction.”
The form and substance of a transaction is the real test of any tax-planning device. The form of a
transaction refers to the transaction, as it appears superficially, though the real intention behind such
transaction may remain concealed. The substance of a transaction refers to the true nature of the transaction
on lifting the veil of legal documents – the substance of a transaction reflects the true intention of the parties
behind the transaction.
How Tax is levied
Before discussing the concept of tax planning in detail, it is essential to understand how tax is levied.

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Though wide latitude is given to the legislature in the matter of levying taxes, it is essential that the taxing
statute ( or the tax) should be constitutionally valid to pass the muster of Article 14 of the Constitution of
India.
Article 265 of the Constitution of India prescribes that “no tax shall be levied or collected except by authority
of law”.
No tax is complete under a fiscal statute unless the subject, the object and the quantum of tax are prescribed
or indicated in the provision. In doing so, there can be different rates of tax levied upon the nature of
business/profession carried on or depending on the capacity of the person to pay the tax and/or other relevant
consideration. No income should be taxed presumptively. There is no equity about taxation and no income
should be taxed twice.
It is now well settled that a modern State, particularly when exercising powers of taxation, has to deal with
complex factors/relating to the objects to be taxed, tax to be levied, the social and economic policies etc.
Thus, the liability of tax depends upon the charging section in the statute vis-a-vis ‘taxable person’, ‘taxable
event’ and ‘subject matter of taxation’. For understanding these inter-related but distinct concepts reference
may be made to the Supreme Court’s decision in State of Tamil Nadu v. M.K. Kandaswami (1975, 36 STC
191).
TAX PLANNING, TAX AVOIDANCE AND TAX EVASION
In India, the tax laws are admittedly complicated because of various deductions, exemptions, relief and
rebates. Therefore, it is only logical that taxpayers generally plan their affairs so as to attract the least
incidence of tax. However, practice of avoidance is a worldwide phenomenon and there is always a
continuing battle in this regard between the taxpayer and the tax collector. The perceptions of both are
different. The taxpayer spares no efforts in maximising his profits and attracting the least incidence. The tax
gatherer, on the other hand, tries to thwart efforts whose sole objective is to save taxes.
In the context of saving tax, there are three commonly used practices, namely (a) Tax Evasion; (b) Tax
Avoidance; (c) Tax Planning.

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v Tax Evasion:
Tax evasion refers to a situation where a person tries to reduce his tax liability by deliberately concealing the
true amount of his income or by inflating the true amount of his expenditure. In tax evasion, one’s income is
shown to be lower than its actual figure; this is achieved by resorting to various types of deliberate
manipulations.
An assessee guilty of tax evasion is punishable under the relevant laws. Tax evasion may involve stating an
untrue statement knowingly, submitting misleading documents, suppression of facts, not maintaining proper
accounts of income earned (if required under the law), omission of material facts in assessments. An assessee
who dishonestly claims benefit under the statute by making false statements, would also be guilty of tax
evasion.
A tax evader has to not only pay a penalty for such acts, but he also incurs the risk of being prosecuted. Tax
evasion can never be construed as tax planning because it amounts to breaking of the law; tax planning is
devised within the legal framework and it allows one to avail or work within the stipulations and provisions
set forth by the legislature. Tax planning ensures not only accrual of tax benefits within the four corners of
law, but it also ensures that tax obligations are properly discharged so as to avoid penal provisions.
In brief:
• Tax evasion – intention to avoid tax liability where there is actual knowledge of liability – involves
deliberate concealment of facts from the revenue authorities.
• Tax evasion is looked upon as illegal conduct
• Examples: collecting revenue in cash with no record / bills, failure by a taxable person to notify the
tax authorities of his presence in the country if he is carrying on taxable activities in such country.
• Chapter XXII, Income Tax Act, 1961 has various penalty provisions
v Tax Avoidance:
The line of demarcation between tax planning and tax avoidance is very thin and blurred. There could be
elements of mala fide motive (as in the case of tax evasion) involved in tax avoidance also. Any planning
which, though done strictly according to legal requirements, defeats the basic intention behind the statute
could be termed as an instance of tax avoidance. It is usually done by taking full advantage of loopholes,
adjusting one’s affairs in such a manner that there is no infringement of taxation laws and such that least
taxes are attracted.
Earlier, tax avoidance was considered completely legitimate; at present, however, it may be illegitimate in
certain situations.

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In the judgement of the Supreme Court in McDowell & Co. Ltd. Vs Commercial Tax Officer (1985), tax
avoidance had been considered as heinous as tax evasion and a crime against society. The Supreme Court
observed – “we think time has come for us to depart from Westminster principle.......tax planning may be
legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and
it is wrong to encourage and entertain the belief that it is honourable to avoid the payment of tax by resorting
to dubious methods. It is the obligation of every citizen to pay honestly without resorting to subterfuges.”
Many of the recent amendments to the income tax Act are now aimed at curbing the practice of tax avoidance.
The types of cases that come under ‘Tax avoidance’ are those where the tax payer has apparently
circumvented the law (without giving rise to an offence) by using a scheme, arrangement or device, though
of a complex nature, with the main or sole purpose of deferring, reducing or completely avoiding tax payable
under the law.
Sometimes, tax avoidance is accomplished by shifting the liability of tax to another person, not at arm’s
length, in whose hands the tax payable is reduced or eliminated.
According to G.S.A. Wheat Craft, “tax avoidance is the act of dodging tax without actually breaking the
law”. It is a method of reducing incidence of tax by taking advantages of certain loopholes of tax laws.
Thus, the line of demarcation between tax avoidance and tax planning is very thin and blurred. There is an
element of mala fide motive involved in tax avoidance.
For the present purposes, the expression “Tax Avoidance” will be used to describe every attempt, by legal
means, to prevent or reduce tax liability, which would otherwise be incurred, by taking advantage of some
provisions or lack of provisions of law. Tax evasion, thus, excludes fraud, concealment or other illegal
measures”.
In brief:
• Unlike evasion, it indicates structuring one’s income with the aim of avoiding tax through legal means
- arranging affairs in such a way as to take advantage of weaknesses or ambiguities in the tax law.
• Justice Reddy describes it as ‘the art of dodging tax without breaking the law’ (McDowell)
• Black’s Law Dictionary defines tax avoidance as ‘the minimization of one’s tax liability by taking
advantage of legally available tax planning opportunities. Tax avoidance may be contrasted with
evasion, which entails the reduction of tax liability by using illegal means’.
• Although the means are legal and not fraudulent, results are considered improper or abusive.
Some examples of tax avoidance strategies:
• Compensating employees by structuring a significant part of income in the form of allowances and
perks.

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• Investment by foreign institutional investors (FIIs) in shares of companies listed on stock exchanges
by routing investments through a firm floated in Mauritius. Capital gains in the hands of FIIs is
taxable in Mauritius where capital gains from shares are exempt. (Azadi Bachao Andolan v Union of
India (2004) 10 SCC 1)
• An example of a more complex tax avoidance strategy involving multiple jurisdictions is one known
famously as Double Irish with a Dutch Sandwich.
Double Irish With a Dutch Sandwich:
The double Irish with a Dutch sandwich is just one of a class of similar international tax avoidance schemes.
Each involves arranging transactions between subsidiary companies to take advantage of the idiosyncrasies
of varied national tax codes. These techniques are most prominently used by tech companies, because these
firms can easily shift large portions of profits to other countries by assigning intellectual property rights to
subsidiaries abroad.
The double Irish with a Dutch sandwich is generally considered to be a very aggressive tax planning strategy.
It is, however, famously used by some of the world's largest corporations, such as Google, Apple and
Microsoft. In 2014, it came under heavy scrutiny, especially from the United States and the European Union,

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when it was discovered that this technique facilitated the transfer of several billion dollars annually tax-free
to tax havens.
How it works:
The process involves two Irish companies, a Dutch company, and an offshore company located in a tax
haven. The first Irish company is used to receive large royalties on goods, such as iPhones sold to U.S.
consumers. The U.S. profits, and therefore taxes, are dramatically lowered, and the Irish taxes on the royalties
are very low. Due to a loophole in Irish laws, the company can then transfer its profits tax-free to the offshore
company, where they can remain untaxed for years.
The second Irish company is used for sales to European customers. It is also taxed at a low rate and can send
its profits to the first Irish company using a Dutch company as an intermediary. If done right, there is no tax
paid anywhere. The first Irish company now has all the money and can again send it onward to the tax haven
company.
The End of the Double Irish With a Dutch Sandwich:
Due largely to international pressure and the publicity surrounding Google's and Apple's use of the double
Irish with a Dutch sandwich, the Irish finance minister, in the 2015 budget, passed measures to close the
loopholes and effectively end the use of the double Irish with a Dutch sandwich for new tax plans. Companies
with established structures will continue to benefit from the old system until 2020.
v Tax Planning/Mitigation:
Tax planning refers to the arranging of the financial activities in such a way that maximum tax benefits are
enjoyed by making use of all beneficial provisions in the tax laws which entitle the assessee to get certain
rebates and reliefs. Tax planning is permitted and not frowned upon by law.
Thus, tax planning would imply compliance with the taxation provisions in such a manner that full advantage
is taken of all tax exemptions, deductions, concessions, rebates and reliefs permissible under the Income Tax
Act so that the incidence of tax is the least.
Tax planning can neither be equated with tax evasion nor with tax avoidance. It amounts to the reasonable
and ethically-justified planning of the assesee’s operations to minimize, postpone or defer the his liability by
availing various incentives, concessions, allowances, rebates and relief’s provided for in the tax laws. They
are meant to be availed of and they have certain clear objectives to achieve.
Therefore, notwithstanding legal rulings in cases like McDowell and its English parallels, real and genuine
transactions aimed at a valid tax planning cannot be turned down merely on grounds of reduction of the tax
burden.
Flexibility has to be considered as a practical feature in a tax system.
While planning a scheme relating to tax affairs, tax planners need to assure that tax their planning device
does not lose its efficiency due to changes in law. It would be short-sighted to settle with a planning device
that is in conformity with the law as it exists in the present, ignoring the fact that it might get nullified by a
subsequent change in law (especially where the change may be of a retrospective nature). Hence, a tax plan

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has to be flexible in nature and the planner has to account for future scenarios while devising a plan to save
tax.
In brief:
• Tax avoidance may be further classified into acceptable and unacceptable conduct
• Conduct resulting in mitigation of tax exposure by the use of preferences given under the law
(example – utilizing the deductions and exemptions available under the law)
• An example from the Expert Committee on GAAR: setting up an industry in a SEZ so as to avail the
various tax sops under law
• Is it a person’s legitimate right to so arrange his affairs? (Westminster approach)
• In McDowell’s case (AIR 1986 SC 649), the Supreme Court held that tax planning may be legitimate
provided it is within the framework of law. However, a colourable device was held to be outside the
scope of tax planning (tax evasion).
Is GAAR (General Anti-Avoidance Rule) the solution?:
• Codification of the substance over form approach in the domain of tax laws
• The idea behind GAAR (as presently drafted) is to tackle an impermissible avoidance arrangement
(IAA).
• An IAA means a transaction where the main purpose is to obtain a tax benefit and includes
transactions where there is an abuse / misuse of the law or where the transaction lacks commercial
substance.
• Latest announcement: GAAR will be implemented from April 2016 and would apply to business
arrangements where the tax benefit exceeds Rs. 3 crores.
---
GAAR is an anti-avoidance measure which empowers tax authorities to call a business arrangement or a
transaction an ‘impermissible avoidance arrangement’, and thereby deny tax benefits to the parties.
Avoidance is legal possibility which allows investors to legally reduce their tax liability.
GAAR is a concept which generally empowers the revenue authorities in a country to deny tax benefits to
transactions or arrangements which do not have any commercial substance or consideration, other than
achieving the tax benefit.
Whenever revenue authorities question such transactions, there is normally a conflict which ensues with tax
payers. Thus, different countries started making rules so that tax cannot be avoided by such transactions.

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Australia introduced such rules in 1981. Later on, countries like Germany, France, Canada, New Zealand,
South Africa etc too opted for GAAR.
GAAR in India:
In India, discussions on GAAR came to light with the release of the draft Direct Taxes Code Bill (popularly
knownas DTC 2009) on 12th August, 2009. It contained provisions for GAAR. Later on, a revised Discussion
Paper was released in June 2010, followed by the tabling in Parliament on 30th August, 2010, a formal Bill
to enact the law known as the Direct Taxes Code 2010.
The concept of avoidance has been an area of debate, and the Supreme Court in its latest Vodafone judgment
has held it to be valid, provided it is allowed by the law; the Court also opined that India has room to enact
GAAR.
The intention to introduce GAAR was announced in the Finance Act 2012. The first draft of GAAR, when
published, received heavy criticism.
The Shome committee was formed to come up with recommendations and guidelines.
Many provisions of GAAR have been criticised by various people. However, the basic criticism of GAAR
provisions is that it is considered to be too sweeping in nature and there was a fear (considering the poor
record of income tax authorities in India) that Assessing Officers will apply these provisions in a routine
manner (or read misuse) and harass the honest tax payer.
There is only a fine distinction between Tax Avoidance and Tax Mitigation, as any arrangement to obtain a
tax benefit can be considered an impermissible avoidance arrangement by the assessing officer. For this
reason, there has been a sustained demand to put checks and balances in place to avoid arbitrary application
of the GAAR provisions by the assessing authorities. It was felt that there is a need for further legislative and
administrative safeguards and at least a minimum threshold limit for invoking GAAR should be introduced
so that small time tax payers are not harassed.

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I. Basic Overview of International Tax Provisions – An Indian Perspective
After the liberalization of the Indian economy and easing of restrictions on the entry of foreign entities, cross
border business transactions have increased manifold. Since India becoming a member of the World Trade
Organisation (WTO) in January 1995, the Indian economy has became robust and an atmosphere has
emerged wherein Foreign Institutional Investments (FII) in India have increased tremendously.
These developments have had ramifications on the framework and system of taxation in the country.
Issues/concerns pertaining to tax havens, transfer pricing, double taxation, WTO, Subpart F, etc. are required
to be taken care of and have become a part and parcel of international taxation regime.
BASIC CONCEPTS
A. Tax Haven
• A country that offers foreign individuals and businesses little or no tax liability in a politically and
economically stable environment.
• Tax havens also provide little or no financial information to foreign tax authorities.
• Individuals and businesses that do not reside a tax haven can take advantage of these countries' tax
regimes to avoid paying taxes in their home countries.
• Tax havens do not require that an individual reside in or a business operate out of that country in
order to benefit from its tax policies.
• However, pressure from foreign governments that want to collect all the tax revenue they believe
they are entitled to have caused some tax haven countries to sign Tax Information Exchange
Agreements (TIEAs) and mutual legal assistance treaties (MLAT) that provide foreign governments
with formerly secret information about investors' offshore accounts.

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A tax haven is a country that offers foreign individuals and businesses little or no tax liability in a politically
and economically static environment. Tax havens also share limited or no financial information with foreign
tax authorities. Tax havens do not require residency or business presence for individuals and businesses to
benefit from their tax policies. Due to the globalization of business operations, an increasing number of U.S.
corporations, including Microsoft, Apple and Alphabet, are keeping cash in offshore tax havens to minimize
corporate taxes.
Tax haven status benefits the host country as well as the companies and individuals maintaining accounts in
them. Tax haven countries benefit by drawing capital to their banks and financial institutions, which can
form the foundation of a thriving financial sector. Individuals and corporations benefit through tax savings
resulting from rates ranging from zero to the low single digits versus higher taxes in their countries of
citizenship or domicile.
The list of tax haven countries includes Andorra, the Bahamas, Belize, Bermuda, the British Virgin Islands,
the Cayman Islands, the Channel Islands, the Cook Islands, Hong Kong, The Isle of Man, Mauritius,
Lichtenstein, Monaco, Panama, and St. Kitts, and Nevis.
The Organisation for Economic Co-operation and Development (OECD) in its 1998 Report on Harmful Tax
Competition describes a tax haven as a jurisdiction which imposed no or nominal effective tax and provided
opportunities to non-residents to escape their home taxes or to indulge in illegal activities.
The following is the criteria identified by OECD in identifying a Tax Haven:
I. Tax rates: there is zero or nominal tax on income (generally or in specified circumstances).
II. No effective exchange of information: information cannot (or not easily) be obtained from banks and
other financial institutions for official purposes such as tax collection (including other countries’
taxes)
III. Lack of transparency: in the operation of the legislative, legal or administrative provisions
IV. Jurisdiction facilitates establishment of foreign owned entities without the need for a local substantive
presence or prohibits entities from having a commercial impact on the economy (withdrawn in 2002)
- Tax Havens are characterized by a combination of tax and non-tax factors (infrastructure, relaxed regulatory
framework).
- The Government of a Tax Haven country often facilitates the establishment of foreign owned enterprises
without requiring strict compliance of local laws or prohibits such entities from having any mechanical
impact on the local economy.
- Conducting business through tax haven countries may not always be profitable. Some tax havens have
resulted in failed adventures or misadventures – e.g. Beirut, Tangiers and Liberia.

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- Distinction between tax havens and preferential tax regimes (significant revenues from taxation, subject to
preferential features and adopting ring fencing).
Purposes served by a tax haven:
Ø Location for holding passive investments
Ø Location where paper profits can be booked
Ø Affairs of taxpayers, particularly their bank accounts, are shielded from scrutiny by tax authorities of
other countries
Negative externalities:
Tax havens or harmful preferential tax regimes that drive the effective tax rates levied on income from mobile
activities significantly below rates in other countries have the potential to cause harm by:
Ø distorting financial and, indirectly, real investment flows;
Ø undermining the integrity and fairness of tax structures;
Ø discouraging compliance by all taxpayers;
Ø re-shaping the desired level and mix of taxes and public spending;
Ø causing undesired shifts of part of the tax burden to less mobile tax bases, such as labor, property and
consumption; and
Ø increasing the administrative costs and compliance burdens on tax authorities and taxpayers.
B. Offshore Financial Centres (OFCs)
• Described as countries or jurisdictions with financial institutions that deal primarily with non-
residents on a scale disproportionate to their size.
• Usually possess one or more of the following characteristics: low or zero taxation, moderate or light
financial regulation and banking secrecy and anonymity.
• OFCs are not easily defined, but they can be characterized as jurisdictions that attract a high level of
non-resident activity.
• Traditionally, the term has implied some or all of the following (but not all OFCs operate this way):
- Low or no taxes on business or investment income;

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- No withholding taxes;
- Light and flexible incorporation and licensing regimes;
- Light and flexible supervisory regimes;
- Flexible use of trusts and other special corporate vehicles;
- No need for financial institutions and/or corporate structures to have a
- physical presence;
- An inappropriately high level of client confidentiality based on
- impenetrable secrecy laws;
- Unavailability of similar incentives to residents.”
C. Shell Companies
• A shell corporation is a company which serves as a vehicle for business transactions without itself
having any significant assets or operations. Some shell companies may have had operations, but those
may have shrunk due to unfavorable market conditions or company mismanagement.
• Shell corporations are not in themselves illegal, and they do have legitimate business purposes.
However, they are a main component of the underground economy, especially those based in tax
havens.
• They may also be known as international business company, personal investment companies, front
companies, or “mailbox" companies.
• Shell companies are also used for tax avoidance. A classic tax avoidance operation is based on the
buying and selling through tax haven shell companies to disguise true profits. The firm does its
international operations through this shell corporation, thus not having to report to its country the
sums involved, avoiding any taxes.
D. Global Forum
In charge of promoting tax cooperation and information exchange among tax administration, the Global
Forum was restructured in September 2009 in Mexico in response to the G20 call to strengthen exchange of
information in the context of major progress made towards full transparency.
The Global Forum is the continuation of a forum which was created in the early 2000s in the context of
OECD work on tax havens. The restructured Global Forum now ensures that all its members are on an equal
footing and will fully implement the standard on exchange of information they have committed to implement.
Who are the members of the Global Forum?
As of April 2013, there are 120 members. As agreed in Mexico the initial potential members are: all the
financial centers which participated in the previous Global Forum; all OECD countries and all G20
economies. The initial 91 potential members have confirmed their membership. In addition, in order to
maintain a level playing field, the Global Forum has identified countries of relevance to its work. This has
been the case of Botswana, the Federated States of Micronesia, Ghana, Jamaica, Former Yugoslav Republic
of Macedonia, Lebanon, Qatar and Trinidad & Tobago. Only Lebanon has so far refused to commit to the

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standard and become a member of the Global Forum despite being identified as a jurisdiction relevant to the
Global Forum’s work. Finally, as requested by the G20, developing countries are invited to join the Global
Forum to benefit from the new environment of transparency; many developing countries have joined in 2012
and 2013.
How did the peer review process come about?
Tax evasion and the need for effective international co-operation in tax matters has been very high on the
political agenda in recent years, and has received a lot of attention from the G20. In 2009, unprecedented
progress was made by the international community in the fight against tax fraud and evasion, however there
was a need to ensure that the progress made results in full transparency and effective exchange of information
for tax purposes.
Reflecting this, the Global Forum on Transparency and Exchange of Information for Tax Purposes was
dramatically restructured at its Mexico meeting in September 2009 to make it a more effective and open
body and it was mandated to put in place a robust and in-depth peer review mechanism.
The aim is to safeguard the commitments jurisdictions made and to respond in particular to the G20 call for
rapid and effective implementation of the standards of transparency and exchange of information.
All members of the Global Forum as well as jurisdictions identified by the Global Forum as relevant to its
work, will undergo reviews of the implementation of their systems for the exchange of information in tax
matters. The peer review process is overseen by the 30 members of the Peer Review Group, which is chaired
by France, assisted by four vice-chairs from India, Japan, Singapore and Jersey.
How does the peer review process work?
The Peer Reviews happen in two Phases:
Phase 1 is a review of each jurisdiction’s legal and regulatory framework for transparency and the exchange
of information for tax purposes and
Phase 2 involves a survey of the practical implementation of the standards.
Some jurisdictions have been selected to do a combined Phase 1 and Phase 2 review. Reviews are conducted
in accordance with the Methodology, which guarantees that peer input is provided at each stage.
Once a review is launched, all members of the Global Forum are asked to provide input regarding the assessed
jurisdiction, particularly in Phase 2 reviews where all exchange of information partners are asked to complete
a detailed questionnaire about their practical experience with the jurisdiction.
Reviews are conducted by an assessment team composed of 2 expert assessors provided by peer jurisdictions
and coordinated by a member of the Global Forum Secretariat.
The assessment team’s report is presented to the 30-member Peer Review Group and, once approved it
becomes a report of the PRG.

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Finally, all members of the Global Forum are asked to adopt the PRG report. As all members are on equal
footing, this is done on a consensus-minus-one basis, so that no one jurisdiction can block the adoption of a
report.
E. Double Taxation and Double Taxation Avoidance Agreements
In the current era of cross-border transactions across the world, due to unique growth in international trade
and commerce and increasing interaction among the nations, residents of one country extend their sphere of
business operations to other countries where income is earned.
One of the most significant results of globalization is the noticeable impact of one country’s domestic tax
policies on the economy of another country.
This has led to the need for incessantly assessing the tax regimes of various countries and bringing about
indispensable reforms.
Therefore, the consequence of taxation is one of the important considerations for any trade and investment
decision in any other countries.
Double Taxation:
Where a taxpayer is resident in one country but has a source of income situated in another country, it gives
rise to possible double taxation. This arises from two basic rules that enable the country of residence as well
as the country where the source of income exists to impose tax, namely,
Source rule: The source rule holds that income is to be taxed in the country in which it originates
irrespective of whether the income accrues to a resident or a non-resident
Residence rule: The residence rule stipulates that the power to tax should rest with the country in
which the taxpayer resides.
If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the cost of
operating in an international scale would become prohibitive and deter the process of globalization.
The Fiscal Committee of OECD in the Model Double Taxation Convention on Income and Capital, 1977
defines double taxation as:
‘The imposition of comparable taxes in two or more states on the same tax payer in respect of the
same subject matter and for identical periods’
Double Taxation of the same income would cause severe consequences on the future of international trade.
Countries of the world therefore aim at eliminating the prevalence of double taxation. Such agreements are
known as "Double Tax Avoidance Agreements" (DTAA) also termed as "Tax Treaties”.

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In India, the Central Government, acting under Section 90 of the Income Tax Act, has been authorized to
enter into double tax avoidance agreements with other countries
Double Taxation Avoidance Agreements (DTAA):
• International double taxation has adverse effects on the trade and services and on movement of capital
and people. Taxation of the same income by two or more countries would constitute a prohibitive
burden on the tax-payer.
• The domestic laws of most countries, including India, mitigate this difficulty by affording unilateral
relief in respect of such doubly taxed income (Section 91 of the Income Tax Act).
• But as this is not a satisfactory solution in view of the divergence in the rules for determining sources
of income in various countries, the tax treaties try to remove tax obstacles that inhibit trade and
services and movement of capital and persons between the countries concerned. It helps in improving
the general investment climate.
• The double tax treaties (also called Double Taxation Avoidance Agreements or “DTAA”) are
negotiated under public international law and governed by the principles laid down under the Vienna
Convention on the Law of Treaties.
• It is in the interest of all countries to ensure that undue tax burden is not cast on persons earning
income by taxing them twice, once in the country of residence and again in the country where the
income is derived. At the same time sufficient precautions are also needed to guard against tax
evasion and to facilitate tax recoveries.
Necessity for DTAAs:
The need and purpose of tax treaties has been summarized by the OECD in the ‘Model Tax Convention on
Income and on Capital’ in the following words:
‘It is desirable to clarify, standardize, and confirm the fiscal situation of taxpayers who are engaged,
industrial, financial, or any other activities in other countries through the application by all countries
of common solutions to identical cases of double taxation’.
The need for Double Taxation Avoidance Agreement (DTAA) arises because of rules in two different
countries regarding chargeability of income based on receipt and accrual, residential status etc. Double
taxation is frequently avoided through DTAAs entered into by two countries for the avoidance of double
taxation on the same income. The DTAA eliminates or mitigates the incidence of double taxation by sharing
revenues arising out of international transactions by the two contracting states to the agreement. As there is
no clear definition of income and taxability thereof, which is accepted internationally, an income may
become liable to tax in two countries. In such a case, the possibilities are as under:
1. The income is taxed only in one country.

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2. The income is exempt in both countries.
3. The income is taxed in both countries, but credit for tax paid in one country is given against
tax payable in the other country.
If the two countries do not have a DTAA, then, in such a case, the domestic law of a country will apply. In
the case of India, the provisions of Section 91 of the Income Tax Act will apply. The Central Board of Direct
Taxes has clarified vide Circular No.333 dated 2nd April, 1982 that in case of a conflict in the provisions of
the agreement for Tax Avoidance of double taxation and the Income Tax Act, the provisions contained in
the Agreement for Double Tax Avoidance will prevail.
Objectives of DTAAs:
Avoiding and alleviating the adverse burden of international double taxation, by –
i. laying down rules for division of revenue between two countries;
ii. exempting certain incomes from tax in either country;
iii. reducing the applicable rates of tax on certain incomes taxable in either countries.
Tax treaties help a taxpayer of one country to know with greater certainty the potential limits of his tax
liabilities in the other country.
Another benefit from the tax-payers point of view is that, to a substantial extent, a tax treaty provides against
non- discrimination of foreign tax payers or the permanent establishments in the source countries vis-à-vis
domestic tax payers.
Functions of DTAAs:
• DTAAs ensure that countries adopt common definitions for factors that determine taxing rights and
taxable events. Crucial among these is the definition of a permanent establishment.
• Most treaties also specify a Mutual Agreement Procedure (MAP) which is invoked when
interpretation of treaty provisions is disputed.
• To prevent abuse of treaty concessions, treaties increasingly incorporate restrictions and rules, such
as a general anti- avoidance rule (GAAR), that allow tax authorities to determine if a transaction is
only undertaken for tax avoidance or not.
• Benefit limitation tests and controlled foreign corporation (CFC) rules also place limits on claims of
residence in countries eligible for treaty concessions.
• Exchange of tax information on either a routine basis or in response to a special request is provided
for in most treaties to assist countries counter tax evasion.

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Salient Features of DTAAs between India and other Countries:
• As of now, there exist 88 Double Taxation Avoidance Agreements (DTAAs) between India & other
countries.
• These treaties are usually between countries with substantial trade or other economic relations. Most
treaties are between pairs of developed countries while, of the balance, most are between developed
and developing countries.
• DTAAs
- Provide reciprocal concessions to mitigate double taxation,
- Assign taxation rights roughly in accordance with that “existing consensus” and
- Largely though not rigidly follow the OECD Model Tax Convention or, for developing countries,
the UN Tax Convention.
• Recent treaties contain new clauses following the OECD Model Tax Conventions of 2005 to 2010
which extend areas of cooperation to administrative and information issues.
• A typical DTA Agreement between India and another country covers only residents of India and the
other contracting country who has entered into the agreement with India. A person who is not resident
either of India or of the other contracting country cannot claim any benefit under the said DTA
Agreement.
• Such agreement generally provides that the laws of the two contracting states will govern the taxation
of income in respective states except when express provision to the contrary is made in the agreement.
DTAAs and Relevant Provisions of the Income Tax Act, 1961:
• Section 90 - Agreement with foreign countries or specified territories –Bilateral Relief
Since the tax treaties are meant to be beneficial and not intended to put tax payers of a contracting
state to a disadvantage, it is provided in Sec. 90 that a beneficial provision under the Indian Income
Tax Act will not be denied to residents of contracting state merely because the corresponding
provision in tax treaty is less beneficial.
• Section 90A - Double taxation relief to be extended to agreements (between specified

Associations) adopted by the Central Government
• Section 91 - Countries with which no agreement exists-Unilateral Agreements

Some Double Taxation Avoidance agreements provide that income by way of interest, royalty or fee
for technical services is charged to tax on net basis.

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This may result in tax deducted at source from sums paid to Non-residents which may be more than
the final tax liability. The Assessing Officer has therefore been empowered under Section 195 to
determine the appropriate proportion of the amount from which tax is to be deducted at source.
There are instances where as per the Income-tax Act, tax is required to be deducted at a rate prescribed
in tax treaty. However, this may require foreign companies to apply for refund.
To prevent such difficulties Sec. 2(37A) provides that tax may be deducted at source at the rate
applicable in a particular case as per section 195 on the sums payable to non- residents or in
accordance with the rates specified in D.T.A. Agreements.
Types of Relief:
1. Bilateral Relief: Under this method, the Governments of two countries can enter into an agreement
to provide relief against double taxation by mutually working out the basis on which relief is to be
granted. India has entered into 88 agreements for relief against or avoidance of double taxation.
Bilateral relief may be granted in either one of the following methods:
A) Exemption method by which a particular income is taxed in only one of the two countries;
and
B) Tax relief methods under which an income is taxable in both countries in accordance with the
respective tax laws read with the Double Taxation Avoidance Agreements. However, the
country of residence of the taxpayer allows him credit for the tax charged thereon in the
country of source.
2. Unilateral Relief: This method provides for relief of some kind by the home country where no mutual
agreement has been entered into between the countries.
Methods of Eliminating Double Taxation:
1. Exemption Method: One method of avoiding double taxation is for the residence country to altogether
exclude foreign income from its tax base. The country of source is then given exclusive right to tax
such incomes. This is known as complete exemption method and is sometimes followed in respect of
profits attributable to foreign permanent establishments or income from immovable property. Indian
tax treaties with Denmark, Norway and Sweden embody the principle with respect to certain incomes.
2. Credit Method: This method reflects the underline concept that the resident remains liable in the
country of residence on its global income, however as far the quantum of tax liabilities is concerned
credit for tax paid in the source country is given by the residence country against its domestic tax as
if the foreign tax were paid to the country of residence itself.
3. Tax Sparing: One of the aims of the Indian Double Taxation Avoidance Agreements is to stimulate
foreign investment flows in India from foreign developed countries.

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One way to achieve this aim is to let the investor to preserve to himself/itself benefits of tax incentives
available in India for such investments. This is done through “Tax Sparing”. Here the tax credit is
allowed by the country of its residence, not only in respect of taxes actually paid by it in India but
also in respect of those taxes India forgoes due to its fiscal incentive provisions under the Indian
Income Tax Act.
Thus, tax sparing credit is an extension of the normal and regular tax credit to taxes that are spared
by the source country i.e. forgiven or reduced due to rebates with the intention of providing incentives
for investments.
DTAA Models:
There are two major types of DTAA models:
1. OECD Model: OECD Models are generally adopted by developed nations and their emphasis is on
the residency-based taxation.
2. UN Model: UN Model emphasis is on the source based taxation and generally adopted by the
developing nations.
There are also the US model Convention & Indian Model Convention too.
Components of a Tax Treaty:
1. The date on which to come into effect.
2. Applicability – Applies to a person who is resident of one or both the countries. “Resident” is defined
under domestic law of different counties differently. Article 4 expects that it should be based upon
domicile, physical residence, place of management or such other criteria but makes it clear that where
a person is a resident in both the countries, it is the location of the permanent home or where vital
interests are located or where there is fixed abode or where he is citizen, in that order, will decide the
residential status. There may be cases, when it has been found that the assessee is resident in both the
countries then tie-breaker rule has to apply to determine the residential status.
a. In the case of individual his personal & economic ties determine his residential status.
b. In the case of others, it is the place of effective management.
3. General Definitions – Article 3 of DTAA generally covers general definition of Person, Company,
contracting state, Enterprise of a contracting state, Competent Authority, national etc, which all are
applicable to the respective DTAA.
4. The Tax which it covers – What kind of tax the treaty covers should be known as there are different
form of tax in different countries & the DTAA will provide the relief on the specified tax as mentioned
in the DTAA.

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5. The definition which will be applicable in both countries irrespective of domestic law, as for example
on such vital issues as residence, which may be different from the residential statute in local law with
greater stress on nexus between source & income, definition of certain categories’ like technical
services etc.
6. Permanent Establishment (PE) and its parameters –
a. PE means a fixed place from where the business of the enterprise is carried on.
b. PE includes place of management, branch, office, factory, workshop, mine , quarry, an oil or
gas well, a construction site for long duration, a service location for a long duration and a
dependent agency with power to conclude contracts.
7. The definition of concepts like immovable property, dividend, business profits, royalty, technical
fees, salaries etc.
8. Different ways of tax-sharing depending upon the residential statute, permanent establishment, fixed
base or tax sharing with both countries giving agreed part of relief.
9. Stipulation as to the method of relief either by way of exempting income or where it is taxable, taxing
it at stipulated rate, which may be lower than the domestic rate, or by unilaterally giving credit for
tax paid in the other country.
10. Exchange of information with special reference to the concept of associated enterprises primarily to
tackle diversion of income to avail treaty benefit or evasion of tax in one or the other country.
11. Provision for elimination of double taxation.
12. Provision for non- discrimination etc.
13. Other clauses to suit the requirement of the participating countries.
Important Case Law on the subject of DTAAs:
• UOI v. Azadi Bachao Andolan (Mauritius): Validity of CBDT Circular No. 786, providing that
Mauritian tax residency certificate was sufficient proof to avail benefits under Indo-Mauritius DTAA,
upheld: Supreme Court
• Aditya Birla Nuvo Limited v. ADIT (Italy): Payment made by assessee to an Italian Company (GTA)
for Deputing Certain Technicians to India for Supervising installation of Machinery would not be
chargeable to tax in India because person who rendered services were not present in India for required
number of days as envisaged by article 5(j) of DTAA.

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F. Transfer Pricing
In the present age of globalization, diversification and expansion, many companies work under the
umbrella of a group engaged in diverse fields/sectors. This has led to the prevalence of a large number of
transactions between related parties.
Related Party transaction refers to a transaction between/among the parties which are associated by reason
of common control, common ownership or other common interest.
The mechanism for accounting, the pricing for these related transactions, is called Transfer Pricing.
Transfer Price is the price at which divisions of a company transact with each other, such as the trade of
supplies or labour between departments. Transfer prices are used when individual entities of a larger multi-
entity firm are treated and measured as separately run entities. A transfer price can also be known as a
transfer cost.
Transfer price affects the revenue of the transferring division and the cost of the receiving division. As a
result, the profitability, return on investment and managerial performance evaluation of both divisions are
also affected.
This may be understood well by the following examples:
1. Arihant & Companies is a group of Companies engaged in diversified business. One of its units,
i.e. Unit X, is engaged in manufacturing of automotive batteries. Another Unit Y is engaged in
manufacturing of Industrial Trucks. Unit X is supplying automotive batteries to Unit Y. In such
cases transfer price mechanism is used to account for the transfer of automotive batteries.
2. XYZ Co. is an expert in providing electrical and electronic services. It is engaged in providing
support to its associated company as well as it is engaged in outsourcing contract. If XYZ Co.
provides some services to its associated company, the transaction should be accounted at price
calculated using transfer price mechanism.
Importance of Transfer Pricing:
The transfer pricing mechanism is very important for following reasons:
1. It helps ensuring the correct pricing of Product/Services - An effective transfer pricing mechanism
helps an organization in correctly pricing its product and services. Since in any organization,
transaction between associated parties occurs frequently, it is necessary to value all transaction
correctly so that the final product/ services may be priced correctly.
2. It helps in Performance Evaluation: For the performance evaluation of any entity, it is necessary that
all economic transactions are accounted. Calculation of correct transfer price is necessary for
accounting of inter related transaction between two Associated enterprises.

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3. It helps in complying with Statutory requirements: Since related party transactions have a. direct
bearing on the profitability or cost of a company, the effective transfer pricing mechanism is very
necessary. For example, if the related party transactions are measured at less value, one unit may
incur loss and other unit may earn undue profit. This will result in income tax imbalances at both
parties end. Similarly, wrong transfer pricing may lead to wrong payment of excise duty, custom duty
/sales tax (if applicable) as well.
Transfer Pricing Provisions in India:
Increasing participation of multi-national groups in India gave rise to new and complex issues emerging from
transactions entered into between two or more enterprises belonging to the same group. Hence, there was a
need to introduce a uniform and internationally accepted mechanism of determining reasonable, fair and
equitable profits and taxes in India. Accordingly, the Finance Act, 2001 introduced the law of transfer pricing
in India through Sections 92 to 92F of the Income Tax Act, 1961 which guides computation of the transfer
price and suggests detailed documentation procedures. The year 2012 featured a big change in transfer
pricing regulations in India whereby the government extended the applicability of transfer pricing regulations
to specified domestic transactions which are enumerated in Section 92BA. This would help in curbing the
practice of transferring profit from a taxable domestic zone to tax free domestic zone.
Other previsions: Rule 10A to Rule 10T of the Income Tax Rules; Sections 271(1)(c), 271 AA, 271 BA and
271 G of the Income Tax Act
Overview of Provisions:
• Computation of income from international transaction having regard to arm’s length price - Section
92 of the Income tax Act, 1961 (‘the Act’)
• Meaning of associated enterprises - Section 92A of the Act
• Meaning of international transaction - Section 92B of the Act
• Computation of arm’s length price - Section 92C of the Act
• Reference to transfer pricing officer - Section 92CA of the Act
• Power of Board to make safe harbour rules - Section 92CB of the Act
• Maintenance and keeping of information and document by person entering into an international
transaction - Section 92D of the Act

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---
What Transfer Pricing means to a jurisdiction (country): As the aggregate tax payable by MNCs is
reduced, tax authorities across the world incur significant losses. To guard against such losses, many
countries have introduced transfer pricing legislation to govern the pricing of cross border transactions
between related parties.
India introduced rules and regulations on transfer pricing as of 2001 through sections 92A to 92F of the
Indian Income tax Act, 1961 which guides computation of the transfer price and suggests detailed
documentation procedures.
The Economics of Transfer Pricing: Where tax rates are different between tax jurisdictions, there is a strong
incentive to shift income to a lower tax jurisdiction and deductions to a higher tax jurisdiction so that the
overall Tax Rate is minimized.

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On Whom does Transfer Pricing Apply?: Transfer Pricing Regulations ("TPR") are applicable to the all
enterprises that enter into an 'International Transaction' with an 'Associated Enterprise'. Therefore, generally
it applies to all cross border transactions entered into between associated enterprises.
The fundamental principle of transfer pricing: The fundamental principle of transfer pricing is that the
transfer price should represent the arm’s length price of goods transferred and services rendered from one
unit to another unit.
The purpose of transfer pricing to arrive at the comparable price as available to any unrelated party in open
market conditions and is known as the Arm's Length Price.
The Arm’s Length Price:
In general, the arm’s length price refers to the fair price of goods transferred or services rendered.
In other words, the transfer price should represent the price which could be charged from an independent
party in uncontrolled conditions.
The calculation of arm’s length price is very important for a company. In case the transfer price is not at
arm’s length, it may have following consequences
A. Wrong performance evaluation.
B. Wrong pricing of final product (in cases where the goods/services are used in the manufacturing
of a final product),
C. Non-compliances of applicable laws and thus attraction of penalty provisions. The same may be
explained with the following:
Company X and Company Y is working under the common umbrella of Mohan & Company. Company X
manufactures a product which is raw material for Company Y.

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“The concept of associated enterprises and International transaction are very important for applying the
transfer pricing provisions. Section 92A and Section 92B deals with these two important concepts of chapter
X of Income Tax Act, 1961.”
Associated Enterprises:
Associated Enterprises has been defined in Section 92A of the Act. It prescribes that “associated enterprise”,
in relation to another enterprise, means an enterprise–
(a) Which participates, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise; or
(b) In respect of which one or more persons who participate, directly or indirectly, or through one or
more intermediaries, in its management or control or capital, are the same persons who participate,
directly or indirectly, or through one or more intermediaries, in the management or control or capital
of the other enterprise.
The basic criterion to determine an AE is the participation in management, control or capital (ownership) of
one enterprise by another enterprise.
The participation may be direct or indirect or through one or more intermediaries.
- Participation in management: Appointment of more than half of Board of Directors/ Board of

Members/ one or more Executive Directors/ Executive Members by: a) the other enterprise, b)
the same person(s) in both the enterprises.
- Participation through capital: Holding not less than 26% of the voting power directly or indirectly,
a) in the other enterprise, b) in each of such enterprise

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- Participation through control: *Loan not less than 51% of Book value of Total Assets; *Guarantee
not less than 10% of Total borrowings; *Use of know-how, patents, copy right, etc., of which
other enterprise is owner or has exclusive rights; *Purchase of 90% or more Raw Materials and
Consumables for which prices and other conditions are influenced; *Sale of goods manufactured
or processed to other enterprise or person specified by it for which prices and other conditions are
influenced or Controlled by same person.
Deemed Associated Enterprise: Section 92A(2) of the Act
International Transaction:
International Transaction have been defined vide Section 92B of Income Tax Act. It provides that
“International Transaction” means a transaction between two or more associated enterprises, either or both
of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or
provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits,
income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between
two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or
expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided
to any one or more of such enterprises.
Deemed International Transaction: Further Section 92B provides that, where a transaction entered into by
an enterprise with a person other than an associated enterprises and there exist a prior agreement in relation
to the relevant transaction between such other person and associated enterprise, or the terms of the relevant
transaction are determined in substance between such other person and the associated enterprises then such
transaction shall also be treated as an international transaction.
Specified Domestic Transaction (SDT):
The Finance Act 2012 extended the scope of Transfer Pricing provision to ‘Specified Domestic
Transactions (‘SDT’).
The amendment is in accordance with the suggestion made by the Supreme Court in case of Glaxo
Smithkline Asia (P) Ltd.
The SDT would include the following:
- Expenditure for which payment is made or to be made to domestic related parties-40A 2(b)
payment\
Tax Holiday/ Deductions claimed by the taxpayer, where;
- Transfer of goods or services between various
- businesses of same taxpayer

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- More than ordinary profits derived from transactions
- with closely connected persons
---
Finance Act, 2012 has made a very important change and it has extended the applicability of Transfer
Pricing Provisions to specified domestic transaction w.e.f. 1st April, 2012.
The specified domestic party transactions would essentially include payment made by a company to a
related person referred to in Section 40A(2)(b) of the Act including payment to a director of the company
or any person who has a substantial interest in the company (that is, has a beneficial ownership of shares
carrying not less than 20 per cent of voting power); transactions referred to in Section 80A(6) of the Act
(for example, transfer of goods or services from a tax-incentivised unit/entity to a non-tax-incentivised
unit/entity and vice-versa); and transactions referred to in Section 80IA(8), 80IA(10) and 10AA(9) of the
Act (carried out by industrial undertakings, infrastructure companies and units operating in special
economic zones).
---
Section 92BA has been added in Transfer Price Code by Finance Act, 2012 which provides that –
“Specified domestic transaction” in case of an assessee means any of the following transactions, not being
an international transaction, namely:–
(i) Any expenditure in respect of which payment has been made or is to be made to a person referred
to in clause (b) of sub-section (2) of section 40A;
(ii) Any transaction referred to in section 80A;
(iii) Any transfer of goods or services referred to in sub-section (8) of section 80-IA;
(iv) Anybusinesstransactedbetweentheassesseeandotherpersonasreferredtoinsub-section(10)of
section 80-IA;
(v) Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which
provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable; or
(vi) Any other transaction as may be prescribed,
and where the aggregate of such transactions entered into by the assessee in the previous year exceeds
a sum of five crore rupees.
---

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Thus a specified domestic transaction means a transaction which is covered by criteria as given in
section 92BA and the aggregate value of such transactions exceeds `5 crore in a year.
Transfer Pricing Methods:
1. The Comparable Uncontrolled Price (CUP) Method: The CUP method is grouped by the OECD as a
traditional transaction method (as opposed to a transactional profit method). It compares the price of goods
or services and conditions of a controlled transaction (between related entities) with those of an uncontrolled
transaction (between unrelated entities). To do so, the CUP method requires comparables data from
commercial databases.
If the two transactions result in different prices, then this suggests that the arm’s length principle may not be
implemented in the commercial and financial conditions of the associated enterprises. In such circumstances,
the OECD says the price in the transaction between unrelated parties may need to be substituted for the price
in the controlled transaction. The CUP method is the OECD’s preferred method in situations where
comparables data is available.
An example of when the CUP method works well is when a product is sold between two associated
enterprises and the same product is also sold by an independent enterprise. The OECD gives the example of
coffee beans. The two transactions can be seen as comparable if the conditions are the same, they happen at
a similar time and take place in the same stage of the production or distribution chain. If there are differences
in the product sold in each of the transactions (e.g. the uncontrolled transaction used coffee beans from
another source) then the associated enterprises would need to determine whether this affected the price. If
so, it would need to make adjustments to the cost to ensure it was priced at arm’s length.
2. Resale Price Method: Another traditional transaction method for determining transfer pricing is the resale
price method. This method starts by looking at the resale price of a product that has been bought from an
associated enterprise and then sold onto an independent party. The price of the transaction where the item is

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resold to the independent enterprise is called the resale price. The method then requires the resale price
margin to be identified, which is the amount of money the party reselling the product would require to cover
the costs of the associated selling and operating expenses. The resale price margin also includes the amount
the reseller would need to make a fair profit, taking into account the functions it performed (including assets
used and risks assumed). This gross resale price margin is deducted from the resale price. The amount that
remains after the margin has been subtracted and fair adjustments have been made (e.g. expenses like customs
duty have been taken into account) is the arm’s length price for the original transaction between related
entities.
The resale price method requires resale price margins to be comparable in order for an arm’s length price to
be identified. This means that factors such as whether a warranty is offered (and how it is applied) must be
taken into account. If a distributor offers a warranty and sells the product at a higher price to account for that
warranty, then they will make a higher gross profit margin than a distributor that does not offer a warranty
and sells the product at a lower price. For the two transactions to be comparable, the taxpayer must make
accurate adjustments to the transaction cost to account for the margin discrepancy.
3. Cost Plus Method: The cost plus method is a traditional transaction method that analyzes a controlled
transaction between an associated supplier and purchaser. It is often used when semi-finished goods are
transacted between associated parties or when related entities have long-term arrangements for ‘buy and
supply’. The supplier’s costs are added to a markup for the product or service so that the supplier makes an
appropriate profit that takes into account the functions they performed and the current conditions of the
market. The combined price is the arm’s length price for the transaction.
For example, Party A manufactures zips for business bags and briefcases to be sold by companies around the
world. Party A sells the product to Party B, which is an associated company in another country. From this
transaction with Party B, Party A earns a gross profit markup. Party A does not include operating expenses
in the cost of the product. Party C and Party D are independent enterprises that manufacture zip mechanisms
for coats. They sell their products to independent clothing brands and also earn a gross profit markup for the
transaction. Party C and Party D include operating expenses in the cost of their products. So, the gross profit
markups of Party C and Party D need to be adjusted to be comparable with Party A’s.

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4. Transaction Net Margin Method: The TNMM is one of two transactional profit methods outlined by the
OECD for determining transfer pricing. These types of methods assess the profits from particular controlled
transactions. The TNMM involves assessing net profit against an “appropriate base”, such as sales or assets,
that results from a controlled transaction. The OECD states that, in order to be accurate, the taxpayer should
use the same net profit indicator that they would apply in comparable uncontrolled transactions. Taxpayer
can use comparables data to find the net margin that would have been earned by independent enterprises in
comparable transactions. The taxpayer also needs to carry out a functional analysis of the transactions to
assess their comparability.
If an adjustment is needed for a gross profit markup to be comparable, but the information on the relevant
costs are not available, then taxpayers can use the net profit method and indicators to assess the transaction.
This approach can be taken when the functions performed by comparable entities are slightly different. For
example, an independent enterprise offers technical support for the sale of a piece of IT equipment. The cost
of the support is included in the price of the product but cannot be easily separated from it. An associated
enterprise sells the same product but doesn’t offer this support. So, the gross margins of the transactions are
not comparable. By examining net margins, associated enterprises can more easily identify the difference in
transfer pricing in relation to the functions performed.
5. Transactional Net Margin Method: The second transactional profit method outlined by the OECD is the
transactional profit split method. It focuses on highlighting how profits (and indeed losses) would have been
divided within independent enterprises in comparable transactions. By doing so, it removes any influence
from “special conditions made or imposed in a controlled transaction”. It starts by determining the profits
from the controlled transactions that are to be split. The profits are then split between the associated
enterprises according to how they would have been divided between independent enterprises in a comparable
uncontrolled transaction. This method results in an appropriate arm’s length price of controlled transactions.
There are two main approaches that can be taken for splitting profits. These are:

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a. Contribution analysis: The combined profits are divided based on the relative value of the functions
performed by each of the related entities within the controlled transaction (considering assets used
and risks assumed).
b. Residual analysis: The combined profits are divided in two stages. First, each entity is allocated
arm’s length compensation for its functions and contribution to the controlled transaction. Second,
any remaining profit or loss after the first stage is divided based on analysis of the facts and
circumstances of the transaction.

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J. Vodafone Case
Landmark Supreme Court verdict in the Vodafone case
v Background
The Supreme Court of India (SC) has rendered its judgment in the much awaited verdict in the US $
2 billion Vodafone tax case [S.L.P. (C) No. 26529 of 2010]. In one of the most high profile cross
border tax litigation involving taxability of a transaction between two non-resident companies
(having no presence in India), in relation to transfer of shares of an overseas company, and after a
period of four years involving two rounds of litigation at the High Court, and after hearing the matter
over a period of two months, the SC has given a landmark decision in favour of Vodafone
International BV, a Dutch company (VIH) to hold that the transaction is not taxable in India.
v Facts
• • The Hutchison Group (Hong Kong) had acquired interests in mobile telecommunications industry
from 1992 onwards and over a long period of time, a large and complicated ownership structure1
evolved. The Hutchison Group owned interest in the Indian operating company Hutchison Essar Ltd
(HEL) – now known as Vodafone Essar Ltd. (VEL) through a number of overseas holding companies.
HEL had further step down operating subsidiaries in India.
• • The majority of the share capital of HEL, which was under the direct or indirect control of Hutchison
Group, was held by various Mauritius/Indian companies, which in turn were held by
Mauritian/Cayman companies.
• Hutchison held certain call and put options (representing 15% of shareholding of HEL) over
companies controlled by Asim Ghosh, Analjit Singh, etc. These options were in favour of 3Global
Services Pvt. Ltd. (3GSPL), an Indian company, against consideration of credit support.
• In late 2006, Hutchison Telecommunications International Ltd., Cayman Islands (HTIL) received
various offers from potential buyers to acquire its equity interest in HEL including Vodafone Group
Plc, who made a non- binding offer for 67% of HEL for a sum of US$ 11.076 billion, based on
enterprise value of US$ 18.8 billion of HEL.
• A sale purchase agreement dated 11 February 2007 (SPA) was entered into between VIH and HTIL
for VIH to acquire the sole share of CGP Investment (Holdings) Ltd., a Cayman Islands company
(CGP).
• Subsequently, on 20 February 2007 VIH filed an application under Press Note 1 of 2005 for an
approval from Foreign Investment Promotion Board (FIPB) and for FIPB to make a noting of the
transaction. Subsequently, on 7 May 2007, FIPB granted approval to VIH. On 8 May 2007, VIH paid
over the consideration.

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• VEL received a show cause notice dated 6 August, 2007 under section 163 of the Income-tax Act,
1961 (the Act) from the Revenue Authorities (RA) requiring to show cause as to why it should not
be treated as a representative assessee of VIH which had failed to withhold tax under section 195
from payment made to HTIL. The notice was challenged by VEL in a writ petition before the Bombay
High Court.
• Subsequently, VIH received a show cause notice dated 19 September, 2007 under section 201 from
the RA to show cause as to why it should not be treated as an assessee-in-default for failure to
withhold tax under section 195 from payment made to HTIL. The notice was challenged by VIH in
a writ petition before the Court. The Court passed an order in December 2008 dismissing VIH’s writ
petition and affirming jurisdiction of the RA.
• VIH then filed a Special Leave Petition (SLP) before the SC. The SC, vide its order dated January
2009, held that VIH should submit the agreements with the RA, and the RA should then pass an order
determining jurisdiction as a preliminary issue. The SC also held that the question of law to that extent
shall remain open and VIH shall have a right to approach the Court directly in the event the RA assert
jurisdiction.
• After a number of detailed hearings wherein enormous information and data was gathered from
Vodafone, the RA passed an order dated 31 May 2010 asserting jurisdiction. This order was
challenged by VIH before the Bombay High Court again, in terms of the SC order, by filing a writ
petition. • The Bombay High Court observed/held in September 2010 that
- Alongwith the single share of CGP, other rights and entitlements, which constitute capital assets
and ‘property’ were also transferred which was the real taxable event and VIH, by the diverse
agreements that it entered into, has a significant nexus with Indian jurisdiction.
- The essence of the transaction was a change in the controlling interest in HEL, which constituted
a source of income in India.
- The nature of the transaction has to be ascertained from the covenants of the contract and from
the surrounding circumstances and the subject matter of the present transaction must be viewed
from a commercial and realistic perspective.
- Chargeability and enforceability are distinct legal conceptions. A mere difficulty in compliance
or in enforcement is not a ground to avoid observance.
Accordingly, the Bombay High Court held that in the present case, the transaction in question had a
significant nexus with India.
• Against the order of the Bombay High Court, VIH filed an SLP before the SC. The SC, in the interim,
directed VIH to deposit INR 25 billion with the SC and provide a bank guarantee for INR 85 billion,
within three and eight weeks, respectively.
• Simultaneously, the RA issued a notice to VIH on 23 March 2011, initiating penalty proceedings for
non-deduction of tax. VIH filed a SLP to stay the action of the RA. The SC on 15 April 2011 held

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that VIH should file its representation before the RA and no steps would be taken to enforce a penalty
if imposed on the petitioner i.e. VIH.
• The SC heard the matter for over a period of two months and delivered the judgment on 20 January
2012.
v Ruling of the Supreme Court
There are two judgments given in this matter. One is a majority judgment by Chief Justice of India S
H Kapadia and Justice Swatanter Kumar and the other is a concurring judgment by Justice S
Radhakrishnan.
Observations/decisions made in the majority judgment
A. Azadi Bachao Andolan v. McDowell and Co. Ltd.
Revenue Authority’s (RA’s) argument:
Azadi Bachao Andolan, a landmark SC judgment upholding the applicability of the India-Mauritius
treaty, needs to be overruled insofar as it departs from McDowell and Co. Ltd. principle.
Majority decision:
• The decision in the case of His Grace the Duke of Westminster and W.T. Ramsay Ltd.6 help us
to understand the scope of Double Taxation Avoidance Agreement between India-Mauritius
(Mauritius tax treaty).
• The issue raised by the RA in relation to McDowell and Co. Ltd. (above) is only in relation to
tax avoidance/evasion and not on validity of the Circular(s) concerning Mauritius tax treaty.
• It is the task of the Court to ascertain the legal nature of the transaction and while doing so it has
to look at the transaction as a whole and not to adopt a dissecting approach. In the present case,
the RA have adopted a dissecting approach at the Tax officer level.
• The decision in McDowell & Co. Ltd. decision expresses the majority’s agreement with the
judgment of Reddy, J. only in relation to tax evasion through the use of colourable devices and
by resorting to dubious methods and subterfuges. Thus, it cannot be said that all tax planning is
illegal/illegitimate/impermissible.
• Reading McDowell, in the manner indicated, in cases of treaty shopping and/or tax avoidance,
there is no conflict between the decisions in McDowell & Co. Ltd. (above) and Azadi Bachao
Andolan (above) or between McDowell & Co. Ltd. (above) and Mathuram Agrawal.
Concurring decision/observations by Jc K. S. Radhakrishnan
• RA cannot tax a subject without a statute to support and every tax payer is entitled to arrange his
affairs so that his taxes shall be as low as possible and that he is not bound to choose that pattern

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which will replenish the treasury. RA’s argument that the ratio laid down in McDowell & Co.
Ltd. (above) is contrary to what has been laid down in Azadi Bachao Andolan (above), in view
of the SC, is unsustainable and, therefore, calls for no reconsideration by a larger Bench of the
SC.
II. International tax aspects of holding structures
Majority decision:
• The approach of both the corporate and tax laws, particularly in the matter of corporate taxation,
generally is founded on the separate entity principle, i.e., treat a company as a separate person.
• The fact that a parent company exercises shareholder’s influence on its subsidiaries does not generally
imply that the subsidiaries are to be deemed residents of the State in which the parent company
resides. Further a parent company’s executive director(s) should lead the group and the company’s
shareholder’s influence will generally be employed to that end. This obviously implies a restriction
on the autonomy of the subsidiary’s executive directors which is the inevitable consequence of any
group structure, is generally accepted, both in corporate and tax laws.
• Whether a transaction is used principally as a colourable device for the distribution of earnings, profits
and gains, is determined by a review of all the facts and circumstances surrounding the transaction.
• The SC has given certain examples to explain when the principle of lifting the corporate veil or the
doctrine of substance over form or the concept of beneficial ownership or the concept of alter ego
arises.
• It is a common practice in international law, which is the basis of international taxation, for foreign
investors to invest in Indian companies through an interposed foreign holding or operating company,
such as Cayman Islands or Mauritius based company for both tax and business purposes. Special
Purpose Vehicles (SPVs) and Holding Companies have a place in legal structures in India, be it in
company law, takeover code under Securities Exchange Board of India (SEBI) or even under the
Income tax law.
• The SC further observed that in this case they were not concerned with treaty shopping but with the
anti-avoidance rules or General Anti-Avoidance Rule (GAAR). The concept of GAAR is not new to
India since India already has a judicial anti-avoidance rule, like some other jurisdictions. In the
application of a judicial anti-avoidance rule, the RA may invoke the ‘substance over form’ principle
or ‘piercing the corporate veil’ test only after it is able to establish on the basis of the facts and
circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant.
• The RA cannot start with the question as to whether the impugned transaction is a tax
deferment/saving device but that it should apply the ‘look at’ test to ascertain its true legal nature.
Every strategic foreign direct investment (FDI) coming to India, as an investment destination, should
be seen in a holistic manner keeping in mind the following factors
- the concept of participation in investment,

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- the duration of time during which the holding structure exists;
- the period of business operations in India;
- the generation of taxable revenues in India;
- the timing of the exit; - the continuity of business on such exit.
• The onus will be on the RA to identify the scheme and its dominant purpose and discarding an
interposed holding company has to be done by RA at the threshold.
• The corporate business purpose of a transaction is evidence of the fact that the impugned transaction
is not undertaken as a colourable or artificial device. The stronger the evidence of a device, the
stronger the corporate business purpose must exist to overcome the evidence of a device.
• One of the tests to examine the genuineness of the structure is the ‘timing test’ that is timing of the
incorporation of the entities or transfer of shares etc. Structures created for genuine business reasons
are those which are generally created or acquired at the time when investment is made, at the time
when further investments are being made, at the time of consolidation, etc. CGP was incorporated in
the year 1998 and the same became part of the Hutchison corporate structure in the year 2005.
III. Whether section 9 of the Act is a ‘look through’ provision?
RA’s arguments:
If primary argument fails, that under the SPA, HTIL has directly extinguished its property rights in
HEL and its subsidiaries, in any event, income from the sale of CGP share would nonetheless be
covered by section 9 of the Act since it provides for a ‘look through’.
Majority decision:
The SC held that they find no merit in the submissions of RA that section 9 provides for ‘look through’
for the following reasons –
• Section 9(1)(i) of the Act consists of three elements, namely, transfer, existence of a capital asset,
and situation of such asset in India, which should exist in order to make the capital asset taxable.
• Section 9(1)(i) of the Act cannot by a process of interpretation be extended to cover indirect transfers
of capital assets/property situate in India. To do so, would amount to rewriting/changing the
content/ambit of section 9(1)(i) of the Act and would render the express words ‘capital asset situate
in India’ nugatory. Thus, the expression ‘directly or indirectly’ contained in section 9(1)(i) of the Act
go with the income and not with the transfer of a capital asset (property). Similarly, the expression
‘underlying asset’ do not find place in section 9(1)(i) of the Act. Further, the Direct Taxes Code Bill,
2010 (DTC) proposes taxation of indirect transfer of a capital asset, which in a way indicates that
indirect transfers are not covered by section 9(1)(i) of the Act.

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• The question of providing ‘look through’ or ‘Limitation of Benefit’ in the statute or in the tax treaty
is a matter of policy and has to be expressly provided for in the statute/tax treaty and cannot be read
into by interpretation.
• Source in relation to an income has been construed to be where the transaction of sale takes place and
not where the item of value, which was the subject of the transaction, was acquired or derived from.
Hence, applying this principal in the present transaction, the source of income is outside India, unless
legislation ropes in such transactions. Further, expression used in section 9(1)(i) of the Act is ‘source
of income in India’ which implies that income arises from that source and there is no question of
income arising indirectly from a source in India.
• Wherever the legislature wanted to tax income which arises indirectly from the assets, the same has
been specifically provided so. On a comparison of section 64 (that has the expression ‘directly and
indirectly’ appear twice, once with the income part and then again with the expression ‘transfer’) and
section 9(1)(i) of the Act (which does not contain such an association with the word ‘transfer’), what
is discernible is that the legislature has not chosen to extend section 9(1)(i) of the Act to ‘indirect
transfers’.
IV. Transfer of HTIL’s property rights by extinguishment
RA’s argument
HTIL had under the SPA, directly extinguished its rights of control and management, which are
property rights over HEL and its subsidiaries and, consequent upon such extinguishment, de hors of
the CGP shares, there was a transfer of capital asset situated in India.
Majority decision
• We are concerned with the sale of shares and not with the sale of assets, item- wise.
• We need to apply the ‘look at’ test, according to which, the task of RA is to ascertain the legal nature
of the transaction and, while doing so, it has to look at the entire transaction holistically and not to
adopt a dissecting approach.
• In a case like the present one, where the structure has existed for a considerable length of time
generating taxable revenue right from 1994 and where the Court is satisfied that the transaction
satisfies all the parameters of ‘participation in investment’, then in such a case, the Court need not go
into the questions such as de facto control v. legal control, legal rights v. practical rights, etc. Thus,
it cannot be said that the Hutchison structure was created or used as a sham or tax avoidant. If one
applies the look at test discussed hereinabove, without invoking the dissecting approach, then, in our
view, extinguishment took place because of the transfer of the CGP share and not by virtue of various
clauses of SPA.

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• In this case, we are concerned with the expression ‘capital asset’ in the income tax law. Applying the
test of enforceability, influence/persuasion cannot be construed as a right in the legal sense. The
concept of ‘de facto’ control, which existed in the Hutchison structure, conveys a state of being in
control without any legal right to such state. This aspect is important while construing the expression
‘capital asset’ under the Income tax law.
• There is a conceptual difference between a preordained transaction which is created for tax avoidance
purposes, on the one hand, and a transaction which evidences investment to participate in India. In
our view, on the facts and circumstances of this case, the right of HTIL, if at all it is a right, to direct
a downstream subsidiary as to the manner in which it should vote would fall in the category of a
persuasive position/influence rather than having a power over the subsidiary.
• Under the HTIL structure, as it existed in 1994, HTIL occupied only a persuasive position/influence
over the downstream companies qua manner of voting, nomination of directors and management
rights. Further, the minority shareholders/investors had participative and protective rights (including
right of first refusal (RoFR)/tag along rights (TARs), call and put options which provided for exit)
which flowed from the CGP share. The entire investment was sold to VIH through the investment
vehicle (CGP). Consequently, there was no extinguishment of rights as alleged by RA.
• Controlling interest: Controlling interest might have percolated down the line to the operating
companies but that controlling interest is inherently contractual and not a property right unless
otherwise provided for in the statue. Controlling interest, which stood transferred to Vodafone from
HTIL accompany the CGP share and cannot be dissected so as to be treated as transfer of controlling
interest of Mauritian entities and then that of Indian entities and ultimately that of HEL/VEL.
• Debts/loans through intermediaries: All loan agreements and assignments of loans took place outside
India at face value and, hence, there is no question of transfer of any capital assets out of those
transactions in India, attracting capital gains tax.
• Non-compete agreement: An agreement for a non-compete clause was executed offshore and, by no
principle of law, can be termed as ‘property’ so as to come within the meaning of capital gains taxable
in India in the absence of any legislation.
• Hutch Brand: Under the SPA, the license for using the Hutch brand was given and it was expressly
made free of charge and, therefore, the assurance given by HTIL to Vodafone that the brand name
would not cease overnight, cannot be described as ‘property’ right so as to consider it as a capital
asset chargeable to tax in India.
V. Role of CGP in the transaction
RA’s argument
CGP stood inserted at a later stage in the transaction in order to bring in a tax-free entity (or to create
a transaction to avoid tax) and thereby avoid capital gains. Further, since CGP was merely a holding

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company and could not conduct business in Cayman Islands, the situs of the CGP share existed where
the ‘underlying assets are situated’, that is, India.
Majority decision
• CGP was incorporated in 1998 in Cayman Islands. It was in the Hutchison structure from 1998. The
transaction in the present case was of divestment and, therefore, the transaction of sale was structured
at an appropriate tier, so that the buyer really acquired the same degree of control as was hitherto
exercised by HTIL. VIH agreed to acquire companies and the companies it acquired controlled 67%
interest in HEL. CGP was an investment vehicle.
• Two routes were available, namely, the CGP route and the Mauritius route. It was open to the parties
to opt for any one of the two routes. However, the Mauritius route was available but it was not opted
for because that route would not have brought in the control over 3GSPL. • The sole purpose of CGP
was not only to hold shares in subsidiary companies but also to enable a smooth transition of business,
which is the basis of the SPA. Therefore, it cannot be said that the intervened entity (CGP) had no
business or commercial purpose.
• Under the Indian Companies Act, 1956, the situs of the shares would be where the company is
incorporated and where its shares can be transferred. In the present case, it has been asserted by VIH
that the transfer of the CGP share was recorded in the Cayman Islands, where the register of members
of the CGP is maintained. This assertion has neither been rebutted in the impugned order of the tax
department dated 31 May,2010 nor traversed in the pleadings filed by the RA nor controverted before
us. In the circumstances, we are not inclined to accept the arguments of the RA that the situs of the
CGP share was situated in the place (India) where the underlying assets stood situated.
VI. VIH acquire 67% controlling interest in HEL and not 42% /52%
RA’s argument
VIH had acquired 67% interest in HEL and not 42%/52%, as sought to be propounded by it.
Majority decision
• The expression ‘control’ is a mixed question of law and fact. The basic argument of the RA is based
on the equation of ‘equity interest’ with the word ‘control’. On the basis of the shareholding test and
the facts, HTIL could be said to have a 52% control over HEL and had no control over balance 15%
stake in HEL as suggested even by the FIPB approval.
• Pending exercise, options providing 15% shareholding in HEL are not management rights and at best
be treated as potential shares and till exercised they cannot provide right to vote or management or
control.
• As regards the question as to why VIH should pay consideration to HTIL based on an enterprise value
of 67% of the share capital of HEL is concerned, it is important to note that valuation cannot be the
basis of taxation. The basis of taxation is profits or income or receipt. In this case, enterprise value is
made up of two parts, namely, the value of HEL, the value of CGP and the companies between CGP

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and HEL. In the present case, the RA cannot invoke section 9 of the Act on the value of the underlying
assets or consequence of acquiring a share of CGP.
• The facts indicate that the object of the SPA was to continue the ‘practice’ concerning nomination of
directors on the Board of Directors of HEL which in law is different from a right or power to control
and manage and which practice was given to keep the business going, post acquisition. Under the
company law, the management control vests in the Board of Directors and not with the shareholders
of the company. Therefore, neither from the shareholders agreement nor from the term sheet, one
could say that VIH had acquired 67% controlling interest in HEL. The difference between the 52%
figure (control) and 67% (equity interest) arose on account of the difference in computation under the
Indian and US GAAP.
VII. Acquisition of CGP share with ‘other rights and entitlements’ – as held by Bombay High Court
RA’s contention
As held by the Bombay High Court, applying the ‘nature and character of the transaction’ test, VIH
acquired the CGP share with other rights and entitlements which constituted in themselves ‘capital
assets’ within the meaning of section 2(14) of the Act.
Majority decision
• The subject matter of the transaction has to be viewed in this case from a commercial and realistic
perspective. Applying the principles governing shares and the rights of the shareholders to the facts
of this case, we find that this case concerns a straight forward share sale. The tax consequences of a
share sale would be different from the tax consequences of an asset sale.
• On examination of the impugned judgment, we find a serious error committed by the High Court in
appreciating the case of VIH before FIPB. 67% of the economic value of HEL is not 67% of the
equity capital. If VIH would have acquired 67% of the equity capital, as held by the High Court, the
entire investment would have had breached the FDI norms which had imposed a sectoral cap of 74%.
• The High Court ought to have applied the look at test in which the entire Hutchison structure, as it
existed, ought to have been looked at holistically. When one applies the ‘nature and character of the
transaction test’, confusion arises if a dissecting approach of examining each individual asset is
adopted.
• The High Court has failed to examine the nature of the following items, namely, non-compete
agreement, control premium, call and put options, consultancy support, customer base, brand
licences, etc. On facts, we are of the view that the High Court, in the present case, ought to have
examined the entire transaction holistically.
• A controlling interest is an incident of ownership of shares in a company, something which flows out
of the holding of shares. A controlling interest is, therefore, not an identifiable or distinct capital asset
independent of the holding of shares. The control of a company resides in the voting power of its
shareholders and shares represent an interest of a shareholder which is made up of various rights
contained in the contract embedded in the Articles of Association. The right of a shareholder may

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assume the character of a controlling interest where the extent of the shareholding enables the
shareholder to control the management. Shares, and the rights which emanate from them, flow
together and cannot be dissected.
• The parties to the transaction have not agreed upon a separate price for the CGP share and for what
the High Court calls as ‘other rights and entitlements’ (including options, right to non-compete,
control premium, customer base etc.). Thus, it was not open to the RA to split the payment and
consider a part of such payments for each of the above items.
• Controlling interest does not depend upon the extent to which they had the power of controlling votes.
The principle that emerges is that where shares in large numbers are transferred, which result in
shifting of ‘controlling interest’, it cannot be considered as two separate transactions namely transfer
of shares and transfer of controlling interest. Controlling interest forms an inalienable part of the share
itself and the same cannot be traded separately unless otherwise provided by the statute. Controlling
interest is inherently contractual right and not property right and cannot be considered as transfer of
property and hence a capital asset unless the statute stipulates otherwise.
VIII. Scope and applicability of sections 195 and 163 of Act
Majority decision
• If in law the responsibility for payment is on a non-resident, the fact that the payment was made,
under the instructions of the non-resident, to its agent/nominee in India or its permanent establishment
(PE)/branch office will not absolve the payer of his liability under section 195 of the Act to deduct
tax.
• The investment made by Vodafone Group companies in Bharti did not make all entities of that Group
subject to the provisions of the Act and to the jurisdiction of the tax authorities. Since VIH did not
have any tax presence in India vis-à-vis the overseas transaction, this does not bring VIH under the
jurisdiction of the Indian tax authorities. Further, since the RA failed to establish any connection with
section 9(1)(i) of the Act, the withholding tax provisions under section 195 of the Act would not
apply to VIH.
• On the facts of this case, section 163(1)(c) of the Act – dealing with treating VIH as a representative
assessee of HTIL – is not attracted as there is no transfer of a capital asset situated in India, and
consequently, VIH cannot be proceeded against even under section 163 of the Act as a representative
assessee.
Whether the presumption of territoriality holds good as far as section 195 of the Act is concerned and
is there any reason to depart from that presumption.
• A literal construction of the words ‘any person responsible for paying’ under section 195 of the Act
to include non-residents would lead to absurd consequences. A reading of various sections such as

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191A, 194B, 194C, 194D, 194E, 194I, 194J read with sections 115BBA, 194I, etc. would show that
the intention of the Parliament was first to apply section 195 of the Act only to the residents who have
tax presence in India.
• The expression ‘any person’, in SC’s view, by looking at the context in which section 195 of the Act
has been placed, would mean any person who is a resident in India. This view is also supported, if
we look at similar situations in other countries, when tax was sought to be imposed on non-residents.
• Section 195 of the Act, would apply only if payment is made from a resident to a non-resident and
not between two non-residents where both are situated outside India. In the present case, the
transaction was between two non- resident entities through a contract executed outside India and the
consideration was also passed outside India. In the view of the SC, the ruling in the case of Eli Lilly
and Company (India) P. Ltd. is of no assistance to the facts of the present case, as in that case the
services were rendered in India and also received a portion of their salary from JV situated in India.
• That transaction has no nexus with the underlying assets in India. In order to establish a nexus, the
legal nature of the transaction has to be examined and not the indirect transfer of rights and
entitlements in India.
IX. India-Mauritius tax treaty
Decision/observations by Jc K. S. Radhakrishnan
• On the controversy surrounding the India–Mauritius tax treaty, the SC held that in light of i) the fact
that the treaty does not have limitation of benefit (LOB) clause, ii) presence of Circular No. 789
issued by the Central Board of Direct Taxes, and iii) existence of the tax residency certificate (TRC)
issued by the Mauritian authorities, the RA cannot at the time of sale, deny treaty benefits on the
reasoning that the FDI was only ‘routed’ through a Mauritius company.
• The SC also observed, however, that it would not preclude the RA from denying the tax treaty
benefits, if it is established, on facts, that the Mauritius company has been interposed as the owner of
the shares in India, at the time of disposal of the shares to a third party, solely with a view to avoid
tax without any commercial substance.
• The TRC, though can be accepted as a conclusive evidence for accepting status of residents as well
as for beneficial ownership so as to apply the tax treaty, it can be ignored if the treaty is abused for
the fraudulent purpose of evasion of tax.
• Round Tripping involves getting the money out of India, say Mauritius, and then invest back the
money into India in the form of FDI or Foreign Institutional Investment. In such cases, the TRC
defence would be denied if it is established that such an investment is black money or capital that is
hidden, it is nothing but circular movement of capital known as round tripping, since the transaction
is fraudulent and against national interest.
X. Conclusion of the SC by majority

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Majority decision
• Applying the ‘look at’ test in order to ascertain the true nature and character of the transaction, it was
held that the offshore transaction herein is a bona fide structured FDI into India which fell outside
India’s territorial tax jurisdiction, hence not taxable.
• The offshore transaction evidences participative investment and not a sham or tax avoidant
preordained transaction.
• The subject matter of the offshore transaction was the transfer of share of CGP, a company
incorporated in Cayman Islands, and consequently, the RA had no territorial tax jurisdiction to tax
such an offshore transaction.
• Certainty in enactment of laws, and stability, form the basic foundation of any fiscal system and how
tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic
choices in the most efficient manner and helps the tax administration in enforcing the provisions of
the taxing laws.
• The RA is hereby directed to return the sum of INR 25 billion, which came to be deposited by the
appellant in terms of the SC’s interim order, with interest at 4% per annum within two months.
Further, the SC has directed to release the bank guarantee of INR 85 billion as well.
Decision/observations by Jc K. S. Radhakrishnan
• It is difficult to agree with the conclusions arrived by the Bombay High Court that the sale of CGP
share by Hutchison to Vodafone would amount to transfer of a capital asset within the meaning of
section 2(14) of the Act. It is also difficult to agree with the conclusion of the Bombay High Court
that the rights and entitlements flow from framework agreements, shareholders agreements, term
sheet, loan assignments, brand license etc., which form integral part of CGP share attracting capital
gains tax.
• Consequently, the tax demand of nearly INR 120 billion by way of capital gains tax, would amount
to imposing capital punishment for capital investment, since it lacks authority of law and, therefore,
stands quashed.
• Jc K. S. Radhakrishnan also stated that he concurs with all the other directions given in the judgment
delivered by the Lord Chief Justice (i.e. by the majority).
v Concluding Remarks
• The Vodafone controversy, which had created a lot of uncertainty for multinationals having similar
structures and/or which had entered into or were proposing to enter into similar transactions, and thus,
this should provide the much needed respite to these litigants. However, given that the Finance
Budget is around the corner and also given that the DTC proposes to tax similar transactions, one
would need to wait and see what would be the recommendations of the 10-member committee, which
is set up by the Central Board of Direct Taxes post the aforesaid SC judgment to evaluate the
Vodafone judgement.

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• However, any conclusions in this regard in each individual case can only be reached based on the
fine print analysis of the judgement and applying the same in the context of the peculiar facts of each
case. Further, the DTC contains a proposal to tax similar transactions; hence, this ruling may have
limited relevance post implementation of the present form of the DTC.
• Having said the above, the SC judgment does send positive signals to the global investing community
that India is indeed a top destination for investment and provides the much needed certainty around
deals/M&A activity in the otherwise lacklustre market. On the one hand, the judgement settles the
controversy that was pending for long, at the same time it boosts confidence of the investor in the
Indian judiciary that the judiciary would ultimately uphold the law and not be swayed by other
considerations.

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K. Advance Ruling (Sections 245 N-V)

v Meaning of Advance Ruling: It is in essence a binding statement from the Revenue Authorities,
upon the voluntary request of a private person, with respect to the treatment and consequences of one
or a series of contemplated future actions or transactions having eligible consequences.
v Scope of Advance Ruling: It is a mode of Alternate Dispute Resolution mechanism or better put, a
dispute prevention mechanism.
v Objectives of Advance Ruling: a) To reduce litigation; b) Lowering compliance costs to the

Assessee; c) Introducing a level of certainty in taxation; d) To promote better Revenue-Taxpayer
relations; e)To Provide a more congenial and investor friendly business environment to promote
investment.
---
With a view to avoid disputes in respect of assessment of income-tax liability in the case of a ‘Non-Resident’,
a Scheme of Advance Ruling has been introduced by incorporating Chapter XIX-B into the Income Tax Act,
1961 by the Finance Act, 1993.
Section 245N to 245V of the Income Tax Act provide a scheme for giving advance rulings in respect of
transactions involving non-residents, and certain residents, with a view to avoid needless litigation and to
promote better relations with the tax payer.
The Scheme enables the ‘Non-Residents’ to obtain, in advance, a binding ruling from the Authority for
Advance Rulings (AAR) on issues, which could arise in determining their tax liabilities.
The term advance ruling has been defined in section 245N of the Act. “Advance ruling” means,
(i) a determination by the Authority in relation to a transaction which has been undertaken or is
proposed to be undertaken by a non-resident applicant; or
(ii) a determination by the Authority in relation to the tax liability of a non-resident arising out of a
transaction which has been undertaken or is proposed to be undertaken by a resident applicant with
such non-resident; or
(iia) a determination by the Authority in relation to the tax liability of a resident applicant, arising out
of a transaction which has been undertaken or is proposed to be undertaken by such applicant, and

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such determination shall include the determination of any question of law or of fact specified in the
application;
(iii) a determination or decision by the Authority in respect of an issue relating to computation of

total income which is pending before any income-tax authority or the Appellate Tribunal and such
determination or decision shall include the determination or decision of any question of law or of fact
relating to such computation of total income specified in the application;
(iv) a determination or decision by the Authority whether an arrangement, which is proposed to be

undertaken by any person being a resident or a non-resident, is an impermissible avoidance
arrangement as referred to in Chapter X-A or not
Further, advance ruling may be determined for both questions of law or fact – The advance ruling can be
sought on any question of law or fact in relation to a transaction which has been undertaken, or is proposed
to be undertaken, by the non-resident applicant, in respect of Income Tax liability of the non resident in India.
The Authority does not have the jurisdiction to pronounce a ruling on matters relating to taxes levied under
other statutes.
The Authority cannot give a ruling that is hypothetical in nature.
v Authority for Advance Ruling:
Under the scheme of Advance Ruling, the power of giving advance rulings has been entrusted by the Central
Government to an independent adjudicatory body designated as the Authority for Advance Rulings (AAR).
The Authority shall consist of a Chairman and such number of Vice-chairmen, revenue Members and law
Members as the Central Government may, by notification, appoint.
A person shall be qualified for appointment as –
(a) Chairman, who has been a Judge of the Supreme Court;
(b) Vice-chairman, who has been Judge of a High Court;
(c) a revenue Member from the Indian Revenue Service, who is a Principal Chief Commissioner or
Principal Director General or Chief Commissioner or Director General;
(d) a law Member from the Indian Legal Service, who is an Additional Secretary to the Government
of India.
The Central Government shall provide to the Authority with such officers and employees, as may be
necessary, for the efficient discharge of the functions of the Authority under this Act. The terms and
conditions of service and the salaries and allowances payable to the Members shall be such as may be
prescribed.

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The powers and functions of the Authority may be discharged by its Benches as may be constituted by the
Chairman from amongst the Members thereof. A Bench shall consist of the Chairman or the Vice-chairman
and one revenue Member and one law Member.
As per Section 245P of the Act, no proceeding before, or pronouncement of advance ruling by, the Authority
shall be questioned or shall be invalid on the ground merely of the existence of any vacancy or defect in the
constitution of the Authority.
Under Rule 27 of the AAR Procedure Rules, 1996 the proceedings of the Authority shall be conducted in the
following manner :
(1) When one or both of the members of the Authority other than Chairman is unable to discharge
his functions owing to absence, illness or any other cause or in the event of occurrence of any vacancy
or vacancies in the office of the members and the case cannot be adjourned for any reason, the
Chairman alone or the Chairman and the remaining member may function as the Authority.
(2) Subject to the provisions of sub-rule (3), in case there is difference of opinion among the members
hearing an application the opinion of the majority of members shall prevail and orders of the
Authority shall be expressed in terms of the views of the majority but any member dissenting from
the majority view may record his reasons separately.
(3) Where the Chairman and one other member having a case under sub-rule (1) are divided in their
opinions, the opinion of the Chairman shall prevail.
v Who can seek an advance ruling?
As per Section 245N(b) of the Income Tax Act, an advance ruling could be sought by:
(a) A non-resident.
(b) Resident having transactions with non-residents.
(c) Resident referred to in sub-clause (iia) of section 245N (a) above falling within any such class or
category of person as the Central Government may be notification in the Official Gazette specify.
(d) Specified categories of residents.
(e) A resident or non-resident who makes an application under section 245Q(1) in respect of
impermissible avoidance arrangement.
Meenu Sahi Mamik 287 ITR 514: The Applicant, a resident of Netherlands, wants to establish a
manufacturing unit for formulation of pharmaceuticals in partnership with her husband, in the State of
Himachal Pradesh – The applicant sought ruling of the Authority on the question of law under section 80-
IC, with regard to direct business procured by it, and processing charges – Ruling: The AAR ruled that since

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de facto control and management of the firm would be with the applicant’s husband in India, the firm could
not be said to be a non-resident entity – The application was held to be not maintainable.
Dell International Services India Pvt. Ltd. 305ITR37: Indian company making payment to a foreign
company seeking ruling on the question of TDS to be made
Umicore Finance: 318 ITR 78: Non-resident shareholder of an Indian company seeking ruling in respect of
deductions available to the company
Mcleod Russel India Ltd 299ITR 79: Indian company purchasing shares from foreign company can apply
for ruling regarding tax liability of the foreign company on capital gains on such transaction u/s. 245N(b)(ii).
v Barred Applicants
The first proviso to section 245R(2) prescribes that Advance Ruling cannot be sought if the matter in question
is already:
• pending before any income tax authority, the Appellate Tribunal or any court;
• involves determination of fair market value of any property; or
• relates to a transaction which is designed prima facie for avoidance of income-tax.
L S Cables Ltd. V. Director of Income-tax, A.A.R. No. 858-861 of 2009: The issue before the authority was
the determination of the scope of proviso (i) of section 245R (2) vis-à-vis pending applications. – The
Revenue argued that the application of the applicant is not maintainable since similar question of law has
been pending before the High Court in case involving the assessee and another third party, not connected
with the transaction before the AAR in this matter. – Assessee contended that the transaction giving rise to
the said dispute is different and the contract is with a different party and hence the application is out side the
purview of provisio (i), thus maintainable. – It was held that the first clause of the proviso to section 245R(2)
ought not to be read in isolation from other provisions other provisions of the Act. – It was held that the term
‘Already pending’ would be restricted to applications only in respect of the same transaction and applicants
before the AAR. – The mere possibility of conflicting decisions is not a good ground to truncate or restrict
the scope of the remedy provided under the Act.
Airport Authority of India 299ITR102: Applicant sought advance ruling in respect of its obligation to deduct
tax under section 195 in connection with contracts entered into by it with a US based company called
Raytheon Company. – However the question of Raytheon Company’s liability to pay income tax in India
was already pending before the income-tax appellate authority. – The applicant argued that it was Raytheon
Company’s liability under the provisions of the Act, read with DTAA entered into between India and the
US that was under consideration with the appellate authority and not the question of tax deduction at source
specifically. – Held: While the issues were inter-related they were not identical. The application was
maintainable.
Instrumentarium Corporation Finland: 272 ITR 499: The applicant was a tax resident of Finland and had
a fully owned Indian subsidiary, to whom it granted interest free loan. – It sought ruling from the AAR on
the applicability of sections 92 to 92F of the Act with respect to the said transaction. – Ruling: AAR rejected

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the application under the proviso to section 245R(2) as the question raised involved determination of fair
market value (arm’s length price)
P-9 of 1995, In re [1996] 220 ITR 0377: A Mauritian company which is a 100% subsidiary of a UK company
has invested in India and seeks ruling with regard to taxability of capital gains arising in India. – Ruling:
The application was rejected under 2nd proviso to section 245R of the Act on the ground that the question
raised related to a transaction designed prima facie for the avoidance of tax.
David Kenneth v. CIT, 231 ITR 464 (AAR): It has been held that the filing of return of income after
submission of an application before the AAR does not preclude the AAR from dealing with the application.
Ericsson v. CIT, 224 ITR 203 (AAR): An application under section 195(2) for determining the amount of
TDS is not a pending proceeding that may bar the jurisdiction of the AAR.
v Application for Advance Ruling:
The application for advance ruling shall be made in quadruplicate and it should be accompanied by a fee of
ten thousand rupees stating the question on which the advance ruling is sought. An applicant may withdraw
an application within thirty days from the date of the application.
(a) Forms:
The application may be withdrawn within 30 days from the date of the application.
34C Applicable for a non-resident applicant.
34D Applicable for a resident having transactions with a non-resident
34E Applicable for the notified residents.
34EA Applicable to resident/non-resident who seeks advance ruling in respect of impermissible

avoidance arrangement
(b) Procedure on Receipt of Application:
On receipt of an application, the Authority shall forward one copy of the application to the Commissioner
having jurisdiction over the case of the applicant and, if considered necessary by the Authority, relevant
records can also be obtained from the Commissioner. In cases, where the applicants are not existing assesses,
sometimes it becomes difficult to determine as to which Commissioner would have jurisdiction over the case
of the applicant. In such cases, the Central Board of Direct Taxes (CBDT) is to be requested under Rule
13(1) of the Procedure Rules to designate a Commissioner in respect of an applicant within two weeks. The
designated Commissioner is also called upon to offer his comments on the contents of the application under
Rule 13(2) of the Procedure Rules, which are considered by the Authority along with the statement of facts
and submissions of the applicant.

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Section 254R(2) of the Income Tax Act provides that the Authority may, after examining the application and
the records called for, either ‘allow’ or ‘reject’ the application. The word ‘allow has been used synonymously
with ‘admit’. In other words, after examining the records, the Authority either admits or rejects the
application. In case Authority has admitted the application, it is empowered to collect or received additional
material and it will examine all the material thus available to it at the time of hearing and pronouncing a
ruling on the application. In case the application has be rejected then an opportunity of being heard must be
given to the assessee.
Further, where the application is rejected, reasons for such rejection shall be given in the order and a copy of
every order shall be sent to the applicant and to the Principal Commissioner or Commissioner. And where
an application is allowed, the Authority shall, after examining such further material as may be placed before
it by the applicant or obtained by the Authority, pronounce its advance ruling on the question specified in
the application.
On a request received from the applicant, the Authority shall, before pronouncing its advance ruling, provide
an opportunity to the applicant of being heard, either in person or through a duly authorised representative.
The authority shall pass the ruling in writing within six months of the receipt of application and the copy of
the order thereof, shall be sent to the commissioner and assessee.
A copy of the advance ruling pronounced by the Authority, duly signed by the Members and certified in the
prescribed manner shall be sent to the applicant and to the Principal Commissioner or Commissioner, as soon
as may be, after such pronouncement.
(c) Salient Features of the Scheme of Advance Ruling:
(a) Available for Income-tax, Customs and Central Excise:
The benefit of advance ruling is available under the Income Tax Act, 1961, Central Excise Act, 1944
and Customs Act, 1962.
(b) Must relate to a transaction entered into or proposed to be entered into by the applicant.
(c) Questions on which ruling can be sought :
(i) Even though the word used in the definition is singular namely “question”, it is clear that
there can be more than one question in one application. This has been made amply clear by
Column No.8 of the Form of application for obtaining an advance ruling (Form No.34C).
(ii) a question can be both of law or fact, pertaining to the income tax liability of the non-
resident qua the transaction undertaken or proposed to be undertaken.
(iii) The questions may be on points of law as well as on facts or could be mixed questions
of law and facts. There should be so drafted that each question is capable of an answer. This
may need breaking-up of complex questions into two or more simple questions.

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(iv) The questions should arise out of the statement of facts given with the application. No
ruling will be given on a purely hypothetical question. Question not specified in the
application can be raised during the course of hearing. Normally a question is not allowed to
be amended but in deserving cases AAR may allow amendment of one or more questions.
(v) Subject to the limitations to be presently referred to, the question may relate to any aspect
of the non-resident’s liability including international aspects and aspects governed by double
tax avoidance agreements. The questions may even cover aspects of allied laws that may have
a bearing on tax liability such as the law of contracts, the law of trusts etc., but the question
must have a direct bearing, on and nexus with the interpretation of the Indian Income-tax Act.
Authority shall not allow the application where the question raised in the application, –
i. Is already pending before any income-tax authority or Appellate Tribunal [except in the case of a
resident applicant falling in sub-clause (iii) of clause (b) of section 245N] or any court;
ii. involves determination of fair market value of any property;
iii. relates to a transaction or issue which is designed prima facie for the avoidance of income-tax [except
in the case of a resident applicant falling in sub-clause (iii) of clause (b) of section 245N or in the
case of an applicant falling in sub-clause (iiia) of clause (b) of section 245N:
Powers of the Advance Ruling Authority:
Section 245U deals with the Powers of the Authority. Sub-section (1) provides that for the purpose of
exercising its powers, the Authority shall have all the powers of a Civil Court under the Code of Civil
Procedure, 1908 (5 of 1908) as are referred to in Section 131 of the Income-tax Act, when trying a suit in
respect of the following matters, namely :
(a) Discovery and inspection;
(b) Enforcing the attendance of any person, including any officer of a banking company and
examining him on oath;
(c) Compelling the production of books of account and other documents; and
(d) Issuing commissions.
Under sub-section (2), the Authority shall be deemed to be a Civil Court for the purposes of Section 195 of
the Code of Criminal Procedure. Section 195 deals with ‘Prosecution for contempt of lawful authority of
public servants, for offences against public justice and for offences relating to documents given in evidence’.
But it would not be deemed to be a Court for the purposes of Chapter XXVI of the Code of Criminal
Procedure which deals with ‘Provisions as to offences affecting the administration of justice’. Further, every
proceeding before the authority shall be deemed to be a judicial proceeding within the meaning of Sections
193 and 228, and for the purpose of Section 196 of the Indian Penal Code. Section 193 deals with punishment
for false evidence and the same is reproduced below :
“193 : Whoever intentionally gives false evidence in any stage of a judicial proceeding, or fabricates false
evidence for the purpose of being used in any stage of a judicial proceeding, shall be punished with

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imprisonment of either description for a term which may extend to seven years, and shall also be liable to
fine; and whoever intentionally gives or fabricates false evidence in any other case, shall be published with
imprisonment of either description for a term which may extend to three years, and shall also be liable to
fine.”
Section 228 of the Indian Penal Code deals with intentional insult or interruption to public servant sitting in
judicial proceeding and the same is reproduced as below:
“228 : Whoever intentionally offers any insult, or causes any interruption to any public servant, while such
public servant is sitting in any stage of a judicial proceeding, shall be punished with simple imprisonment
for a term which may extend to six months, or with fine which may extend to one thousand rupees, or with
both”.
Section 196 of the I.P.C. deals with ‘using evidence known to be false’ and is set-out as follows :
“196 : Whoever corruptly uses or attempts to use as true or genuine evidence any evidence which he knows
to be false or fabricated, shall be punished in the same manner as if he gave or fabricated false evidence.”.
Thus, the authority would have all the powers of the Civil Court for the purposes of dealing with intentional
insult, false evidence etc.
v Applicability of Advanced Ruling (245S):
The advanced ruling pronounced by the Authority under Section 245R shall be binding only:
(a) On the applicant who had sought it;
(b) In respect of the transactions in relation to which the ruling had been sought; and
(c) On the Principal Commissioner or Commissioner, and the income-tax authorities subordinate to him, in
respect of the applicant and the said transaction.”
---
The advance ruling shall be binding as aforesaid unless there is a change in law or facts on the basis of which
the advance ruling has been pronounced.
The effect of the ruling is, understandably, stated to be confined to the applicant who has sought it as well as
the Principal Commissioner or Commissioner and the income-tax authority subordinate to him having
jurisdiction over the case and that too only in relation to transaction for which advance ruling was sought. It
may, however, be stated that the Authority generally follows the ruling in other cases on materially similar
facts and, most certainly in other cases raising the same question of law, if any, which it has decided. The
rule here is different from the position in other countries where either the taxpayer or the revenue or both are
at liberty to accept the ruling or not.

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v Advanced Ruling to be void in certain circumstances:
As per Section 245T, where the Authority finds, on a representation made to it by the Principal Commissioner
or Commissioner or otherwise, that an advance ruling pronounced by it under sub-section (6) of section 245R
has been obtained by the applicant by fraud or misrepresentation of facts, it may, by order, declare such
ruling to be void ab initio and thereupon all the provisions of this Act shall apply (after excluding the period
beginning with the date of such advance ruling and ending with the date of order under this sub-section) to
the applicant as if such advance ruling had never been made. A copy of such order made shall be sent to the
applicant and the Principal Commissioner or Commissioner.
v Questions Precluded:
Under Section 254R, certain restrictions have been imposed on the admissibility of an application for advance
ruling, if the question concerned is pending before other authorities. According to it, the authority shall not
allow an application where the question raised by the non-resident applicant (or a resident applicant having
transaction with a non-resident) is already pending before any income-tax authority or appellate tribunal or
any court of law.
However, exception has been provided in cases of resident applicants falling in sub-clause (iii) of Clause (b)
of Section 245N in cases of pending before income tax authorities or the Tribunal. Further, the authority shall
not allow the application where the question raised in it:
(i) Involves determination of fair market value of any property; or
(ii) It relates to a transaction or issue which is designed prima facie for the avoidance of income-tax.
v Appeal Against Advance Ruling:
No specific provision for appeal against the Ruling in the Act.
However, the applicant/department can invoke the writ jurisdiction of the High Courts under Article 226 and
227 and extraordinary jurisdiction of the Supreme Court under Article 136 of the constitution.
Columbia Sportswear Company v. DIT:
Special Leave Petition not permitted directly before the Supreme Court against the ruling of the Authority
for Advance Tax Rulings
In brief:
In the case of Columbia Sportswear Company1, the Supreme Court has ruled that the ruling of the Authority
for Advance Rulings (AAR) should be challenged by way of a writ before the High Court. However, if a

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substantial question of general importance is involved or a similar question is already pending before the
Supreme Court, the Petitioner can challenge the ruling by filing a special leave petition (SLP) directly with
the Supreme Court.
Facts:
• The petitioner, Columbia Sportswear Company, a company based in the United States, had
established liaison offices in Chennai and Bangalore with the approval of the Reserve Bank of India
(RBI).
• The petitioner filed an application before the AAR to seek a ruling on the question of whether or not
the petitioner would have business connections or a permanent establishment in India based on the
nature of the activities carried out by the petitioner’s liaison office in India. If the petitioner had
business connections or a permanent establishment in India, how the profits would be computed under
Income-tax Act, 1961 (the Act)/Double Tax Avoidance agreement between India and the USA (the
tax treaty).
• The AAR held that the petitioner’s liaison offices constitute business connections or a permanent
establishment in India under the Act and the tax treaty respectively. The income attributable to the
operations carried out in India is taxable in India under the provisions of the Act and the tax treaty.
• The petitioner filed a SLP before the Supreme Court, challenging the AAR ruling.
• However, the Supreme Court passed orders calling upon the parties to address the maintainability of
the SLP filed by the petitioner.
Issue before the Supreme Court:
On the maintainability of the SLP as called upon by the Supreme Court:
Can an advance ruling pronounced by the AAR be challenged by the applicant or the Commissioner under
Article 226/227 of the Constitution before the High Court or under Article 136 of the Constitution directly
before the Supreme Court?
Petitioner’s contention:
• The orders of the quasi–judicial Tribunal can be challenged before the High Court by way of a judicial
review under Article 226 /227, or before the Supreme Court by way of an appeal under Article 136
of the Constitution.
• The AAR is a quasi-judicial Tribunal as:
- The order of the authority is an adjudicating order determining a question of law or fact.
- The provisions of section 245R(5) of the Act mandates compliance with the principles of natural
justice.

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- The AAR is vested with the powers of a civil court in relation to the discovery and inspection,
enforcing the attendance of persons and examining them under oath, compelling the production
of books of account etc.
• As AAR is a quasi-judicial Tribunal, its orders can be challenged before the High Court or the
Supreme Court.
• The Tribunal, as per Article 136 of the Constitution, includes within its ambit all adjudicating bodies,
provided they are created by the State and are invested with judicial as distinguished from purely
administrative or executive functions.
• Notwithstanding the fact that the order of the Tribunal that is constituted under an Act of legislature
for adjudicating any particular matter is final, the High Court and the Supreme Court are vested with
the powers to exercise jurisdiction under the Constitution even if the order of the Tribunal is final
under the Act.
Supreme Court Ruling:
I. AAR is a tribunal
• Under Article 226 of the Constitution, the High Court can issue writs of Certiorari and Prohibition to
control the proceedings of not only a subordinate court but also of any person, body or authority
having the duty to act judicially, such as a Tribunal.
• Under Article 227 of the Constitution, the High Court has superintendence over all courts and
tribunals throughout the territory in relation to which it exercises jurisdiction.
• Under Article 136 of the Constitution, the Supreme Court may, in its discretion, grant special leave
to appeal from any judgement, decree, determination, sentence or order in any cause or matter passed
or made by any court or Tribunal in the territory of India.
• In view of the above, it is important to determine whether the AAR is a Tribunal within the meaning
of the expression in Articles 136 and 227 of the Constitution and whether the AAR has a duty to act
judicially and is amenable to writs of Certiorari and Prohibition under Article 226 of the Constitution.
• The test to determine whether a body is a Tribunal or not is to find out whether it is vested with the
judicial power of the State by any law to pronounce upon rights or liabilities arising out of some
special law.
• Based on the examination of the provisions in Chapter XIX-B of the Act5 on Advance Ruling, it is
clear that:
- The AAR may determine the tax liability arising out of a transaction. It may include a
determination on a issue of fact or issue of law;
- The AAR may determine the quantum of income and such determination may include a
determination on an issue of fact or issue of law;

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- The determination of the AAR is not just advisory but binding. It is binding for the transaction
for which it is sought and for the parties involved in respect of that transaction;
- The ruling has persuasive value for others. However, it does not mean that a principle of law laid
down in a case will not be followed in future.
• Therefore, the AAR is a body exercising judicial power conferred on it by Chapter XIX-B of the Act
and is a Tribunal within the meaning of the expression in Article 136 and Article 227 of the
Constitution.
II. Jurisdiction of Supreme Court and the High Court over AAR ruling
• Articles 226, 227 and Article 136 are constitutional provisions vesting jurisdiction on the Supreme
Court and the High Court. Therefore, provisions of the Act of legislature making the decision of the
Authority final or binding will not affect the Court’s powers to exercise jurisdiction over applications
challenging the AAR rulings
• The High Courts are vested with the powers to exercise judicial superintendence over the decisions
of all courts and Tribunals within their respective jurisdictions.
• If the ruling of the AAR is not permitted to be challenged before the High Court, it would negate a
part of the basic structure of the Constitution.
• Considering that the objective of the AAR mechanism is to get an advance ruling in respect of a
transaction expeditiously and apprehension that the writ petition may be pending for years before the
High Court if only a writ petition is permitted, the Supreme Court opined that the writs against the
AAR rulings should be heard directly by the Division Bench of the High Court and be decided as
expeditiously as possible.
III. Maintainability of the current petition filed before the Supreme Court
• As per Article 136 of the Constitution, the Supreme Court has discretionary powers to grant a SLP
from any order passed by the Court or Tribunal in the territory of India.
• Even if good grounds are made in the SLP for challenging an advance ruling before the Supreme
Court, it may still, at its discretion, refuse to grant special leave on the grounds that the challenge to
the ruling of the AAR can also be made to the High Court under Articles 226 and/or 227 of the
Constitution on the same grounds.
• In the event that a substantial question of general importance is not involved or similar questions are
not pending before the Supreme Court, the Supreme Court will not be inclined to entertain a SLP
directly against the ruling of the AAR.
• In absence of involvement of substantial question of general importance or any similar question

pending before the Supreme Court in the current petition, the petitioner is not permitted to approach
the Supreme Court directly. Accordingly, the SLP was disposed granting liberty to the petitioner to
move to the appropriate High Court.

Page 179 of 190
Conclusion:
While deciding the next steps against the ruling of the AAR, the question always arises whether a writ petition
should be filed before the High Court or whether it should be challenged before the Supreme Court. In this
landmark judgement, the Supreme Court has laid down the law that the aggrieved party should file the writ
before the High Court. However, if the ruling gives rise to substantial question of general importance or any
similar question pending before the Supreme Court, then SLP can be filed directly with the Supreme Court.
More case law on appeal against AAR rulings:
U.A.E. Exchange Centre LLC v. U.O.I. & Anr., 313 ITR 94 (Del): Issue before the Delhi High Court was
whether a ruling by the AAR can be challenged by way of writ, under Articles 226 and 227 of the
Constitution. – The Court observed that Section 245-S neither expressly nor implicitly exclude the Courts
jurisdiction under Article 226. it further added that there is no provision that gives finality to the
order/decision of the AAR. – Court held that the AAR is a tribunal since it is invested with powers similar
to a civil court under the Civil Procedure Code, i.e., it has ‘Trappings of a Court’. Hence the AAR would
qualify as a tribunal within the scope of both Articles 226 and 227.
Anurag Jain v. AAR & Anr. 308 ITR 302: The Court held that under Article 226 the Court cannot look into
the correctness or validity of the findings of the AAR with respect to the factual matrix and its interpretations
of the agreements/documents. – The Court added that what the Court is concerned with is the legality of the
procedure followed and not the validity of the order, and the courts under judicial review are concerned not
with the decision but with the decision-making process.
The Prudential Assurance Company Ltd. v. DIT: 232 CTR 12: The matter has been decided by the Bombay
High Court on 29.04.2010 – The petitioner is a UK incorporated company who is a registered sub-account
of FII with SEBI – Issue before the AAR was whether gains arising from realization of portfolio investment
in India ought to be treated as business profit or capital gain. – AAR held such income shall amount to the
petitioner’s business profit and would hence be covered by Article 7 of the DTAA between India and UK.
Thus such income shall not be taxable in India as capital gain. – Further, the order of AAR was sought to be
challenged by the CIT under section 263. – The Bombay High Court held: The assessment order that gives
effect to a binding principle, in this case a decision of the AAR, cannot be regarded as being erroneous or
prejudicial to the interest of the revenue for the purpose of invoking the CIT’s jurisdiction under section 263.
– Thus, in accordance with section 245-S, an order under section 245R shall be binding vis-à-vis the
transaction and shall amount to a binding principle.
v Important Decisions by the AAR:
Capital Gains:
Fosters Australia, 302 ITR 289: Situs of the intangible property (brand/technology) owned by a foreign
company but allowed use in India for a fee – whether transfer of such property results in income taxable in
India? – Held: Yes

Page 180 of 190
STAR Television Entertainment ltd. and Others v. DIT (International Taxation), (2010) 329 ITR 1 (AAR):
Where the applicant companies had amalgamated with an Indian company, it was held that benefit of section
47(vi) and (vii) would be available in respect of the transfer of assets/shares pursuant to amalgamation. It
was also held that the taxpayer is not precluded from minimising the tax liability by arranging its affairs, as
long as the transactions are not sham or nominal or which would lead to inference of a contrived device
solely with a view to avoid tax. What is necessary is that the assessee establishes commercial expediency
and the transaction is within the four corners of the law as held in Duke of Wetminster and reiterated by the
Sepreme Court in Azadi Bachao case.
Dana Corporation LLC: Where there was no consideration for the transfer and also it was difficult to
envisage a proportion for the transfer of shares, it was held that no income chargeable to capital gains could
be said to arise under section 45 r.w.s 48. It was further held that even if it was an international transaction,
computation at arm’s length was not possible as no income could be said to arise, and section 92 could apply
only when income arose and was not intended to bring in new head of income.
E-Trade Mauritius: 230 CTR 428: India-Mauritius DTAA - Article 13 - whether capital gains arising out of
sale of shares of an Indian company by a Mauritius-based subsidiary of an American Company are subject
to Indo-Mauritius DTAA or Indo-USA DTAA - whether the concept of beneficial ownership is relevant for
Article 13 relating to capital gains - whether Circular No 789 is applicable for dividends or capital gains or
both – it was held: Yes.
E-commerce:
Factset Research Systems Inc, 225 CTR 55: Whether subscription fees received by a foreign company from
the licensee (customer) for providing database containing financial and economic information of companies
worldwide is taxable as royalty? Decided in the Negative.
ISRO Satellite Centre, 307 ITR 59: Payment for use of a satellite transponder’s capacity whether royalty?
Decided in the Negative.
Dell International Services India Pvt. Ltd.: 305 ITR 37 ; Cable and Wireless Network India Pvt. Ltd.: 315
ITR 72: Whether payment for two-way transmission of voice and data through telecom bandwidth was
royalty? Decided in the Negative.
Permanent Establishment:
Cal-dive Constructions, 315 ITR 334: Where a foreign company renders services through a fixed place of
business in India which is maintained only for few days (15 days) – whether PE exists? Decided in the
Negative.
[Cushman and Wakefield]: 305 ITR 208: Where the non-resident referred potential customers desirous of
obtaining real estate consultancy to Indian company and received referral fee on each completed transaction,
it was held that referral fees was not business income, royalty or fees for technical services.

Page 181 of 190
[Golf in Dubai 306ITR374]: Whether any income arises to a non-resident person from the sponsorship
money received for organising a sporting event in India? Decided in the Negative.
IKEA Trdg/Mustaq Ahmed, 308 ITR 422/307 ITR 401: Whether any income arises to a non-resident person
in India if only engaged in purchase of goods for exports.
Pintsch Bamag, 318 ITR 190: Whether the sub-contractor in India constituted permanent establishment for
the foreign company in India. Held that the sub-contractor was independent and it could not be concluded
that the business of the applicant was being carried on through the sub-contractor's workshop, therefore, it
did not constitute a "permanent establishment”.
Invensys Systems Inc USA, 317 ITR 438: Whether payments under the cost allocation agreement was
taxable. Held- No as the services were not technical or consultancy in nature and further it was not taxable
as the applicant did not have a “permanent establishment” in India.
Fee for Technical Services/Royalty:
[Intertek Testing Service]: 307 ITR 418 ; [Ernst and Young (P) Ltd. vs CIT]: 230 CTR 355: Whether an
Indian company, subsidiary of a UK company providing testing and inspection services to its Indian and
group affiliates as per global management services agreement (GMSA) will be taxable. Held- on a broad
analysis the majority of the services catalogued were in the nature of technical or consultancy services, but
most of them did not make available to the applicant technical knowledge, experience, skill, know-how, etc.,
possessed by the provider of the services.
[Anapharm Inc.]: 305 ITR 394: Whether the payment received by a non-resident company providing clinical
and bio-analytical services to pharmaceutical companies in India is liable to tax. Held-No
Dassault Systems KK v. DIT (International Taxation) (2010) 229 CTR (AAR) 105: The issue before the
AAR was whether consideration received for sale of computer programme to a Value Added Reseller, who
shall then sell it to the eventual customer, amounts to royalty or business profit under the Income Tax Act
and the Indo-Japan DTAA. – The Authority after a thorough discussion into the concept of ‘Copyrights” held
that in order to bring a particular consideration within the definition of the term ‘royalty’ under the Act or
the DTAA, it was necessary that the ‘copyright’ is actually transferred. Mere transfer of the end product
embodying such copyright would not suffice. – Where the product which embodies the copyright is sold or
transferred the same would not amount to transfer of a copyright and the consideration therein would not
come within the realm of ‘royalty’ under the Act/DTAA. It is only when the copyright itself is made available
to other person, i.e. the right to use the copyright has been transferred, then it amounts to a royalty. –
Authority held that since the essence of the transaction was not to make the use of process available to the
end user or the reseller but limited to the sale and supply of the software, the consideration arising could not
be held to be ‘royalty’. – Hence it was held that the amount received by the applicant was not taxable as
‘royalty’ either under the Act or the DTAA and constituted business income, which could be taxed only if
the applicant had a PE in India, which too was held in the negative.

Page 182 of 190
Miscellaneous Issues:
Geoconsult ZT GMbH, 304 ITR 283: It was held that where a Joint venture was to provide project
consultancy services, then despite of the fact that work was allotted to the members of the JV and there was
separate billing and members had separate bank accounts and each member had borne its own costs and
expenses, it would be taxed as Association of persons for the reason that the Joint venture had meeting of
minds of members, common design and common purpose.
[Hyosung Corporation]: 314 ITR 343: It was held that the foreign Co. and L&T could not be treated as an
"association of persons" as none of the stipulations in the contract gave rise to the formation of an AOP in
the matter of the execution of the contract which was a mere collaboration and overall responsibility assumed
by the applicant for the successful performance of the project.
v The Benefits of Obtaining an Advance Ruling:
Obtaining an Advance Ruling:
1. Helps non-residents in planning their income tax affairs well in advance;
2. Brings certainty in determination of the tax liability;
3. Helps in avoiding long drawn litigation; and
4. It is relatively inexpensive, expeditious and binding.

Page 183 of 190
L. Introduction to the Goods and Service Tax (GST)

The GST is a comprehensive destination based tax levy on manufacture, sale and consumption of goods and
services at a national level which will subsume other indirect taxes such as octroi, Central Sales Tax, State-
level sales tax, entry tax, stamp duty, telecom licence fees, turnover tax, tax on consumption or sale of
electricity, taxes on transportation of goods and services, etc. thus avoiding multiple layers of taxation that
currently exist in India.
Introduction of the Value Added Tax (VAT) at the Central and the State level has been considered to be a
major step and important breakthrough in the sphere of indirect tax reforms in India. If the VAT is a major
improvement over the pre-existing Central excise duty at the national level and the sales tax system at the
State level, then the Goods and Services Tax (GST) is indeed be a further significant improvement the next
logical step towards a comprehensive indirect tax reforms in the country.
GST was introduced with the intention to create a single, unified Indian market to make the economy
stronger. The introduction of Goods and Services Tax (GST) at the Central level will not only include
comprehensively more indirect Central taxes and integrate goods and service taxes for the purpose of set-off
relief, but may also lead to revenue gain for the Centre through widening of the dealer base by capturing
value addition in the distributive trade and increased compliance.
Despite the success of VAT, there are still certain shortcomings in the structure of VAT both at the Central
and at the State level. The shortcoming in CENVAT of the Government of India lies inter-alia in several
taxes which are in the nature of indirect tax on goods and services, such as luxury tax, entertainment tax, etc.,
and yet not subsumed in the VAT and thus keeping the benefits of comprehensive input tax and service tax
set-off out of reach for manufacturers/dealers.
GST is not simply VAT plus service tax rather it is an improvement over the previous system of VAT and
disjointed service tax. The essence of GST is that the cascading effects of both CENVAT and service tax
will be removed with set-off, and a continuous chain of set-off from the original producer’s point and service
provider’s point upto the retailer’s level will be established which will reduce the burden of all cascading
effects. The GST may usher in the possibility of a collective gain for industry, trade, agriculture and common
consumers as well as for the Central Government and the State Governments. The GST may, indeed, lead to
the possibility of collectively positive-sum game.
---
Goods & Services Tax Law in India is a comprehensive, multi-stage, destination-based tax that is levied on
every value addition.
GST is a value-added tax (VAT) levied at all points in the supply chain with credit allowed for any tax paid
on input acquired for use in making the supply. It applies to both goods and services in a comprehensive
manner, with exemptions restricted to a minimum.
In keeping with the federal structure of India, GST is levied concurrently by the Centre (CGST) and the states
(SGST).

Page 184 of 190
Inter-state supplies within India attract an Integrated GST (aggregate of CGST and the SGST of the
destination State).
There are 3 applicable taxes under GST:
i. CGST: Collected by the Central Government on an intra-state sale

ii. SGST: Collected by the State Government on an intra-state sale
iii. IGST: Collected by the Central Government for inter-state sale
In addition to the IGST, in respect of supply of goods, an additional tax of up to 1% has been proposed to be
levied by the Centre. Revenue from this tax is to be assigned to origin states. This tax is proposed to be levied
for the first two years or a longer period, as recommended by the GST Council.
v Pre-GST Indian Tax structure:
v Post-GST Indian Tax structure:

Page 185 of 190
v Chronology of events:
2006: UPA finance minister P Chidambaram proposes GST in his Union Budget. The Empowered
Committee (EC) of state finance ministers was assigned the responsibility to chalk out a roadmap for its
implementation.
2008: The empowered committee submits a report “A Model and Roadmap for GST in India.”
2009: The EC after holding discussions with the centre and the states submits the First Discussion Paper on
Goods and Services Tax In India
2011: The Constitution Amendment bill introduced in Lok Sabha and referred to the Standing Committee on
Finance for scrutiny.
2013: The Standing Committee submits its report to Parliament. But UPA government fails to take the
legislation forward. The Bill lapses with the dissolution of the Lok Sabha.
2014: Finance Minister Arun Jaitley introduces the Constitution (122nd Amendment) Bill, 2014 in Lok
Sabha on Dec19.
2015: Jaitley in his budget speech sets GST roll out deadline on April 1, 2016. Lok Sabha approves the bill
on May 6. The Congress demands capping GST rate at 18%. The Narendra Modi government fails to get it
passed in Rajya Sabha, where it does not enjoy majority.
2016: Centre and states agree on Constitution amendment Bill without a cap on the rates. The bill is approved
by the Rajya Sabha on August 2016. The amended bill is passed in the Lok Sabha on August 8.
2016: The GST Council headed by the Union finance minister is formed. The council decided on a four-slab
rate GST structure of 5%, 12%, 18% and 28%. The so called “sin” or “demerit” products such as tobacco
items, aerated drinks and luxury cars, would come under the highest tax slab and may attract a cess, which
could increase the tax burden to 40%. The Bill received assent from the President of India on 8th September
2017: The date for the implementation of the new tax structure is shifted to July 1, 2017, as the Centre and
states took time to finalise the draft Bills—CGST, IGST, SGST and UT-GST. 29 March 2017 CGST , IGST,
UTGST and GST compensation law passed in Lok Sabha.
v Taxable Event:
The taxable event under GST is the supply of goods or services or both made for consideration in the course
or furtherance of business. The taxable events under the pre-GST indirect tax laws such as manufacture, sale,
or provision of services have subsumed in the taxable event known as ‘supply’.
The term ‘supply’ is wide in its import covers all forms of supply of goods or services or both that includes
sale, transfer, barter, exchange, license, rental, lease or disposal made or agreed to be made for a consideration
by a person in the course or furtherance of business. It also includes import of service. GST law also provides
for including certain transactions made without consideration within the scope of supply.

Page 186 of 190
v Input Tax Credit:
Input tax credit is the amount of tax paid by the dealer on purchases for which the dealer is entitled to claim
a credit.
The concept basically allows you to reduce the tax you owe the government by allowing you to claim a credit
on what you have paid on inputs.
For example, you’re a manufacturer, and the tax payable on the final product is Rs. 450. However, you’ve
already paid taxes to the tune of Rs. 100 while purchasing the inputs required for the final product. Hence,
you can claim an input credit of Rs. 100, and only pay Rs. 350 in taxes for the final product.
v Features of Constitutional Amendment Bill:
122nd Amendment Bill introduced in the Lok Sabha on 19.12.2014 and later on it was passed as GST
Constitutional (101st Amendment) Act’ 2016 when the president assented the provisions of bill on 8th Sept’
2016
Key Features:
• Concurrent jurisdiction for levy of GST by the Centre and the States – Article 246A
• Both Union and States in India now have “concurrent powers” to make law with respect to goods &
services
• The intra-state trade now comes under the jurisdiction of both centre and state; while inter-state trade
and commerce is “exclusively” under central government jurisdiction.
• Authority for Centre to levy & collection of IGST on supplies in the course of inter-State trade or
commerce including imports – Article 269A
• A GST is defined as any tax on supply of goods or services or both other than on alcohol for human
consumption – Article 366(12A)
• Goods includes all materials, commodities & articles – Article 366 (12)
• Services means anything other than goods – Article 366 (26A)
• Goods and Services Tax Council (GSTC) - Article 279A
• To be constituted by the President within 60 days from the coming into force of the Constitutional
Amendments
• Consists of Union Finance Minister & Union MOS (Revenue)
• Consists of all State Ministers of Finance

Page 187 of 190
• Quorum is 50% of total members
• Decisions by majority of 75% of weighted votes of members present & voting
• 1/3rd weighted votes for Centre & 2/3rd for all States together
• Council to make recommendations on

o Taxes, etc. to be subsumed in GST
o Exemptions & thresholds
o GST rates
o Band of GST rates
o Model GST Law & procedures
o Special provisions for special category States
o Date from which GST would be levied on petroleum products
• Council to determine the procedure in performance of its functions
• Council to decide modalities for dispute resolution arising out of its recommendations
• Changes in entries in List – I & II
• Compensation for loss of revenue to States for five years
v Features of GST:
• Taxes to be subsumed:

Page 188 of 190
• Indirect Tax Structure:
• Destination based Taxation.
• Applies to all stages of the value chain.
• Based on revenue neutral rates’ or ‘RNR - The primary objective for implementation of GST is not
mobilization of additional resources but reforming of the prevalent tax structure in India. Revenue
Neutral Rate in GST may simply be defined as the tax rate which seeks to achieve and garner similar
revenue under the newly implemented tax structure as collected from taxes which are sought to be
subsumed and were in force prior to the implementation of the new tax structure.
• Apply to all taxable supplies of goods or services (as against manufacture, sale or provision of
service) made for a consideration except –
o Exempted goods or services – common list for CGST & SGST

o Goods or services outside the purview of GST
o Transactions below threshold limits
• Dual GST having two concurrent components –
o Central GST levied and collected by the Centre

o State GST levied and collected by the State

Page 189 of 190
All goods or services to be covered under GST except: Alcohol for human consumption - State Excise plus
VAT, Electricity - Electricity Duty ,Real Estate - Stamp Duty plus Property Taxes and Petroleum Products
(to be brought under GST from date to be notified on recommendation of GST Council)
Petroleum and petroleum products, i.e., crude, high speed diesel, motor spirit, aviation turbine fuel and
natural gas, shall be subject to GST at a later date - date to be notified by the GST Council.
Entertainment tax, imposed by states on movie, theatre, etc., will be subsumed in GST, but taxes on
entertainment at panchayat, municipality or district level will continue.
Stamp duties, typically imposed on legal agreements by states, will continue to be levied.
Administration of GST will be the responsibility of the GST Council, which will be the apex policy making
body for GST. Members of GST Council comprise Central and State ministers in charge of the finance
portfolio.

Page 190 of 190

02 Taxation Notes - Anirudh Belle

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NOTES ON

THE INCOME TAX ACT, 1961

Prepared as per the syllabus of the

• A ‘tax’ is a financial charge imposed by the Government on income, a commodity or an activity.

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

B. Basic Concepts of Income Tax

- Temporary/Permanent: There is no difference between temporary and permanent income under

- Lumpsum/instalments: Income, whether received in lumpsum or in instalments, is liable to be

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Exemptions (Section 10):

Deductions (Chapter VIA):

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Examples of previous year in the case of newly set-up business/profession:

Previous Year Assessment Year

• Computation of Taxable Income and Tax Liability of an Assessee:

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

4. Exclude the income exempt under Section 10 of the Act.

- Tax deducted and collected at source.

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Tax Liablity Calculation: A Basic Example

From this 11 lakh, initial 2.5 lakh becomes tax free.

11,00,000 – 2,50,000 (Tax free) = 8,50,000

8,50,000 – 2,50,000 (5% tax) = 6,00,000

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

6,00,000 – 5,00,000 (20% tax) = 1,00,000

The remaining 1 lakh rupees would be subject to 30% tax.

Total Tax liability = tax 1 + tax 2+ tax 3 + tax 4

The following are the applicable surcharge rates:

Note: Surcharge is calculated from the Total Tax Liability.

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

C. Section 6 – Residential Status

• Residential status impacts the incidence of taxation (Section 5).

• There are different tests for different assessees.

Residential Status of an Individual:

The different types of residential status of an individual are:

Ø Resident and Ordinarily Resident (ROR)

Test for Residence of Individuals – Section 6(1) and Section 6(6)

An individual may either be a (i) Resident in India or (ii) Non-resident in India.

However, an individual cannot be simply called a “resident” in India. If an individual is a resident

(a) Resident and Ordinarily resident in India (ROR) or

(b) Resident, but not Ordinarily a resident in India (RNOR).

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Basic Condition for an Individual to be a Resident:

Test for Non-Resident – Section 6(1)

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

An individual is not ordinarily resident in any previous year if –

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

(v) Steps to determine the residential status of an Individual:

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

The following facts are now available:

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Anirudh Belle / LL.B. (Class of 2019) / Jindal Global Law School

Ø Meaning of place of control and management:

– Control and Management of HUF: It is with the Karta or its Manager.

– Control and Management of Firm/AOP: It is with Partners/Members.