Law of Taxation - Introduction to the key

concepts in the law of Income Tax

- Ms. Dhwani Mainkar
 Outline
 Key concepts: Previous Year, Financial Year, Assessment Year
 Concept of Income along with overview of various exemptions and deductions
 Capital & Revenue receipts
 Accounting entries & their impact on the nature of receipt to be classified as ‘Income’ or not
 Snapshot of five heads of ‘Income’ along with the relevant statutory provisions
 Introduction to Assessment Procedure & computation of taxable income;
 Highlights of the Income Tax
 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 [Vide Entry 82, List I]
 This tax is leviable and collected under Income Tax Act, 1961 which extends to the whole of India. (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). S. 295 of the Act empowers the CBDT to make rules subject to the control
of the Central Govt. These rules are made applicable by a notification in the official gazette.
 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.
Since IT Act is a revenue law, there are bound to be amendments which are generally brought in annually along with the
Union Budget.
 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. Budget 2020 was presented on 1st February, 2021.
 Notifications & Circulars: Notifications are a form of subordinate legislation and are issued either by the Central Govt or
by the CBDT in the official gazette and have a binding force on the tax officials as well as the Assessee.
 Circulars: Circulars are also issued by the CBDT under the exercise of its powers under S. 119 to clarify doubts regarding
the scope and meaning of income tax provisions. These circulars are issued for the guidance of income tax officers. These
circulars are not binding on the Assessee, Commissioner (Appeals) & ITAT or the Courts. These circulars have to be
applied & followed by the IT Officers in performance of their non-adjudication functions. Whenever there is any instruction
in the favour of the Assessee, IT authorities would not be permitted to go back on these instructions in the circular
 Judicial Decisions: Decisions pronounced by the Supreme Court, High Courts, Appellate Tribunals, Income Tax
authorities.
 Scheme of Taxation
 Charging Section → S. 4
 Every person whose total income of the previous year exceeds the maximum amount which not chargeable to income
tax in India, is an Assessee and chargeable to income tax in the assessment year at the rate/rates prescribed by the
Finance Act/Income Tax Act for that relevant assessment Year. His total income shall be determined on the basis of his
residential status in India.
 Although the income of the previous year is subject to income-ax in the assessment year but income tax shall be:
a. deducted at source,
b. paid in advance
where it is so deductible or payable under any of the provisions of the Act.
 Income-tax in India is levied in the following manner:
1. Tax on Person: Income earned by every person is chargeable to income tax provided it exceeds the maximum amount
which is not chargeable to tax. i.e. it exceeds the maximum exemption limit.
2. Annual tax: It is charged on the total income of the previous year but is taxable in the next following assessment year
at the rates applicable to such assessment year.
3. Tax Rate: Income Tax is charged at the rates prescribed in the Finance Act or the Income tax Act.
4. Tax on Total Income: Tax is charged on the ‘total income’ computed according to the provisions of this Act.
5. Total income of an individual is determined on the basis of his residential status in India.
6. In instances where ‘Tax deducted at Source’ (TDS) or advance tax is applicable, the Assessee is made to pay income
tax on the basis of ‘pay as you earn’ in the same previous year. However, it is to be noted that the tax paid in the
previous year shall be deducted from the income tax due on the total income in the Assessment year.
 Assessment Year & Previous Year
 The financial year in India begins on April 1 and ends on March 31. The assessment year for
FY 2020-21 will be AY 2021-22.
 Assessment Year [Section 2(9)]: {AY} “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. The year
in which tax is computed & becomes payable.
 Previous Year [Section 3]: {PY} 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. Save as
otherwise provided in this section, "previous year" for the purposes of this Act, means the
financial year immediately preceding the assessment year.
 Income tax is payable on the income earned during the previous year and it is assessed in the
immediately succeeding financial year which is called the Assessment year. Eg. FY 2019-20
is the PY for the income earned during that year and it would be subject to assessment &
payment in 2020-2021.
 However, there are exceptions to this rule [Cases where income of the PY is assessed in the same
year]- In the following instances, the AY & PY would be the same.
 EXCEPTIONAL CASES:
1. Shipping Business of non-residents (Sec. 172)
2. Income of persons leaving India either permanently or for a long period of time - no present
intention of coming back to India (Sec.174)
3. Assessment of Association of persons or body of individuals or an artificial juridical person
formed for a particular event or purpose. (Sec. 174A)
4. Income of a person trying to alienate his assets with a view to avoiding payment of tax
(Sec.175).
5. Discontinued business (Sec. 176) [discretionary power on the IT officer- may charge tax in the
same PY]
 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: Y sets up a new business on May 15, 2013. What is the previous year for the assessment
year 2014- 15.
 Person & Assessee
 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 & includes:
- an individual; [an individual means a natural person i.e. human being.
- a Hindu Undivided Family; [As per Hindu law, it means a family which consists of persons who have lineally descended from a common ancestor
including their wives and unmarried daughters.]
- a company; [generally would mean an incorporated association which is an artificial person having an independent legal entity, with a perpetual
succession a common seal, a common capital comprised of transferable shares] – defined as per S. 2(17) of the IT Act 1961 [an Indian Company under S.
2(26) of the IT Act 1961]
 - a firm; [Section 4 of the Indian Partnership Act 1932 defines a partnership as a ‘relationship between persons who have agreed to share the profits of a
business carried on by all or any of them acting for all’. Persons who have entered into partnership are called partners & collectively referred to as a Firm.
Further, the term ‘firm’ also includes a ‘Limited Liability Partnership (LLP) – which is treated as a separate legal entity under the provisions of the LLP Act
2008. A LLP is liable to the full extent of its assets but liability of the partners is limited to their agreed contribution in the LLP. Since liability of the partners
is limited to their agreed contribution in the LLP, it contains elements of both a corporate structure as well as a partnership firm structure. There is no
personal liability of a partner except in the case of a fraud. Moreover, a partner is not responsible or liable for another partner’s misconduct or negligence
as there is no joint liability in the case of LLP.]
- Association of Persons/Body of Individuals, whether incorporated or not [CIT v. Indira Balkrishna (1960) 39 ITR 546 SC – Association of persons means
two or more persons who join a common purpose. AOPs may have companies, firms, joint families as its members (M.M. Ipoh v. CIT 1968 67 ITR 106 SC]
Body of Individuals on the other hand means a group of individuals who carry on some activity together.
- Local Authority [As per Sec. 3(31) of the General Clauses Act 1897, a Local Authority means a Municipal Committee, District Board, body of port
commissioners or other authority legally entitled to or entrusted by the Government with the control and management of a municipal or local fund]
- Any artificial juridical person not falling under any of the above categories. [They are not natural persons but separate entities in the eyes of the law.
They can be sued under their name through persons managing them. Artificial persons with juridical personalities will fall herein if not classified
elsewhere. It covers not only deities – Jogendra Nath Naskar v/s. CIT but also all AJPs such as Bar Council – Bar Council of Uttar Pradesh v. CIT 1983.
Guru Granth Sahib is to be regarded as a juristic person – Shiromani Gurudwara Prabhandhak Committee Amritsar v. Som nath Das [2000] 160 CTR
(SC) 61.]
Explanation —For the purposes of this clause, an association of persons or a body of individuals or a local authority or an artificial juridical person shall be
deemed to be a person, whether or not formed or established or incorporated with the object of deriving income, profits or gains;
Assessee- S. 2(7) Assessee means a person by whom any tax or any other sum of money (i.e. Penalty or interest) is payable under the Act. Further, it includes a
person in respect of whom any proceeding under the Act is undertaken. Every person who is assessable in respect of income or loss of another person, or who is
deemed to be an Assessee or who is deemed to be an Assessee in default.
 TDS- Tax deducted at Source
 TDS means ‘Tax Deducted at Source’. TDS is one of the modes of collection of taxes, by which a certain percentage of amount is
deducted by a person at the time of making / crediting certain specific nature of payment to the other person and deducted amount is
remitted to the Government Account.
 TDS deductions are made on payments including salary, rent, brokerage, professional fees, commission, interest, once these payments
cross a prescribed threshold. In case of TDS, tax obligation is not of the payer but of the recipient only. Only onus is shifted on the
payer. Once TDS is deducted, it is taken in consideration while determining/computing the tax liability of the recipient.
 Form 16, Form 16A, Form 16 B and Form 16 C are all TDS certificates. TDS certificates have to be issued by a person deducting TDS
to the Assessee from whose income TDS was deducted while making payment.
 For instance, banks issue Form 16A to the depositor when TDS is deducted on interest from fixed deposits. Form 16 is issued by the
employer to the employee.
 The Tax Deducted at Source must be deposited to the government by 7th day of the subsequent month.
 Form 26AS [TDS TRACES] This form is a consolidated tax statement which is available to all PAN holders.
 FORM 26AS Includes info on tax deducted on your income by deductors
 Details of tax collected by collectors
 Advance tax paid by the taxpayer
 Self-assessment tax payments
 Regular assessment tax deposited by the taxpayers (PAN holders)
 Details of refund received by you during the financial year
 Details of the High-value Transactions in respect of shares, mutual fund etc.
 Eg. Bright Pvt Ltd make a payment for office rent of Rs 1,00,000 per month to the owner of the property. TDS is required to be
deducted at 10%. Bright pvt ltd must deduct TDS of Rs 10000 and pay balance Rs 90,000 to the owner of the property. Thus the
recipient of income i.e. the owner of the property in the above case receives the net amount of Rs 90,000 after TDS. He can take credit
of the amount already deducted i.e. Rs 10,000 by Bright pvt ltd against his final tax liability.
 TCS – Tax Collected at Source
 TCS or Tax Collected at Source is a mechanism where the receiver (seller) collects a certain amount as tax
of the payer and deposits the same with the government.
 Tax collected at source (TCS) is the tax payable by a seller which he collects from the buyer at the time of
sale. Section 206C of the Income-tax act governs the goods on which the seller has to collect tax from the
purchasers. [Monetary value INR 50Lakh].
 While, Collection of Tax at Source (TCS) is generally the tax collected by the seller when selling specified
category of goods to a buyer. TCS deductions are made on the sale of goods such as scrap, timber, mineral
wood, tendu leaves, alcoholic liquor for human consumption, minerals like coal. Lignite, iron ore etc.
 If the tax collector responsible for collecting the tax and depositing the same to the government does not
collect the tax or after collecting doesn’t pay it to the government as per the due dates, then he will be
liable to pay interest of 1% per month or a part of the month.
 Tax collection at source is exempted in the following cases :
 1. When the eligible goods are used for personal consumption.
 2. The purchaser buys the goods not for the purpose of trading of those goods.
 Advance Tax [S. 207 to 211, 218 & 219]: The taxpayer estimates his
annual in advance and thereby total tax liability.
 Tax is required to be paid in the financial year in which income is
received and hence it is also called as “pay-as-you-earn” scheme.
 Advance–tax is mandatory only if the net tax liability for the
financial year (after considering TDS and tax relief) is Rs. 10,000/-
or more. (S. 208)
 If you are a salaried employee, you need not pay advance tax as your
employer deducts it at source, known as TDS (tax deducted at
source).
 Advance tax is applicable when an individual has sources of income
other than his salary.
 Failure to abide by the deadline - 1% simple interest per month on
the defaulted amount.
 If the amount paid as advance tax is higher than the total tax liability,
the assessee will receive the excess amount as a refund. Interest
@6% per annum will also be paid by the I-T Department to the
assessee on the excess amount (if the amount is more than 10% of
the tax liability).
 S. 207: A resident senior citizen (age of sixty years or more at any
time during the financial year) is exempted from making payment of
advance tax unless such person derives income from business or
profession.
 Steps to Compute Advance Taxes
 I – Estimate the current income of the financial year for which advance tax is payable.
 II – Compute tax on such estimated current income at the rate(s) of tax given under Part III of
the First Schedule of the relevant Finance Act
 III – On the tax computed at Step II – add surcharge, if applicable
 IV – Add health & education cess to the amount computed at Step III
 V- Allow relief in the form of rebate, if any
 VI – Account for TDS/TCS
 VII – The balance amount is the advance tax payable provided it is Rs. 10,000/- or more & it is
payable as per the instalments demonstrated on the previous slide.
 RECAP
 Q1. Every person whose estimated tax liability for the year is Rs. ___________or more, shall pay his tax in advance, in the
form of “advance tax”.
 Q2. A resident senior citizen (i.e., an individual of the age of 60 years or above) not having any income from business or
profession is not liable to pay advance tax. (a) True (b) False
 Q3. All taxpayers are required to pay up to 45% of advance tax by ___________. (a) 15th June (b) 30th June (c) 15th
September (d) 30th September
 Q4. After making payment of first/second/third instalment of advance tax, if there is a change in the tax liability, then the
taxpayer can revise the quantum of advance tax in the remaining instalment(s) and pay the tax as per revised estimates. (a)
True (b) False
 5. Difference between TCS & TDS
 6. Explain AY v/s. PY.
 7. Ascertain under what category would the following fall?
A. Bar Council of Maharashtra & Goa
B. Guru Granth Sahib
C. Sai Baba Sansthan
D. Bombay Municipal Corporation
E. Indian Textiles Association
F. Adv. Dhwani Mainkar
G. Mr. Boring Joyson & Mr. Krishi Sunak
H. Bumble Co. & Cannabis Pvt. Ltd.
  RECAP QUESTIONS
1. Body of Individuals consists of. (a) Individuals (only) (b) Company
(c) Any Person other than (a) (d) Any kind of person
2. Association of persons consists of . (a) Individuals (only) (b)
Company (c) Any Person other than (a) (d) Any kind of person
3. The term “Person” includes . (a) Registered Firm (b) Unregistered
Firm (c) Both of (a) & (b) (d) None of (a) or (b)
4. Assessment Year is the period of 12 month commencing on 1st day
of . (a) April every year (b) December every year (c) July every year
(d) January every year
5. A person follows Calendar year for accounting purpose. For taxation,
he has tofollow (a) Calendar year only – 1 Jan to 31 December (b)
FY only - 1 April to 31 March (c) Any Calendar or FY as per his
choice (d) He will follow extended year from 1st January to next 31st
March (a period of 15 months)
6. In which of the following cases, income of PY is assessable in the
previous year itself. (a) A persons leaving India (b) Salaried
Employee (c)Illegal business (d) Charitable institution
7. Pick-the correct one. (a) AY & PY are same concepts. (b) AY is the
year next to the PY. (c) PY is the year next to the AY. (d) None of the
above
8. Notifications issued by CBDT are binding on . (a) Assessee (b)
Income TaxAuthority (c) Both of above (d) None of the above
9. Circulars issued by CBDT are binding on . (a) Assessee (b) Income
TaxAuthority (c) Both of above (d) None of the above
10. As per Section 2(7),“Assesses” means a person (a) By whom any tax
or other sum of money is payable (b) Against whom proceeding has
been taken under the act (c) A person deemed to be assessee in
default (d) All of the above
 Concept of Income- S. 2(24)
 I.) INCOME [S.2(24)] : Definition contains the word “includes”, and therefore the list is intended to be inclusive,
not exhaustive. Further it contains certain items, including those which cannot ordinarily be considered as income
but are treated statutorily as such.
 In CIT v/s. Shaw Wallace & Co. [1932 LR 59 I.A. 206], Sir George defined ‘Income’ as follows: “Income
connotes a periodical monetary return ‘coming in’ with some sort of regularity, or expected regularity from
definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be
one whose object is the production of a definite return, excluding anything in the nature of a mere windfall.”” –
[However, in the Income Tax Act 1961, even certain income which does not arise regularly are treated as income
for tax purposes e.g. Winnings from lotteries, crossword puzzles, etc.]
 Minister of Finance v. Smith, 1927 A.C. 193 – Canada Supreme Court
The Income-Tax Act is not necessarily restricted in its application to lawful business only. The Revenue merely looks at
an accomplished fact. It brings the profit to tax but it does not condone or take part in the illegal enterprise.
Prosecutions for the offence will not disentitle the I-T department from taxing the profits arising out of the commission
of the offence. Hence, Parliament can impose a tax on income derived from any source lawful or unlawful.

 In Emil Webber v. C. I. T [1993 AIR SC 1466], it was explained that, “The definition of 'Income' in S. 2(24) of
the Act is an inclusive definition. It adds several artificial categories to the concept of income but on that account
the expression 'income' does not lose its natural connotation. It is repeatedly said that it is difficult to define the
expression 'income' in precise terms. Anything which can properly be described as income is taxable under the Act
unless, of course, it is exempted under one or the other provision of the Act.” In this case, the personnel employed
received reimbursement of the Tax amount by the employer firm and these personnel contended that the tax
amount received cannot be treated as an income of the assessee at all. However, it was laid down that the said tax
amount received in integral to the salary component of the assessee and was thereby included as perquisites
received in lieu of salary.
 Concept of Income

S. 2(24) describes various receipts that can be characterized as income, as follows:.

-
Subsidy. Grant or any form of assistance from Govt
-
Fair market value of inventory
-
Compensation for termination of agency
-
Non-compete compensation
-
Movable/immovable property received as a gift exceeding
value of Rs. 50,000/-
- Winnings from an entertainment program, card - Value of any perquisite/profit in lieu of salary (compensation on
games. termination of employment)
- Benefit or perquisite received by a Director of a - Interest, Salary, bonus commission received by the Partner of a
Company Firm.
- Profits of any business of insurance carried on by a - Export Incentives such as duty drawbacks, cash compensation
mutual insurance company or a Co-operative Society. or refunds
 CIT v. G.R. Karthikeyan [1993 Supp (3) SCC 222]
Issue: Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the
total sum of INR 22,000 received by the assessee from the Indian Oil Corporation and All India Highway Motor Rally
should not be brought to tax?
Facts:
The assessee participated in the All India Highway Motor Rally. He was awarded the first prize of INR 20,000 by the Indian
Oil Corporation and another sum of INR 2000 by the All India Highway Motor Rally. On the above basis, the assessee won
the first prize and received a total sum of INR 22,000.
The Income Tax Officer included the same in the income of the respondent-assessee relying upon the definition of ‘income’ in
clause (24) of Section 2.
On appeal, the Appellate Assistant Commissioner held that in asmuch as the rally was not a race, the amount received cannot
be treated as income within the meaning of Section 2(24)(ix).
Madras High Court: In the present case, the rally was not a race and the receipt does not represent winnings as they fail to fit
the sub-clause.
Supreme Court, assessing the implications of the judgment of the High Court:
 If winnings from gambling/betting activities are included within the ambit of income, why should monies from non-
betting activities not included?
 SC held that the expression income must be construed in its widest sense. The definition of income is an inclusive
one. Hence, the prize money received by the assessee will form the part of the income. It also stated that the High Court
erred in reading several clauses of Section 2(24) and considered it as exhaustive definition.
 Even if the receipt does not fall within the ambit of any of the sub-clauses in Section 2(24), it may still be income if it
partakes of the nature of income.
 The idea behind providing inclusive definition to Section 2(24) is not to limit its meaning but to widen its net. This court
has repeatedly said that the word ‘income’ is of widest amplitude, and that it must be given its natural meaning.
 Concept of Income
• Cash or Kind: Income may be received in cash or in kind. When income is received in kind (such as perquisites), its valuation will be made
in accordance with the rules prescribed in the Income Tax Rules, 1962.
• 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 Minister of Finance vs Smith (1927 AC 193 PC)it was laid down that the Income-Tax Act is not necessarily
restricted in its application to lawful business only. Prosecutions for the offence will not disentitle the I-T department from taxing the profits
arising out of the commission of the offence. Income is income even though tainted. The power of the Dominion Legislature to impose
income tax would not be limited by provincial law declaring an activity illegal. In CIT v. Piara Singh (1980) 3 Taxman 67, 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.
 Important: Section 37 which deals with allowance and deduction of expenditure, was amended vide Finance Act, 1998 w.e.f.
01.04.1962 whereby Explanation 1 was added to clarify that any expenditure incurred by an assessee for any purpose which is an
offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no
deduction or allowance shall be made in respect of such expenditure. In contrast thereto, consciously no such restriction has been
brought in law with regard to set off of the value of the unaccounted stock in trade which have been absolutely confiscated.
Explanation 1 to Section 37(1) of the Act expressly disallows any expenditure incurred by an assessee for any purpose which is an
offence or is prohibited by law, which may be claimed as an expenditure incurred for the purpose of business/profession. A
penalty or a confiscation is a proceeding in rem, and therefore, a loss in pursuance to the same is not available for deduction
regardless of the nature of business, since a penalty or confiscation cannot be said to be incidental to any business.
• 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. Example: arrears of salary/ outstanding salary or bonus received in lump sum is
income and charged to tax as salary
• Same Income Cannot be taxed twice
• Income Tax is a composite tax on all incomes received by or arising during a year.
• Income/real profit is to be computed on commercial principles, subject to the IT Act and is distinguished from statutory profits (Poona
Electric Supply Co. v. CIT - MANU/SC/0121/1965)
• Gifts: The Finance Act 2004 introduced section 56(2)(x) for taxing gifts in the hands of the recipient. Aggregate value
of cash gifts received without consideration during a financial year (FY) would be taxable as other income in the hands
of the recipient. However, if the aggregate value of such gifts is less than Rs 50,000, then it would be exempt from tax.
The recipient is not required to pay income tax if the money or property is received from a relative or under certain
specified circumstances such as on the occasion of marriage or under a will or by way of inheritance, or in
contemplation of death of payer etc. This rule applies irrespective of the value of the gift.
• Income Should be real & not fictional
• Contingent Income is not income until the contingency has been realized fully.
• This real accrual of income test was elaborated by the Supreme Court in Godhra Electricity Company v/s. C. I. T.,
(1997) 4 SCC 530. In this case, a government circular entitled the Assessee to recover consumption charges from its
customers at enhanced rates. As this order was the subject matter of protracted litigation, the Assessee was unable to
recover the enhanced charges. Consequently, it challenged the inclusion of such amount within its assessable income on
the ground that no real income had accrued. The Court held that tax cannot be imposed on hypothetical accrual of
income. It was observed that the question of real accrual of income must be considered by taking the probability of
realisation in a realistic manner.
• Composite Income: Income tax is composite tax on all the incomes received by or arising to a taxpayer during a year.
Therefore, tax will be imposed on the aggregate of all incomes earned/received by the assessee during the year.
• Nomenclature used by the parties is not decisive of the character of receipts.
• 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).
• 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 which distinguished from capital, it cannot be
charged to tax. This implies (subject to certain exceptions) only revenue receipts are taxable.
 Receipt V/s. Accrual basis
 E. D. Sasoon vs CIT [1954] 26 ITR 27 (SC)- “Income may accrue to an assessee without the
actual receipt of the same. If the assessee acquires a right to receive the income, the income can
be said to have accrued to him though it may be received later on its being ascertained. The
basic conception is that he must have acquired a right to receive the income. There must be a
debt owed to him by somebody.. Unless and until there is created in favour of the assessee a
debt due by somebody it cannot be said that he has acquired a right to receive the income or
that income has accrued to him.”
 Receipt of Income refers to the first occasion when the recipient gets the money under his
control.
 Accrues and arises is used in contra-distinction to the word ‘receive’. 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 / arise.
 ◦ For income to accrue it must have ripened into a debt, that is, the assessee should have
acquired a right to receive the payment though the receipt itself may take place later. The payer
must have an unconditional liability to pay the taxpayer.
 Capital Receipt v/s. Revenue Receipt

Hon'ble Bombay High Court had an occasion to deal with issue relating to taxability of "Capital Receipts" in case of Cadell Weaving Mill
Co. (P) Ltd. Vs. Commissioner of Income Tax 116 Taxman 77 wherein Court has observed as under: "It is well settled that capital receipts
do not come within the ambit of the Income Tax Act except to the extent of any capital receipt being expressly sought to be covered by the
Act of the Parliament".
Capital Receipts v. Revenue Receipts
 Capital Receipt v/s. Revenue Receipt
 Receipts are of two types, viz. Capital Receipts & Revenue Receipts.
 The distinction between the two is vital because capital receipts are exempt from tax unless
they are expressly taxable (for instance capital gains [S.45] are taxable even if they are
capital receipts). On the other hand, revenue receipts are taxable unless expressly exempt
from tax (for eg. Agricultural income exempt u/s. 10).
 Act does not define these terms.
 The essential difference between capital & revenue is that capital is a fund; revenue is a flow
– French v/s. Wolf 160 SO 396, 181 La. 733 [SC of Lousiana].
 Although the general principle of law is to tax only revenue receipts as income, there are
exceptions to this rule under which capital receipts are also taxable as income & included in
the definition of income:
 Capital Receipts are inherently exempt unless expressly taxable in the Act [for eg in the
following instances], while Revenue receipts are inherently taxable unless expressly
exempt in the Act.
(i) Any compensation received for termination of employment or modification of the terms of
employment would be taxable as salary income. [S. 17(3)(i)]
(ii) Compensation or other payment due to specified persons covered u/S. 28(ii)(a)(b) & (c)
(iii) Capital Gains S. 45
(iv) Non-compete Fee S. 28(va)
 There are various tests relevant for the determination of the nature of receipts.
The Supreme Court in Oberoi Hotel (P) Ltd. Vs. CIT (1999) XI SITC 109 (SC), has held that the question
whether the receipt is the capital or the revenue has to be determined by drawing the conclusion of law
ultimately from the facts of the particular case and it is not possible to lay down any single test as infallible or
any single criterion as decisive
1. 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.
2. Distinguish between Fixed Asset & Circulating Asset - Fixed Asset is that which may or may not be
involved directly in the process of business and remains unaffected by the process. Circulating asset is that part
of the capital which is turned over in the business and which ultimately results in profit or loss. A receipt
referable to a fixed asset is a capital receipt, while what is referable to circulating asset or stock in-trade of an
Assessee would be a revenue receipt. What is a fixed asset for one person may be a circulating asset for another.
Machinery in the hands of a manufacturer is part of his fixed asset, whereas the same machinery with a
machinery dealer is part of his circulating asset.
3. Receipt in the hands of the recipient is material: 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)]. Eg. Payment received on the
redemption of debentures, if held as investment by the recipient = capital receipt in the hands of the recipient,
even if the company makes payment out of its trading profits (revenue in nature). [source is irrelevant]
 Non-compete fee : Guffic Chemical Pvt Ltd v CIT Belgaum - Ranbaxy paid a non-compete fee of INR 50,00,000
to Guffic Chemicals. In turn, Guffic agreed to not compete for a period of 20 years from the date of the
agreement. The territory for the purpose of agreement was within India and the rest of the world. The agreement
further showed that the payment was in consideration of the restrictive covenant undertaken by the assessee for a
loss of source of income. Court held: Capital receipt. From April 1, 2003, Parliament has made non-compete fee
a taxable capital receipt under Section 28(va) which is now covered within Section 2(24).
 Whether receipt is in lieu of Source of Income: A receipt in lieu of source of income is capital receipt
(compensation for loss of employment), while a receipt in lieu of income is revenue receipt.
 Payments made to secure the services of key employees are considered revenue expenditures because they are
part of the company’s ordinary business operations. The lump sum is not spent on creating any new capital asset,
but rather on retaining an employee
The Supreme Court in KCP Ltd. vs. CIT (2000) 245 ITR 421 has held that it is not the name given by the
Assessee or even the revenue of anyone else that matters, but it is the true character of the receipt that
determines its taxability and being regarded as falling within the capital field or out of it.
 IRRELEVANT PROPOSITIONS:
- Payer’s motive not material.
- Nomenclature used – irrelevant
- Treatment as income by the assessee is not conclusive
- Source is irrelevant
- Magnitude of the receipt is not a determining factor
- The Fact the receipt is recurring or non-recurring in nature
bonus
CIT v/s. Vazir Sultan & sons AIR 1959 SC 814
 Facts - 1931: Assessee, a registered firm, was sole distribution agent for the Hyderabad State for the cigarettes manufactured by
M/s. Vazir Sultan Tobacco Co. 1939: The arrangement was extended, and Assessee was also made agent outside the Hyderabad
State. 1951: The board of Directors passes a resolution & reverted back to original arrangement and Assessee was paid Rs
2,19,343 as compensation for the loss of agency outside Hyderabad State. The Income-tax Officer included this sum in the
Assessees total income and taxed it as a revenue receipt. Prime Issue- The question was whether the amount paid to Assessee is
revenue receipt or capital receipt?
 Revenue’s argument: Sole selling agency which was granted to the Assessee in 1931 was merely expanded in 1939 so far the
territory is concerned; decision in 1951 merely reverted to the original arrangement. What was done in 1951 did not affect the
structure, profit making or business apparatus of the Assessee. Expansion and restriction of Assessees territory were in the
ordinary course of business and merely accidents of business. Thus, sum received by Assessee as compensation is income receipt
 Firm’s Arguments - We are not in the business of acquiring agencies. The agency granted to us in the Hyderabad State was a
capital asset. The agency granted to us outside the Hyderabad State was accretion to capital asset. Thus, loss of the latter agency
resulted in ‘sterilisation of the capital asset’. Hence the compensation is capital receipt as it is for loss of a capital asset.
 HELD - In the case before us the agency agreement in respect of territory outside the Hyderabad State was as much an asset of the
Assessees 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 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.
 Nothing on record to show that the acquisition of agencies constituted the Assessees business. Agency was not the business of the
Assessee but the means by which it entered into business transactions i.e. distribution of cigarettes. The agency agreements in fact
formed a capital asset of the Assessees 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 Assessees business. Thus, agency was nothing but capital asset of the Assessee and
compensation for loss of same would be nothing but capital receipt
 TAXABILITY OF SUBSIDIES – Whether Revenue receipts or capital receipts?
 M/S. Sahney Steel And Pressworks vs The Commercial Tax Officer & Ors [AIR 1985 SC 1754] (Purpose test) SC, in this
case, examined the taxability of subsidy received by company from State Government. The subsidy was received by way of
refund of sales tax paid on raw material, power subsidy, land rates concessions etc., only after the commencement of production.
The SC held that the nature of a subsidy, whether capital or revenue, depends on the purpose. In case purpose of the subsidy is to
support the assessee to set up its business, to complete a project, or to acquire a capital asset, the subsidy would be capital receipt.
If it is given for assisting him in carrying out the trade/business operations only after commencement of production, such subsidy
would be a revenue receipt. SC held that as subsidies were not granted for production of any new asset & were granted year after
year only after setting up of the new industry and commencement of production, such subsidy would be regarded as assistance
given for business purposes = Revenue Receipt.
 CIT v. Ponni Sugars & Chemicals Ltd. (SC)- (2008) 306 ITR 392 (SC) SC held that the character of the receipt of a subsidy
under a scheme has to be determined wrt. purpose. The point of time at which the subsidy is paid is irrelevant. If the object of the
subsidy is to enable the Assessee to run the business more profitably then it is a revenue receipt. If the object is to enable the
setting up a new unit or to expand an existing unit then it would be capital receipt. Here, subsidy was given in the form of capital
cost to encourage upgrading the sugar industry is clearly a capital receipt.
 CIT vs. Chaphalkar Bros. 178 (SC)/[2018] 252 Taxman 360 (SC) – SC held that subsidy in the form of concession in
entertainment tax to construct new multiplexes is capital in nature, while taking into account the purpose test laid down in the
above two cases.
 What is most important is the ‘Purpose test’ that determines the character of the receipt in the hands of the assessee for which the
subsidy is given. If the object of the subsidy scheme was to enable the assessee to run the business more profitably, the receipt is
on revenue account. On the other hand, if the object of the assistance of subsidy scheme was to enable the assessee to set up a
new unit or to expand the existing unit then the receipt is of capital nature.
 However, the Finance Act, 2015 [relevant for financial year (FY) 2016-17 onwards] with effect from 01/04/2016 which ultimate
culminated into the taxing belt with the due insertion of Sub-Clause (xviii) in Section 2(24) of the Income Tax Act, 1961 providing an
inclusive definition of the expression `Income’ under the taxing law. It includes any assistance in the form of subsidy/ grant/ cash, duty
incentive etc., received from the government as income for the purposes of the Act.
 5 heads of Income
 As per S. 14 of the IT Act 1961, all income shall, for the purposes of Income Tax and Computation of
Total Income be classified under the following heads of income:
i. Salaries [Sections 15 to 17]
ii. Income from House Property [Sections 22 to 27]
iii. Profits & Gains from Business & Profession [Sections 28 to 44DB]
iv. Capital Gains [Section 45-55A]
v. Income from other sources [Section 56-59]
Aggregate of incomes computed under the above 5 heads, after applying clubbing provisions and making
adjustments of set off & carry forward of losses is known as Gross Total Income [Section 80B] - (" gross
total income" means the total income computed in accordance with the provisions of this Act, before making
any deduction under Chapter VIA)
 Total Income/ Total Taxable Income: The total income of an assessee is computed by deducting from the
gross total income, all deductions permissible under Chapter VIA of the IT Act – i.e. deductions under
Section 80C to Section 80U.
 Salary [Refer to the notes mentioned below]
 Salary is the remuneration paid by the employer to the employee for the services rendered for a certain period of time. It is paid in fixed
intervals i.e. monthly one-twelfth of the annual salary. Salary includes: Basic Salary or the fixed component of salary as per the terms of
employment.​ Fees, Commission and Bonus that the employee gets from the employer​. Allowances that the employer pays the employee to
meet his personal expenses. Allowances are taxed either fully, partially or are exempt.
 Sec 15 - any salary due from an employer or a former employer, any salary paid or allowed to him in the previous year and any arrears of
salary paid or allowed to him
 Sec 16 - ❖ chargeable income is arrived at making a deduction of fifty thousand rupees or amount of salary, whichever is less ❖ deduction
in respect of any allowance in nature of an entertainment allowance
❖ deduction of any sum on account of a tax on employment within meaning of Art 276(2)
 Section 17 - What constitutes salary and perquisites – definitions
 Income from House Property [Refer to the notes mentioned below]
 The basis of charge of income is the Annual Value of the property. Annual Value is inherent capacity of the property to earn an income. It is
the amount for which the property might reasonably be expected to let from year to year.​ Income from house property is charged to tax
on as generally tax is not on receipt of Income but on the inherent potential of the house property to generate income.
 Sec 22 - the annual value of any property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner ❖
Other than such portions of of such property as he may occupy for the purposes of any business or profession carried on by him the profits
of which are chargeable to income tax
 Sec 23 - annual value is determined by ❖ Sum for which the property might be expected to let from year to year ❖ Where property is let
and the sum is more than expected, then such sum
 Sec 24 - deductions ❖ Thirty per cent of the annual value
❖ Where the property has been repaired, renewed, etc with borrowed capital then
the interest on such capital ❖ Municipal taxes
 Sec 27 - owner of property defined
 Income from House property is added to the person's total income only if such house or part of the house is let out for whole or part of the
year, or any other benefit derived from the house by the owner.
 When the assessee has more than one house then, then he/she can exercise an option to treat anyone of the house to be self-occupied. ​For
being taxed, assessee must be the owner of the property.​​
 If the property is occupied by an assessee for the purpose of its business or profession, the profits of which are already chargeable to tax, then
annual value of property shall not be taxed under this head.​ The levy of tax while taxing income from house property is on the income
from the property and not on the property itself.​
Sec 28 - profits and gains of any business or profession carried on by the assessee during the previous year –
 Incomes that are to be added in this head include:​
 Any profit and gains earned form business or profession during previous year.​
 Any income received/due for any compensation or payment for managing the affairs of the company, in connection with termination or
modification of such management.​
 Income derived from providing specific services for its members by trade, profession or any similar association.​
 holding agency in relation to business of any other person; salary, bonus or commission received by a partner of a firm
 Sec 30, 31, 32 - Some expenses are there in a business that are completely deductible like:​ Rent rates, salaries, preliminary expenses,
depreciation, travelling, printing and postage expensed., etc.​
 Some expenses are only deductible at time of actual payment like:​ Any duty, cess or fees , Contribution to provident fund, gratuity fund or
other funds for welfare of employees. ​Bonus or commission or leave encashment payable to employees.​ Interest on loan from public financial
institutions, state financial corporation or from scheduled bank​
 Capital Gains - Sec 45 - profits or gains arising from transfer of a capital asset in the previous year
 Income from other sources - Sec 56 - income which is not to be excluded from the total income but is not chargeable under any of the above
4 heads . Dividends​, Winning from lotteries, crossword puzzles, gambling etc.​ Interest on FDs.​ Gifts received by an individual or HUF.
Exemptions & Deductions

Basics of Assessment Procedure
As per section 14, the income of a person 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

There are specific deductions prescribed under every head which pertain to the particular expenditures incurred against
such head to arrive at the Gross Total Income. No deduction or adjustment on account of any expenditure can be made
except as provided by the act.

 Gross Total Income: Aggregate income [NET AFTER CONSIDERING HEAD-WISE DEDUCTIONS FOR
EXPENDITURE] under these heads in accordance with the provisions of the Act before making any
deduction under Sec.s 80C to 80U.
 Total taxable Income: It is the Gross Total Income as reduced by the amount permissible as deduction under Secs
80C to 80U. https://cleartax.in/s/80c-80-deductions

 Exemptions (Sec.10): income that qualifies as an exemption is not included in the computation of total income

 Deductions (Chapter VIA)- (Sec 80C- 80U):

- Given to encourage investments & savings eg. NSC, Life Insurance, PPF, Infrastructure bonds etc.

Arrived at after taking an

aggregate of the net income
under all 5 heads
 Computation of Taxable Income and Tax Liability of an Assessee:
 1. Determine the residential status of the person as per Section 6 of the Act.
 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. Do not add/include the income exempt under Section 10 of the Act. (just mention in the Return)
 5. Aggregate of net 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 taxable
Income. The total taxable income is rounded off to the nearest multiple of Rupees ten. (Section 288A) . Calculate tax.
 7. Calculate income tax on capital gains, and on other income at specified rates.
 8. The amount of income tax as per (6) above plus the amount of income tax at (7) above will be the income tax in
respect of the total income.
 9. Deduct the following from the amount of tax calculated under (8) above:
 - Tax deducted and collected at source. - Advance tax paid. -
 Further calculate cess & surcharge.
10. The balance of amount left after deduction of items given in (9) above, shall be the net tax payable or net tax
refundable for the Assessee.
 11. 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.
 RECAP
1. State whether the following are capital or revenue receipts:
 A. AB & Co. received Rs. 2Lakh towards compensation for premature termination of contract of agency.
 A partner was paid Rs. 5L on his resignation towards a non-compete fee so as to ensure he does not share his
know-how in the market
 Payment of Rs. 50,000 was received as compensation for cancellation of a contract pertaining to the purchase of
plant & machinery to be used as the means of production.
 A sum of Rs. 10L was received as profit from the sale of shares and was utilized towards purchasing stock in
trade for the business.
 XYZ & Co. received a subsidy of Rs. 1 cr for the revival of their shipping business from the Central Govt.
2. State True or False:
 A. Gross Income – Deductions = Total Income
 B. Income from all sources + Exempt Income = Gross Income.
 C. Surcharge is calculated as a percentage on the total income.
 D. Cess is a percentage of the tax liability.
 E. Fixed capital is a revenue receipt.
 F. Circulating Capital is a Revenue receipt.
 3. EXPLAIN THE ASSESSMENT PROCEDURE
SAMPLE IT RETURN → ITR-1