preface - [email protected] page 1 of 68 - income tax...

Mgmt study material created/ compiled by - Commander RK Singh [email protected]

of 68 - Income Tax Notes

Jamnalal Bajaj Institute of Mgmt Studies

PREFACE

Income tax is a field which interests almost every body since it takes away almost a

fourth of our hard earned money without any concrete promise to give any thing in return.

For the corporates, it is even worse since the slice being taken gets even bigger.

It is endeavour of every one to reduce his tax burden to bare minimum. While

professional tax consultants and Chartered Accounts are a great help in this regard, good

self knowledge of Income tax regulations will be of definite help in keeping the tax burden

low.

These notes have been created not to just pass the MBA exam but also to carry

forward some real knowledge in the field of Income tax which will come handy to every

reader in the years to come. Thus, some additional matter which possibly may not be

required for exam, has also been included. Such matter has been put in blue colour/light

print. Text which has been underlined (other than paragraph headers) are important

concepts and should be understood and remembered clearly. It is recommended that entire

text, blue/light print as well as black, be read carefully once or twice and understood.

During the subsequent readings, blue/light text can be omitted. Paragraphs marked with

broad vertical lines on right hand side are very important concepts and should be

understood clearly.

These notes should be read with past question papers. There are generally only one

or two problems in the question paper where calculations are involved. Remaining 6 to 7

questions are pure theory. Therefore, understanding of the concepts is essential.




BASIC CONCEPTS

Income tax is an annual tax on income. Income of PERSON is to be charged to tax in the

following year. However, govt has introduced concept of advance tax to mobilize the

resources on regular basis. It is now compulsory to pay minimum of 90% of annual tax as

advance tax failing which interest would have to be paid for the shortfall.

Heads of Income: Income from different sources is treated differently to

accommodate the peculiarities of each of the source. Thus, income is segregated into

five different heads for the ease of application of different rates of deductions and

taxes.

(a) Salary

(b) House Property

(c) Capital Gains

(d) Business and Profession

(e) Other income.

Income Tax Act, 1961 has 23 Chapters containing 298 Sections numbered serially from

1 to 298. (Each chapter starts with next serial number after the last serial number of

previous chapter). Each section is divided into sub sections which are further subdivided

into clause and sub clause. Then follow explanations and Provisio (Exceptions to

Provisions or special applications (Preconditions).

Sub section 1

Section 9 S 9 (1) (V) (a) Sub Clause (a)

Clause V

IT Act is applicable to whole of India including J&K.

Definitions

There are two kinds of definitions in the IT Act.

(a) Exclusive Definitions: In a definition, when word “means” is used, it

translates that there is no scope for discretion or arbitrariness over what is

stated. No addition or deletion can be made by any authority. Definition is

exhaustive. Such definitions are normally found in the deductions,

allowances, rebates, etc.




(b) Inclusive Definitions: When a definition starts with “It includes”, it is

called Inclusive Definition. Such definitions are basically broad guide lines

and therefore not exhaustive. In such cases, definition is open to

interpretation by the IT officer and he may include any more heads over and

above what is stated in the Act. Such definitions are common place where

chargeable heads are listed.

Assessment Year [Sec 2(9)]: Assessment Year is the year in which the Income Tax

Return is to be filed (and assessed by the Income Tax Department). So, for the income

earned in Financial Year of 2004-05, the Income Tax return has been filed in Sep 05 i.e. in

Financial Year 2005-06 and thus Assessment Year for income earned in 2004-05 is 2005-

06. It always starts on April 1, and ends on March 31 of the next year.

Example: Assessment year 2005-06 starts on 01 April 2005 and ends on 31 March 2006.

Previous Year [Sec 3]: It is financial year in which income is earned. Thus, it is the

year previous to Assessment Year. Income of the “Previous Year” is taxed in the following

“Assessment Year”. For the Assessment Year 2005-06, Previous Year is 2004-05. Previous

Year normally starts (but not always) on 01 April and ends on 31 March of the following

year. The first previous year in the case of a new assessee or a newly set up business will

be the period commencing from the date of setting up of the business/profession.

Example No.1. Mr Mohan sets up a new business on 15 August 2004. What are the

previous year and assessment year for Mr Mohan?

Solution:

Previous Year – 15 Aug 2004 to 31 Mar 2005 (Since new business was started on

15 Aug 05).

Assessment Year – 01 Apr 2005 to 31 MAR 2006 (Assessment Year always starts

on 01 Apr and finishes on 31 Mar of the following year without any exception)

Income to be Taxed in the Previous Year Itself. Income of a Previous Year is

almost always assessed and taxed in the Assessment Year which follows the Previous Year.

However, there are certain circumstances where income of the previous year is taxable in

the previous Year itself:

1. Income of a non- resident from shipping

2. Income of a person leaving India permanently or for long period

3. Income of Bodies formed for short duration

4. Income of a person trying to alienate his assets

5. Income of a discontinued business.

This exception has been instituted to ensure that tax evasion does not take place due to time

lag. All the above entities have high possibility of default in tax compliance if allowed time

till regular Assessment Year.




Note: All income tax assessees are to follow Financial Year concept i.e. 01 Apr to 31

Mar as income period for filing tax returns even if they are maintaining their business

accounts on calendar year basis.

Assessee [Sec 2(7)]: Assessee means any Person by whom Income tax is payable.

Who are included in Person?

There are 7 categories of Persons. This definition is inclusive and therefore

further additions at the discretion of IT officer are possible.

(a) An Individual (defined as a natural person – living human being)

(b) A Hindu Undivided Family (HUF)

(c) A company

(d) A Firm

(e) An association of person or a body of individuals, whether

incorporated or not.

(f) A local authority and

(g) Every artificial judicial person not falling within any of the preceding

categories.

Is income from illegal professions taxable?

Yes. Any income in the hands of an assessee is taxable irrespective of its source, whether

legal or illegal. But funds transfer is not an income. Therefore, funds transfer are not

charged to tax.

Deduction: Deduction is a case where assessee is permitted to reduce the approved

amount from his salary prior to calculating tax on it. Tax is then calculated on the residual

amount. Provisions of Section 80 are available as deductions. Loss from Self Occupied

House Property is also allowed as deduction.

Rebate: In case of rebate, tax is calculated on salary inclusive of amount eligible for

rebate and then rebate allowed is calculated and reduced from the tax liability already

calculated. Provisions under Section 88 like PF contributions, Insurance Premiums,

Principal repayment of House Loan, etc are rebate clauses.




RESIDENTIAL STATUS

For Income Tax purposes, persons are classified as

(a) Resident,

(i) Resident and Ordinarily Resident

(ii) Resident but Not Ordinarily Resident

(b) Non Resident

Resident classification is not to be confused with Indian citizenship of a person. A resident

can be a foreign national while a Non Resident can still be a full citizen enjoying his voting

rights.

For Assessing the Residential Status of Any Person:

Rule 1. Under section 6(1), an individual will be treated as Resident in India in any

previous year, if he satisfies at least one of the following

TWO BASIC CONDITIONS:

(a) He should have stayed in India for a period or periods amounting to 182

days or more in the previous year.

OR

(b) He should have stayed in India for a period or periods amounting in all to 60

days or more in the previous year AND 365 days or more during 4

years preceding the previous year.

If he satisfies ANY ONE of the above 2 conditions, he will be treated as a Resident

of India for the previous year.

Exceptions:

By virtue of explanation (1) to section 6(1), the period of “60 days” referred to in

(b) above has been extended as follows:

(i) An Indian citizen who leaves India during the previous year for the

purpose of employment (but not for education, medical treatment,

etc) or an Indian citizen who leaves India during the previous year as

a member of crew of an Indian ship will be considered as a Resident

of India, if his stay in India for the previous year is 182 days or

more.




(ii) Indian citizen or a person of Indian origin who comes on a visit to

India during the previous year will be considered as a Resident of

India, if his stay in India in the previous year is 182 days or more.

In simplified form, it means that only Rule 1(a) is to be applied and Rule

1(b) is to be disregarded in cases of

(i) Person who leaves India for employment or

(ii) Any Indian or person of Indian origin who comes to India for

visit.

Rule 2. For Assessing Whether a Person is Resident and Ordinarily

Resident:

To find out whether an individual is a Resident and Ordinarily Resident, one has

to proceed as follows:

Step 1: Find out if an individual is resident in India by applying the Rule 1 above.

Step 2: If he satisfies at least one of the two conditions laid down, then find out if

he is a “Resident and Ordinarily Resident” by applying the following TWO

ADDITIONAL CONDITIONS:

(a) He should have been a resident in India for at least 2 out of last 10

years preceding the previous year.

(b) He should have stayed in India for a total of 730 days or more

during the last 7 years preceding the previous year.

Under section 6(6), an individual will be treated as Resident And Ordinarily

Resident in any previous year, if in addition to satisfying any of the two basic

conditions listed in the Rule 1 above, he/she also satisfies both the Additional

Conditions:

Note: Both the additional conditions are cumulative. If any individual does not

satisfy any condition of Rule 1, i.e. he is not a Resident in India, then no further

investigation (application of additional condition) is necessary.

Rule 3. For Assessing Whether a Person is “Resident but not Ordinarily

Resident”:

An individual who satisfies at least one of the Basic Conditions i.e. conditions

given under Rule 1 above but does not satisfy both the additional conditions

given at Rule 2 above, then he will be treated as a “Resident but not Ordinarily

Resident” in India.




Rules of Residence for an Individual in Brief: The tables given below summaries the

rule of the residence.

Resident and Ordinarily

Resident

Resident but not

Ordinarily Resident

Non - Resident

Must satisfy at least one of

the basic condition and both

of the additional conditions.

Must satisfy at least one of

the basic conditions and

only one or none of the

additional conditions.

Must satisfy none of the

basic conditions.

Rule 4. Determining the Residential Status of a Firm and Association of

Persons [Sec 6(2)]

A Partnership Firm and Association of Persons are said to be “Resident and

Ordinarily Resident” in India if control and management of theirs is wholly or

partly situated within India during the relevant previous year. They are, however

treated as Non –Resident in India only if control and management of their affairs is

situated Wholly Outside India.

The above rule may be summarized as follows:

Place of Control Resident Status

Control and management of the affairs of the firm /

association of a person is –

Wholly in India

Wholly outside India

Partly in India and partly outside India

Resident

Non – resident

Resident

Note: A firm / Association of Persons can never be “Resident but not Ordinarily

Resident” in India.

Rule 5. Determining the Residential Status of a Company [Sec 6(3)]

An Indian company is always Resident in India. However, a foreign company is

treated as “Non-Resident” if, during the previous year, control and management is

situated even partly outside India. Thus, a foreign company is Resident in India

only if, during the previous year, control and management of its affairs is situated

Wholly in India.

Note: A company can never be “Resident but not Ordinarily Resident” in India.

Incidence of Tax in Case of “Resident and Ordinarily Resident” Assessee

[Sec 5(1)]

A “Resident and Ordinarily Resident” assessee is assessable to tax in respect of:

(a) Income which accrues or arises or is deemed to accrue or arise to him in

India during the previous year; and




(b) Income, which accrues or arises to him outside India during the relevant

previous year.

In simple form – Any and every income earned where ever by a R&OR is

taxable.

Incidence of Tax in Case of “Resident But Not Ordinarily Resident” Assessee

[Sec 5(1)]

In case of a “Resident but Not Ordinarily Resident” assessee, income is not chargeable to

tax if it satisfies all the following conditions:

(a) Income is neither received nor deemed to be received in India.

(b) It is neither accrued nor deemed to be accrued in India.

(c) It is derived from a business or a profession controlled/set up outside India.

Incidence of Tax in the Case of a “Non Resident” Assessee [Sec. 5(2)]

Non-resident is liable to tax only in respect of income received or deemed to be received in

India by or on his behalf and accrues or arises or deemed to accrue or arise in India during

the previous year.




INCOME FROM SALARY

Definition of Salary

The term ‘salary’ does not have a uniform definition in Income Tax. It varies from clause

to clause. So, definitions of ‘salary’ for calculation of gratuity and exemption in respect

house rent allowance are different.

‘Salary’ under Section 17(1), includes the following:

(a) Wages,

(b) Any annuity or pension,

(c) Any gratuity,

(d) Any fees, commission, perquisite or profits in lieu of or in addition to any

salary or wages,

(e) Any advance of salary,

(f) Encashment of leave while in service,

(g) Arrears of salary to the extent not already taxed on due basis,

(h) Funds transferred from an unrecognized Provident Fund to recognized

Provident Fund,

(i) Contribution by the central government to the account of the employee

under a pension scheme U/S 80CCD.

Employer and Employee Relationship: In order to charge any income under the head

salary, there must be the relationship of an employer and an employee or master and

servant between payer and payee. There has to be a formal contract between the two for a

fixed payment on time period basis say monthly pay. A professor employed in a university

draws his monthly salary. This is charged under Salary Head. But if he gets some payment

from other university for paper setting or guest lecture, it is not to be counted as salary.

More Than One Salary: Duration of employment has no bearing on salary. A person

can be employed in more than one place at the same time, say on part time basis, and draw

two or may be three salaries every month. But, if each of his monthly payments is covered

under the employee-employer relationship, all of them will be counted as salaries. The

salaries received from all the employers should be clubbed together and charged under the

head salaries.

It is important to note that what ever may be the number of sources of salaries, the

benefits like deductions and concessions will be available as if only one salary is

being drawn. Simpler way to remember is that benefits are available to the salary




earner (Individual) and not to the salary. So, remember the Golden Rule - One

assessee, one benefit. Benefits are accounted on cumulative basis. If the same

benefit is claimed a second or third time, limit of exemption would be reduced to the

extent already availed in past.

Example: Current tax exempt limit for Gratuity Payment is Rs 3,50,000. Mr Bhaskar had

received Rs 1,40,000 as tax exempted Gratuity payment from his previous employer. If he

receives a gratuity of Rs 2,40,000 from his current employer now, his tax exempted limit

for receipt of gratuity would be reduced by Rs 1,40,000 from Rs 3,50,000 and thus only Rs

2,10,000 would be treated as tax exempted gratuity payment and not Rs 3,50,000. He

would be taxed for Rs 30,000 (2,40,000 – 2,10,000).

Accrued Salary: Salary is taxed on accrual basis, which means that once the salary

payment is due (employer is obliged to make the payment), it is taxable whether

actually received or not. Once salary has accrued, its subsequent waiver is considered

to be an application (use) of income and is liable to be taxed. Even donation of full

salary to any charitable trust directly by the employer under the employee’s direction

is still taxable in the hands of the employee. (He can only claim any tax

concessions/exemptions if available for donations to that particular charity).

Voluntary Surrender of Salary: Surrender of salary back to employer gets no tax

exemption. However, voluntary surrender of salary (either in part or full) to the Central

Government, whether by govt employee or Pvt company employee, is exempt from tax

under Section 2 of the Voluntary Surrender of salaries ( Exemption from Taxation).

Income Tax on Salary if Tax is Paid by the Employer: If the salary is being paid net of

tax, which means employer bears the burden of the tax on the salary of the employee, the

taxable income from salary will consist of not only the salary received by the employee but

also include the tax paid by the employer.

Example – Salary net of tax received by the employee- Rs 91000/-

Tax paid by the employer - Rs 39000/-

Net Taxable salary Rs 130000/-

Voluntary Payments: All the payments, on whatever count, received by the employee from

the employer are counted as salary. Only certain payments as reimbursements of actual

expenses incurred on behalf of the company are excluded.

Gifts: Small gifts to the maximum limit of Rs 5000 in a year are exempt from tax. Bigger

gifts given to employees to celebrate important occasions, like silver Jubilee of the

company or on completion of 20 years of service, under a company’s well laid down

policy/scheme, are also exempted.. Other occasions of gift exempted in the hands of the

employees are given below:

Award/Gift by the employer, in appreciation of display of some exceptional

personal qualities of the employee, like bravery or honesty.




Award given to a player for medal winning performance in an international

event.

Basis of Charge: Salary is chargeable to tax either on ‘due’ basis or on ‘receipt’ basis

whichever is earlier. Simply stated, the tax is due whenever either money is received or

payment has become due, whichever is earlier. So, a salary which become due on 31 Mar

05 is taxable in AY 2005 – 06 whether actually received or not. Similarly, advance of

salary for the month of Apr 05 received in Mar 05 is taxable in AY 2005 – 06 itself. Once

tax is paid either on receipt basis or due basis, it will not be taxed again in the next year.

Advance Salary: Advance salary is taxable in the “Previous Year” of receipt. It is

possible that when advance salary is included and charged in a particular previous year, the

rate of tax at which the employee is assessed may be higher than the normal rate of tax to

which he would have been assessed. Section 89 (1) read with Rule 21A provides for relief

in these types of cases.

Salary Arrears: Arrears of salary, if not already charged on due basis, are to be

charged in the year of receipt. Relief under Section 89 (1) is available in this case also.

Place of Accrual of Salary: Any salary earned by way of work done in India is taxable

irrespective time and place of payment. Therefore, pension of an employee who worked in

India and has now settled down in UK is taxable in India. Similarly, payment against any

leave encashment if the leave was earned in India is again taxable in India.

Exception: By virtue of Section 10(7), any allowance or perquisites paid or

allowed outside India by the Government to a citizen of India for rendering services

outside India will be fully exempt.

Loan: Loan is not salary. However, if loan is given on concessional rate of interest,

savings made by the employee due to low interest rate is to be considered as profits in lieu

of salary and charged to tax.

Gratuity [Section 10(10)]: Gratuity was to be a voluntary payment (Now a Statutory

payment) made by an employer in appreciation of services rendered by the employee.

(a) In Case of Government Employees: Any death – cum- retirement gratuity

(DCRG) received is wholly exempt from tax.

(b) In Case of Employees Covered by the Payment of Gratuity Act, 1972:

Such gratuity is exempt from tax to the extent of the least of the following-

(i) 15 days’ salary (7 days’ in the case of employees of a seasonal

establishment) for every completed years of service or part thereof in

excess of six months.

(ii) Rs 3,50,000.

(iii) Gratuity actually received.

Explanations:




(i) ‘Salary’ means salary last drawn by the employee and includes DA

but does not include any bonus, performance linked commission,

HRA, overtime wages and any other allowance. If, however, under

the terms of employment, commission is payable at a fixed

percentage of turnover achieved by an employee, such commission

will be considered as salary.

(ii) Salary for 15 days or 7 days, as the case may be, is calculated by

dividing the salary last drawn by 26 i.e., maximum number of

working days in a month.

(iii) In the case of a piece-rated employee, 15 days’ salary would be

computed on the basis of monthly average of total wages received

for a period of 3 months immediately preceding the termination of

his employment.

(c) In Case of Any Other Employees: In all other cases, (employees not

covered under Gratuity Act – 1972) gratuity received on retirement, death,

termination, resignation or incapacitation prior to retirement is exempt from

tax to the least of the following: -

(i) Rs 3,50,000 in respect of gratuity becoming payable on or after

24.9.1999.

(ii) Half month’s average salary for each completed year of

service. (Advantage of converting part of year into full year is

not available in this case. 21 years and 11 months and 29 days

will be counted as 21 years only and not 22 years)

(iii) Actual amount received as Gratuity.

Explanations:

(i) Average monthly salary is calculated by adding up the salary drawn

during last 10 months and dividing by 10. If the person does not

draw full salary in the month of retirement, it is excluded in

calculation. Therefore, if a person retires on 15 Mar 2005, 10 months

will be counted backwards starting from salary for Feb 2005.

(ii) Salary for this purpose means basic salary and includes DA. If,

however, under the terms of employment, commission is payable at

a fixed percentage of turnover achieved by an employee, such

commission will be considered as salary but will exclude all other

allowances and perquisites.

(d) An employee can not claim tax exemption in excess of Rs 3,50,000 in his

life time. Thus, in cases where an employee has received some gratuity from

one employer, his tax free limit of gratuity from the next employer would be

reduced to that extent. Thus, if 1,50,000 has been claimed once as tax free




receipt of gratuity, he will be exempted up to Rs 2,00,00 only for gratuity

received from any subsequent employers.

(e) Income tax concession to Gratuity is available only when it is paid as

terminal benefit, ie. Employee is quitting his/her job. Gratuity paid to an

employee while in service is not exempt from tax.

(f) For getting exemption under this Section, employee must be a salaried

employee, i.e. there must exist the relationship of employer – employee.

Gratuity received in any other mode is not exempt. For example, gratuity

payable by the LIC of India to its insurance agents does not qualify for

exemption because such agents are not salaried employees of the LIC.

Leave Salary [Section 10(10AA)]

(a) Leave Salary to Central/State Government Employees: In case of

Central / State Government employees, any amount received as cash

equivalent of leave salary in respect of period of earned leave at his credit at

the time of retirement/ superannuation is completely exempt from tax. But

leave encashed during the service is fully taxable.

(b) Leave Salary to Other Employees: In case of non-government employees

(including employees of a local authority or statutory corporation) leave

salary is exempt from tax to the extent of the least of the following:

(i) Cash equivalent of the leave salary in respect of the period of earned

leave standing to the credit of employee at the time of retirement/

superannuation. For this purpose, earned leave entitlement cannot

exceed 30 days for every year of actual service rendered for the

employer, or

(ii) 10 months’ average salary, or

(iii) Rs 3,00,000, or

(iv) The amount of leave encashment actually received at the time of

retirement.

(c) Meaning of Salary : Same as in gratuity section.

(d) More Than One Employer: Remember the basic principle of income tax

benefits – One assessee, one benefit. Benefits are accounted on cumulative

basis. So the limits stated above are to be followed whether the benefit is

received from one source or ten sources.

(e) Income tax relief in the incidence of encashment of leave is only available

as part of terminal benefit, i.e. when employee quits the job. Any

encashment of leave while in service is fully taxable.




(f) Salary paid to the legal heirs of the deceased employee in respect of

privileges leave standing to the credit of such employee at the time of his

death is not taxable in the recipient’s hands.

(g) Leave salary received by the family of a government servant who died in

harness i.e., while in employment is not taxable in the hands of recipient.

(h) These provisions are applicable even in the case of voluntary retirement.

Salary to a Partner: Salary paid to a partner by a firm is nothing but an appropriation

of profits. Explanation (ii) to Section 15 clarifies that any salary, bonus, commission or

remuneration, by whatever name called, due to or received by partner of a firm shall not be

regarded as salary. Same is to be charged as income from profits and gains of business or

profession.

Pension: Pension is to be treated as salary for all purposes. In the case of a resident,

pension is taxable whether it is in respect of services in India or abroad and whether paid in

India or abroad. However, in the case of Non-Resident and a Resident But Not Ordinarily

Resident, pension earned and received abroad but later on remitted to India is exempt from

tax. Standard deduction is available in respect of pension.

Commuted Pension: Commutation means “Inter-Change”. Many people convert part of

their future right to receive pension into a lump-sum amount receivable immediately on

retirement. Any payment in respect of commutation of pension is exempted from tax.

However, monthly receipts of uncommuted portion of the pension, is chargeable to tax at

par with salary.

Basis of Charge:

(a) Any commuted pension received by a government employee is wholly

exempt from tax under Section 10 (10A).

(b) In the case of non-government employees:

(i) Where he receives gratuity – The commuted value of up to 1/3rd

of

the pension which he is normally entitled to receive is exempt.

(ii) In other cases – The commuted value of one-half of such pension

which he is normally entitled to receive is exempt.

(c) Pension is chargeable to tax on accrual basis. (Due basis, whether it is

actually received or not).

(d) Arrears of pension are taxable whenever declared due, whether paid or not.

Annuity: ‘Annuity’ is not necessarily treated as salary. Annuity is a regular sum payable

on annual basis. If a person invests some money in any scheme entitling him to series of

equal annuals sums, such annual sums are called annuities.

(a) Annuity received from the present employer is to be taxed as salary.

(b) Annuity received from a past employer is taxable as profit in lieu of salary.




(c) Annuity received from a person other than employer is taxable as “income

from other sources”.

Retrenchment Compensation [Section 10(10B)]: Compensation received by a

workman at the time of retrenchment under-

(a) The Industrial Disputes Act, 1947

(b) Any other Act or Rules, Orders or Notifications issued there under, or

(c) Any standing order or

(d) Any award, contract of service

is exempt from income tax to the extent of :

(a) An amount calculated in accordance with the provisions of Section 25(b) of

the Industrial Disputes Act, 1947; or

(b) Rs 5,00,000.

whichever is less.

Exceptions:

(a) The aforesaid limits are not applicable in cases where the compensation is

paid under any scheme approved by the Central Government.

(b) Compensation received by a workman at the time of closing down of the

factory/establishment in which he is employed shall be deemed to be

compensation received at the time of his retrenchment.

(c) Compensation received by a workman due to termination of employment at

the time of the transfer of the ownership or management of the undertaking

shall be deemed to be compensation received at the time of retrenchment if

the following conditions are fulfilled :

(i) The service of the workman has been interrupted by such transfer;

(ii) The terms and conditions of service under the new

owner/management are less favourable to him than before;

Profits in Lieu of Salary: Monetary benefits paid to an employee under heads other than

salary are called “Profits in Lieu of Salary”. Like - employer’s contributions to the

Provident Fund in excess of statutory requirements, Club membership, etc.

It also includes following:

(a) Any compensation received from the present or former employer in

connection with the termination of his employment.

(b) Any compensation received by an assessee from his present or former

employer in connection with the modification of the terms and conditions of

employment.




The payment must be arising due to master-servant relationship between the payer

and the payee. If it is not on that account, but due to consideration totally

unconnected with employment, such payment is not profit in lieu of salary.

Example: Lachman Das was posted to a factory in Karachi. At the time of

partition, he migrated to India. He suffered loss of personal property in Pakistan due

to partition. He sought compensation for such losses from his employer. He

received some payments as compensation. This compensation was not deemed to be

taxable as ‘profit in lieu of salary’.

(c) Any payment received by an assessee from his employer or former

employer or from provident fund or from other funds to the extent to which

it does not consist of contributions by the assessee or interest on such

contributions.

For example, if any sum is paid to an employee from (a) an unrecognized provident

fund or (b) an approved superannuation fund or (c) any other similar fund, it is to be

dealt with as follows:

(i) That part of the sum which represents the employer’s contribution to

the fund and interest thereon is taxable under salaries.

(ii) That part of the sum which represents employee’s contribution and

interest thereon is not chargeable to tax since the same have already

been taxed under the head ‘salaries’ and ‘other sources’ respectively

on an yearly basis.

Exceptions: However, the above definition does not include the following

payments:

(a) Gratuity;

(b) Commuted pension;

(c) Retrenchment compensation;

(d) House rent allowance.

(d) Any payment received by an assessee under a Key-man Insurance policy

including the sum allocated by way of bonus on such policy. Key-man are

important people like CEO, Finance Director, etc for whom companies take

extra insurance policies. Insurance premium on such policies are considered

to be profits in lieu of salaries.

(e) Any amount received either before joining the employment or after quitting

the employment.

Salary From United Nations Organisations

Salaries and pensions and other emoluments paid by United Nations to its employees are

exempted from Income Tax.




Compensation Received On VRS [Section 10 (10C)]

Any compensation received by an employee of a public sector company or of any other

company at the time of his voluntary retirement or termination of his service is exempt up

to a maximum limit of Rs 5,00,000. However, such payment should be in accordance with

a scheme of voluntary retirement or in the case of a public sector company referred, a

scheme of voluntary separation. Such schemes should be in accordance with prescribed

guidelines.




ALLOWANCES

Total pay of employees includes, besides Basic Pay, various allowances. Allowances are

given to employees to meet some particular requirements like house rent, expenses on

uniform, conveyance etc. While initially, most of the allowances were exempt from the tax,

their misuse for evading taxes, has led to withdrawal of most of the concessions available

to allowances. Under the Act, allowance is taxable on due or receipt basis, whichever is

earlier. Various types of allowances and their tax treatment are as follows:

City Compensatory Allowance: City Compensatory Allowance is intended to

compensate the employees for the higher cost of living in big cities. It is taxable at normal

rate as part of the salary.

House Rent Allowance [Section 10 (13A) and rule 2A]: The Act gives exemption in

respect of house rent allowance as follows:

Least of the following is exempt from tax :

(a) 50% of salary if residential house is situated at Bombay, Calcutta, Delhi or

Madras or 40% of salary if the residential house is situated in any other

place

OR

(b) Actual house rent allowance received by the employee in respect of the

period during which the rental accommodation is occupied by the employee

during the previous year

OR

(c) Excess of rent paid over 10% of salary.

Explanations

(i) ‘Salary’ means basic salary (inclusive of Dearness Pay) and includes

Dearness Allowance. It also includes commission based on a fixed

percentage of turnover achieved by an employee but excludes all

other allowances and perquisites.

(ii) Basic salary, dearness allowance and commission are determined on

‘due’ basis in respect of the period during which rental

accommodation is occupied by the employee in the previous year.

(iii) Similarly, salary for a period other than the pervious year need not

be considered even though such amount is received during the

previous year and is taxable on receipt basis.

(iv) If the rent paid does not exceed 10% of salary, no exemption will be

available.




(v) It is essential that he must incur expenditure towards rent of the

house to claim IT exemption. Therefore, if an employee lives in his

own house, no exemption is permissible.

Entertainment Allowance: This allowance is meant to compensate the employees

towards miscellaneous hospitality expenses in receiving business related visitors. Full

Entertainment allowance is first to be included in the salary and then the permissible

deduction is to be claimed. Only govt employees are allowed this deduction to the

extent of Rs 5000/- or 10% of the salary which ever is less.

Special Allowances [Section 10 (14)]: As stated earlier, most of the allowances are

taxable at par with salary unless there are specific exemptions available under the Act.

Section 10 (14) exempts the following allowances from income-tax:

(i) Any special allowance or benefit granted to meet expenses wholly,

necessarily and exclusively incurred in the performance of the duties

provided such expenses are actually incurred for that purpose. Such

allowances are listed in rule 2BB discussed below:

(ii) Any allowance granted to the assessee to meet extraordinary personal

expenses at the place where the duties of his office or employment of profit

are ordinarily performed by him or at the place where he ordinarily resides,

to compensate him for the increased cost of living. Again such allowances

have been prescribed in rule 2BB discussed below.

Please note that this exemption is available only if the place of posting or stay is ‘Hard’ and

not for nature of job.

Rule 2BB: Following allowances (EXEMPT FROM TAX) have been prescribed for the

purposes of Section 10 (14)(i):

(a) Cost of travel on tour or on transfer;

(b) Daily allowance during travel and temporary duty

(c) Local conveyance in performance of duties.

(d) Hiring of helper in connection with official work.

(e) Any allowance granted for encouraging the academic research and training

pursuits in Educational and Research Institutions;

(f) Uniform (dress) allowance.

Prescribed allowances for the purposes of Section 10 (14) (ii) :

(a) Special Compensatory (Hilly Areas) Allowance or High Altitude Allowance

or Uncongenial Climate Allowance or Snow Bound Area Allowance or

Avalanche Allowance – Rs 800 or Rs 7,00 or Rs 300 per month depending

upon the specified locations.

High Altitude (Uncongenial climate) Allowance




- between 9000 to 15000 feet – Rs 1,060 p.m.

- above 15000 feet – Rs 1,600 per month.

(b) Any Special Compensatory Allowance in the nature of Border Area

Allowance or Remote Locality Allowance or Difficult Area Allowance or

Disturbed Area Allowance Rs 1,300 or Rs 1,100 or Rs 1,050 or Rs 750 or

Rs 300 or Rs 200 per month depending upon the specified locations.

Special compensatory Highly Active Field Area allowance – up to Rs 4,200

per month. Island Allowance for Armed Forces in Andaman and Nicobar

and Lakshadweep Island – Rs 3,250 per month.

(c) Special Compensatory (Tribal Areas / Schedule – Areas / Agency Areas)

Allowance – Rs 200 per month.

(d) Any allowance paid to drivers of long route transport to meet his personal

expenditure during travel provided that such employee is not in receipt of

daily allowance – 70% of such allowance up to a maximum of Rs 6,000 per

month.

(e) Children Education Allowance – Rs 100 per month per child up to a

maximum of two children.

(f) Any allowance granted to an employee to meet the hostel expenditure on his

child - Rs 300 per month per child up to a maximum of two children.

(g) Compensatory Field Area Allowance – Rs 2,600 per month in specified

areas.

(h) Compensatory Modified Field Area Allowance – Rs 1,000 per month in

specified areas.

(i) Any special allowance in the nature of Counter Insurgency Allowance

granted to the members of Armed Forces operating in areas away from their

permanent locations for a period of more than 30 days – Rs 3,900 per

month.

Any assessee claiming exemption in respect of the allowances mentioned at serial

numbers (g) and (h) shall not be entitled to exemption in respect of the allowance

referred to at serial (b).

Any assessee claiming exemption in respect of the allowance mentioned at serial (i)

shall not be entitled to the exemption in respect of disturbed area allowance referred

to at serial No.2.

(j) Any transport allowance granted to an employee (other than these referred

to in Sl. (k) below) to meet his expenditure for the purpose of commuting

between the place of his residence and the place of his duty – Rs 800 per

month.

(k) Transport allowance granted to an employee who is blind or orthopaedically

handicapped for commuting between his residence and place of duty – Rs

1600 per month.




(l) Underground Allowance - Rs 800 per month would be granted to an

employee who is working in unnatural climate in underground coal mines.

Allowance to High Court Judges: Any allowance paid to a Judge of a High Court under

Section 22A (a) of the High Court Judges Conditions of Service) Act, 1954 is not taxable.

Compensatory Allowance Under Article 222(2) of the Constitution: Compensatory

allowance received by judge under Article 222(2) of the Constitution is not taxable since it

is neither salary not perquisite.

Sumptuary Allowance: Sumptuary allowance given to High Court Judges under Section

22C of the High Court Judges (Conditions of service) Act, 1954 and Supreme Court Judges

under Section 23B of the Supreme Court Judges (Conditions of Service) Act, 1958 is not

chargeable to tax.




PERQUISITES

As per the dictionary, ‘Perquisites’ are defined as casual profit additional to normal

revenue: thing that has served its primary use and to which a subordinate or servant has

then a customary right: incidental benefit attached to employment etc: customary

gratuity”. Thus, the term ‘perquisite’ indicates some extra benefit in addition to the amount

that may be legally due by way of contract for services rendered. In the present times, the

salary package of an employee normally includes monetary element and perquisite like

housing, car etc. Perquisites may or may not be taxable. Important aspects of perquisites

are as follows:

(a) Perquisite may be in cash or in kind.

(b) Reimbursement of expenses incurred in the discharge of official duties is not

a perquisite.

(c) Perquisite may arise in the course of employment or in the course of

profession. If it arises from employment, then the value of the perquisite is

taxable as salary. However, if it arises due to profession, the value of such

perquisite is chargeable as profits and gains from business or profession.

(d) An advantage is termed as Perquisite only if it is legally acquired. Any

illegally acquired advantage will not be considered to be perquisite but will

be taxable as income from other sources.

(e) Premium paid by employer towards the personal accident policy of

employee is completely exempt from tax.

(f) Income-tax paid by the employer out of his pocket on the salary of the

employee is a perquisite in the hands of the employee whether the payment

is contractual or voluntary.

Definition: Under the Act, the term ‘perquisite’ is defined by Section 17(2) to include the

following:

(a) Value of rent free accommodation provided to the assessee by his employer

Section 17(2) (i);

(b) Value of any concession in the matter of rent in respect of any

accommodation provided to the assessee by his employer – Section 17 (2)

(ii);

(c) Value of any benefit or amenity granted or provided free of cost or at

concessional rate in cases of Specified Employees:

(d) Any sum paid by the employer in respect of any obligation which would

have been payable by the assessee – Section 17 (2) (iv);

(e) Any sum payable by the employer whether directly or through a fund other

than a recognized Provident Fund or approved Superannuation Fund or

Deposit-Linked Insurance Fund to effect an assurance on the life of the

assessee or to effect a contract for an annuity; Section 17(2) (v).




It should be noted that the aforesaid definition of perquisite is an inclusive one. More terms

can be added in.

Specified Employees:

(a) Director: An employee of a company who is also a director is a specified

employee. It is immaterial whether he is a full-time director or part-time

director.

(b) An Employee Who Has Substantial Interest in the Company: An

employee of a company who has substantial interest in that company is a

specified employee. A person has a substantial interest in a company if he is

a beneficial owner of equity shares carrying 20% or more of the voting

power in the company.

(c) Employee Drawing in Excess of Rs 50,000: An employee other than

an employee described in (a) & (b) above, whose income, chargeable under

the head ‘salaries’, exceeds Rs 50,000 is a specified employee.

Normal Perquisites: Following perquisites are generally allowed by an employer to his

employees:

(a) Rent-free accommodation

(b) Accommodation at concessional rent;

(c) Furnishings for the above accommodation;

(d) Motor – car;

(e) Free gas, electricity or water – supply;

(f) Free education;

(g) Free transport;

(h) Free domestic servants.

Rule 3 of the Income-tax Rules, 1962 contains the guidelines for the purpose of valuation

of perquisites;

Types of Perquisites: Perquisites may be divided into three broad categories:

(a) Perquisites taxable in the case of all employees.

(b) Perquisites exempt from tax in case of all employees

(c) Perquisites taxable only in the hands of specified employees.

Perquisites Taxable in Case of All Employees: Following perquisites are chargeable to

tax in all cases.

(a) Value of rent-free accommodation




(i) Value of concession in rent in respect of accommodation provided to

the assessee by his employer

(ii) Value of any benefit or amenity granted or provided free of cost or at

concessional rate to Specified Employees; However, this sub-clause

shall not apply in case of Employees Stock Option Plan.

Exception: Rent-free official residence provided to a Judge of a High Court or to

a Judge of the Supreme Court is not taxable. Similarly, rent-free furnished house

provided to an Officer of Parliament, is not taxable.

(b) Amount paid by an employer in respect of any obligation which otherwise

would have been payable by the employee – Section 17(2) (iv). Example:

pay of the domestic servant hired by the employee but paid for by the

employer is a taxable perquisite. However, a gardener’s salary paid by

company for maintenance of a company owned house allotted to an

employee may not be chargeable to tax in the hands of employee since

gardener may not have been employed by the employee otherwise.

(c) Insurance and Annuity premiums paid by the employer. However, there are

schemes like Group Annuity Scheme, Employees State Insurance Scheme

and Fidelity Insurance Scheme, which are not considered as perquisites and

are exempted from tax.

(d) Value of any other fringe benefit or amenity as may be prescribed.

Perquisites Exempt from Tax in All Cases: Following perquisites from employer are

exempt from tax in all cases:

(a) Residential telephone facility.

(b) Goods sold by an employer to his employees at concessional rates;

(c) Transport facility, free or concessional, if the employer is engaged in

transport business;

(d) Privilege passes and privilege ticket orders granted by Indian Railways to its

employees;

(e) Perquisites allowed outside India by the Government to a citizen of India for

rendering services outside India;

(f) Sum payable (statutory requirement) by an employer to a recognized

Provident Fund or an approved Superannuation Fund or Deposit-Linked

Insurance Fund established under the Coal Mines Provident Fund or the

Employees’ Provident Fund Act;

(g) Employer’s contribution to Staff Group Insurance Scheme;

(h) Leave travel concession;

(i) Payment of annual premium on personal accident policy;

(j) Refreshment during working hours in office premises;




(k) Subsidised meals.

(l) Recreational facilities extended to employees in general i.e. not restricted to

a few select employees;

(m) Amount spent by the employer on training of employees or amount paid for

refresher management course including expenses on boarding and lodging;

(n) Medical facilities subject to certain prescribed limits;

(o) Rent-free official residence provided to a Judge of High Court or the

Supreme Court;

(p) Rent-free furnished residence including maintenance provided to an Officer

of Parliament, Union Minister and a Leader of Opposition in Parliament;

(q) Conveyance facility provided to High Court Judges under Section 22B of

the High Court Judges (Conditions of Service) Act, 1954 and Supreme

Court Judges under Section 23A of the Supreme Court Judges (Conditions

of Service) Act, 1958.

Perquisites Taxable Only in the Hands of Specified Employees [ Section 17 (2) (iii)]: All

other perquisites which have not been included above will be taxable in the hands of

specified employees:

Types of Employees: For the purpose of valuation of the perquisite in respect of

unfurnished accommodation the employees are divided into two categories:

(a) Central and State Government Employees: The value of the perquisite

will be equal to the license fee.

(b) Private Sector Employees:

(i) Where the accommodation is owned by the employer, the value will

be as follows:

(aa) 10% of salary in cities having population exceeding 4 lacs as

per 1991 census;

(bb) 7.5% of salary in other cities

(ii) Where the accommodation is taken on lease or rent by the employer,

the value will be equal to the actual amount of lease rental paid or

payable by the employer or 10% of salary whichever is lower.

Definition of Salary: “Salary” includes the pay, allowances, bonus or commission

payable monthly or otherwise or any monetary payment, by whatever name called

from one or more employer, as the case may be, but does not include the following,

namely :-

(i) Dearness Allowance or Dearness Pay unless it enters the

computation of superannuation or retirement benefits of the

employee concerned;




(ii) Employer’s contribution to the provident fund account of the

employee;

(iii) Allowances which are exempted from payment of tax;

(iv) Value of perquisites specified in sub-Section (2) of Section 17 of

the Income-tax Act;

(v) Any payment or expenditure specifically excluded under proviso to

sub-clause (iii) of clause (2) or proviso to clause of Section 17.

Furnished Accommodation: When the accommodation provided to the employee is

furnished by the employer, the computation of the value of the perquisite has to be done in

the following manner :-

(a) First compute the value of the perquisite as if the accommodation is

unfurnished.

(b) Then, add to the value arrived at under (i) above ;

(i) 10% of the original cost of the furnishings per annum if the

furnishings are owned by the employer; or

(ii) If the employer has taken the furnishings on hire and provided them

to the employee, add the hire charges borne by the employer.

This addition in respect of furnished accommodation is applicable to all

categories of employees.

In this context, the term ‘ furnishings’ will include furniture like sofa sets, cots, dining table

etc. TV sets, radio sets, refrigerator and other household appliances, air-conditioning plant

or equipments.

Provision of Motor-Car by Employer: Situations where no perquisite will arise -

(a) Only in case of specified employees as discussed earlier.

(b) If the car is used wholly for official purposes even if the car is owned by the

employee or is owned/ hired by the employer.

Method of Valuation of Motor Car: The method of valuation depends upon who owns

the motor-car, who bears the maintenance and running charges, the H.P. rating of the car,

whether a chauffeur has been provided and whether the car has been provided exclusively

for personal use of the employee or partly for official use and partly for personal purposes.

The method of valuation under various situations are discussed below.

Sl.

Circumstances

Where cubic capacity of

engine does not exceed

1.6 litres

Where cubic capacity of

engine exceeds 1.6 litres.

1. Motor car is owned or

hired by the employer and




1(a) is used wholly and

exclusively in the

performance of official

duties;

No value provided that

the documents specified

in clause (B) of this sub-

rule are maintained by the

employer





employer

1(b) is used exclusively for the

private or personal

purposes of the employee

or any member of his

household and the

running and maintenance

expenses are met or

reimbursed by the

employer.

Actual amount of

expenditure incurred by

the employer on the

running, maintenance,

depreciation and

chauffeur

Actual amount of

expenditure incurred by

the employer on the

running, maintenance,

depreciation and

chauffeur

1(c) is used partly in the

performance of duties and

partly for private or

personal purposes of his

own or any member of

his household and

(i) The expenses on

maintenance and running

are met or reimbursed by

the employer.

Rs 1,200 (plus Rs 600, if

chauffeur is also provided

to run the motor car)

Rs 1,600 (plus Rs 600, if



(ii) The expenses on


for such private or

personal use are fully met

by the assessee

Rs 400 (plus Rs 600, if

chauffeur is provided by

the employer to run the

motor car)

Rs 600 (plus Rs 600 if



2. Where the employee own

a motor car but the actual


charges (including

remuneration of the

chauffeur, if any) are met

or reimbursed to him by

the employer and

2(i) Such reimbursement is

for the use of the vehicle

wholly and exclusively












for official purposes employer. employer.

2(ii) Such reimbursement is


partly for official

purposes and partly for

personal or private

purposes of the employee

or any member of his

houseold.

Subject to the provisions

contained in clause (B) of

this sub-rule, the actual

amount of expenditure

incurred by the employer

as reduced by the amount

specified in col. (1) (c) (i)

above.






as reduced by the amount

specified in col.(1)(c)(i)

above.

3. Where the employee

owns any other

automotive conveyance

but actual running and

maintenance charges are

met or reimbursed to him

by the employer and

3(i) Such reimbursement is


wholly and exclusively

for official purposes.





employer.

Not applicable.

3(ii) Such reimbursement is


partly for official

purposes and partly for

personal or private

purposes of the employee.






as reduced by an amount

of Rs 600/-

Valuation of Provision for Domestic Servants: At actual cost borne by the employer.

Valuation of Supply of Gas, Electricity or Water Supplied by Employer: At actual cost

borne by the employer.

Valuation of Free or Concessional Educational Facilities: At actual cost borne by the

employer. However if the educational institution itself is maintained and owned by the

employer and free educational facilities are provided to the children of the employee or

where such free educational facilities are provided in any institution by reason of his being

in employment of that employer, nothing contained in this sub-rule shall apply if the cost of

such education or the value of such benefit per child does not exceed Rs 1,000/- p.m.




Valuation of Other Fringe Benefits and Amenities:

(a) Interest-Free or Concessional Loan: The value of the perquisite is

calculated as the difference between the interest rate charged to the

employee and following rates on monthly rest basis

(i) 10% per annum (simple interest) in respect of loans for house and

conveyance

(ii) 13% per annum (simple interest) for other loans

However, no value would be charged if

(aa) Loans up to Rs 20000/-

(ab) Loans for medical treatment in respect of certain diseases

(b) Paid Holidays: At actuals with exception of concession or assistance

referred to in Rule 2B.

(c) Free Meals: Allowed in most cases with few limits.

(d) Gifts, etc. Received From Employer: At actuals. However, where the

value of such gift, voucher or token is below Rs 5,000/- in the aggregate

during the previous year, the value of perquisite shall be taken as nil.

(e) Credit Card Expenses: At actuals except when used for official purpose.

(f) Club Membership: At actuals.

(g) Use of Assets : At 10% per annum of the actual cost of such asset or the

amount of rent or charge paid or payable by the employer.

In the case of computers and electronic items, the normal wear and tear would be

calculated at the rate of 50% and in the case of motor cars at the rate of 20% by the

reducing balance method.

Medical Facilities: Proviso to Section 17(2) provides that the following medical

facilities will not amount to perquisites:

(a) Value of any medical treatment provided to an employee or any member of

his family in any hospital maintained by the employer;

(b) Any sum paid by the employer in respect of any expenditure actually

incurred by the employee on his medical treatment or treatment of any

member of his family in any hospital maintained by the Government or any

local authority or any other hospital approved by the Government for the

purpose of medical treatment of its employees;

(c) Any sum paid by the employer in respect of any expenditure actually

incurred by the employee on his medical treatment or treatment of any

member of his family in respect of the prescribed disease or ailments in any

hospital approved by the Chief Commissioner having regard to the

prescribed guidelines. However, in order to claim this benefit, the employee

shall attach with his return of income a certificate from the hospital




specifying the diseases or ailment for which medical treatment was required

and the receipt for the amount paid to the hospital.

(d) Health insurance premium paid by an employer

(e) Family health insurance premium paid by employer for approved schemes.

(f) Reimbursement of medical expenses for self and family not exceeding Rs

15,000 in the previous year.

(g) Travel, medical and other expenses related to Medical treatment of

employee and family outside India

(h) Any reimbursement by the employer in respect of any expenditure actually

incurred by the employee for any of the purposes specified in (g) above.

Payment of Premium on Personal Accident Insurance Policies: Not considered to be

perquisite.




DEDUCTIONS FROM SALARY

The income chargeable under the head ‘salaries’ is computed after making the following

deductions:

(a) Standard Deduction [Section 16(i)]

(b) Entertainment Allowance [ Section 16(ii)]

(c) Professional tax [ Section 16 (iii)]

Standard Deduction: It is on a flat basis without any conditions attached to it. But

irrespective of how many salaries (from different employers) are being drawn by the

assessee, only one Standard Deduction is allowed. Remember the rule, benefits are

available to earner of the income not against the source of income. So, one earner, one

benefit only. The amount of deduction is as follows:

(a) If income from salary (before allowing Standard Deduction) does not

exceed Rs 5,00,000, the amount of deduction will be 40% of salary or Rs

30,000, whichever is less.

(b) If income from salary exceeds Rs 5 lakhs, - NIL

For this purpose, the term ‘salary’ will include fees, commission, perquisites or

profits in lieu or in addition to salary, but will not include any payments received by

the employee which are specifically exempt from tax under clauses (10), (10A),

(10AA), (10B), (11), (12) & (13A) of Section 10 of the Income-tax Act.

(c) Pensioners are also entitled to the Standard Deduction.

Entertainment Allowance: Entertainment allowance is first to be included in the salary

and thereafter the following deduction is to be made:

Entertainment allowance is deductible only in case of Government employees. No

deduction in respect of Entertainment Allowance is available to the Pvt Company

employees. The amount of deduction will be equal to one-tenth of his salary or Rs 5,000/-

or actual allowance received, whichever is less. For this purpose, salary excludes any

allowance, benefit or other perquisites.

Deduction is permissible even if the amount received as entertainment allowance is not

proved to have been spent – CIT Vs. Kamal Devi [ 1971] 81 ITR 773 (Delhi).

Professional Tax: Professional tax or taxes on employment are allowed as deduction.




PROVIDENT FUND

Provident fund scheme is a scheme intended to give support to the employee in case of any

untimely death or as financial support at the time of his retirement. Under this scheme, a

specified sum is deducted from the salary of the employee as his contribution towards the

fund. The employer also generally contributes equal sum out of his pocket, to the fund. In

most cases such contributions of the employer are fully exempted from tax and

contributions by the employee qualify for rebate under Sec 88.

There are four types of Provident Funds:

(a) Statutory Provident Fund

(b) Recognised Provident Fund.

(c) Unrecognised Provident Fund.

(d) Public Provident Fund.

Statutory Provident Fund (SPF): It applies to employees of government, railways,

semi-government institutions, local bodies, universities and all recognized educational

institutions. Under the Income tax Act, all contributions by employer, interest accrued on

PF deposit and repayment of balance are wholly exempt from tax. Employees contribution,

subject to a maximum limit, is eligible for rebate under Section 88.

Recognised Provident Fund (RPF): Recognised provident fund means a provident fund

recognized by the Commissioner of Income-tax or a fund constituted under Employees

Provident Fund and Miscellaneous Provisions Act, 1952. The provisions with regard to a

recognized provident fund are as follows:

(a) Employee’s Own Contribution: It qualifies for rebate under Section 88.

(b) Employer’s Contribution: Employer’s contribution up to 12% of the

employee’s salary is exempt. The excess over such a limit is chargeable

under “salaries” as profits in lieu of salary. ‘Salary’ here means basic salary

plus dearness allowance and any commission paid to the employee as a

fixed percentage of the turnover achieved by him. It does not include any

other allowance or perquisite.

(c) Interest Accrued on PF Deposits: Interest credited @ of 12% p.a. or below

is exempt. In case interest exceeds the above limit, the excess may be

chargeable as salary.

(d) Payment of Accumulated Balance: The accumulated balance due and

payable to an employee in a recognized provident fund, upon resignation,

termination or death, is exempt subject to the following conditions :

(i) He must have rendered continuous service with the employer for

five years or more;




(ii) If the service period is less than five years due to reasons beyond the

control of the employee such as ill-health, contraction or

discontinuance of the employer’s business;

(iii) If, after termination of his employment with one employer, he

obtains employment under another employer, then, only so much of

the accumulated balance in his provident fund account will be

exempt which is transferred to his individuals account in a

recognized provident fund maintained by the new employer. In such

a case, for exemption of payment of accumulated balance by the new

employer, the period of service with the former employer shall also

be taken into account for computing the period of five years’

continuous service.

In case none of the three conditions stated above is satisfied and hence the

accumulated balance due to the employee becomes taxable, the RPF will be deemed to be

an unrecognized Provident Fund and the employee’s total income for all the concerned

years will be recomputed by the Assessing Officer on this basis.

Unrecognised Provident Fund (UPF): A fund not recognized by the Commissioner of

Income-tax is Unrecognised Provident Fund. The provisions relating to it are as follows:

(a) Employee’s Contribution: Does not qualify for rebate under Section 88.

(b) Employer’s Contribution: The amount contributed by the employer is,

for the time being, ignored. It is not included in the employee’s gross salary.

(c) Interest accrued on PF Deposits: The amount of interest credited to the

account of the employee is divided into two parts:

(i) Interest on employee’s own contribution

(ii) Interest on the contribution made by the employer.

(d) Interest on employer’s contribution is for the time being ignored. Interest on

employee’s own contribution is chargeable in his hands of employee from

year to year under “Income from Other Sources”.

(e) Payment of Accumulated Balance: There are two possible situations here :

(i) The accumulated balance standing to the credit of the employee may

be paid to him on his resignation etc.

(ii) The accumulated balance in his account may be transferred to a RPF,

say when he changes the job.

Tax treatment : The amount of the refund or transferred balance will be

divided into two parts:

(aa) Employee’s own contribution to the fund and interest

thereon;

(ab) Employer’s contribution and interest thereon.




Since employee’s contribution to such fund did not at any time qualify for any tax

benefits, it is obvious that the same has already been taxed. Similarly, interest on his

own contribution has already been taxed under income from other sources from

year to year. So, it will not be taxed again. The balance representing the

employer’s contribution and the interest thereon has all along remained untaxed and

as such it will now be included under “salaries” as “profit in lieu of salary”, in the

year in which the accumulated balance has been paid to the employee or transferred

to recognized provident fund.

Public Provident Fund (PPF): For getting a rebate of tax under Section 88, a member is

required to contribute to the PPF a minimum of Rs 100 in a year. A maximum amount that

may qualify for rebate on this account is Rs 60,000. Contributions to PPF will qualify for

rebate under the overall limit of Rs 60,000 under Section 88. For the remaining purposes, it

is treated at par with RPF.

APPROVED SUPERANNUATION FUND

The tax treatment of the fund is as follows:

(a) Employer’s contribution is exempt from tax.

(b) Employee’s contribution qualifies for rebate of tax under Section 88;

(c) Interest on accumulated balance is exempt from tax.

Section 10(13) grants exemption in respect of payment from the fund-

(a) To the legal heirs on the death of beneficiary (e.g. payment to widow of the

beneficiary) or

(b) To an employee in lieu of or in commutation of an annuity on his retirement

at or after the specified age or on his becoming incapacitated prior to such

retirement or

(c) By way of refund of contribution on the death of the beneficiary or,

(d) By way of refund of contribution of an employee on his leaving otherwise

than in the circumstances mentioned in (b).

APPROVED GRATUITY FUND

The tax treatment of the fund is as follows:

(a) Employer’s contribution is exempt from tax.

(b) Actual payment received by the employee is exempt from tax within the

limits specified in Section 10(10).




TAX REBATE UNDER SECTION 88

Under the provision of Section 88, an assessee will be entitled to a rebate of tax at a

prescribed percentage of the amount invested in LIC policies, provident funds,

superannuation funds, etc. from the income-tax payable by him on his total income. Where

at least 90% of the gross total income of an individual consists of salary income and such

income does not exceed Rs 1 Lakh before allowing Standard Deduction, the rebate will be

30% of the amount invested under Section 88.

Example No.1. Mr. Dinesh is retiring from a company in the private sector on

29 February 2004. His other details are as follows:

(a) Salary at the time of retirement : Rs 22100

(b) Average salary received during the 10 months ending on 29 February 2004:

Rs 22100

(c) Duration of service : 24 Years

(d) Leave entitlement for every year of service : one and half months

(e) Leave availed while in service : 16 months

(f) Leave at the credit of the employee at retirement : 20 months

(g) Leave salary paid at retirement: Rs 795600

Determine the amount of exemption.

Ans. Max Leave Credit as per IT rules (not exceeding 30 days in a year) = 24 months

Leave availed by Mr Dinesh = 16 months

Net tax free Leave encashment = 24 -16 = 08 months

Max leave salary allowed tax free = 10 months

Average Salary during last 10 months of service = Rs 22100/-

Tax free leave salary entitlement = 22100 x 08 = Rs 1,76,800/-

Example No. 2. Dinesh, an employee of the Central Government of India, receives Rs

48000 as gratuity at the time of retirement on 13 September 2003. Is the gratuity fully

exempt from tax ?

Ans: Yes. Gratuity payment to Govt. employees is fully exempt from Tax.

Example No. 3. Rajesh, an employee of Reliance Industries Limited (and covered by

the payment of gratuity Act,1972), receives Rs 45000 as gratuity. He retires on 26

December 2003 after rendering service of 28 years and 7 months. At the time of retirement

his monthly salary was Rs 800/= Is the entire amount of gratuity exempt from tax?

Ans: Qualifying Service: 29 Years

Tax free Gratuity amount = 15 x 800 x 29 = 13385

26

Therefore entire amount of gratuity is not tax free.




INCOME FROM HOUSE PROPERTY

Rental value of a house is considered to be the income from house property. Income from

house property is charged in the hands of the owner of the house property. Any income

from a house property in the hands of a person who is not the owner is charged as income

from other sources. Thus, income from subletting is not income from house property as the

house is not owned by the person subletting the house.

Vacant plot is not considered to be a house property and income from same is not covered

under these provisions. However, land attached to the building is part of the house

property.

Ownership or Deemed Ownership

Deemed Ownership:

(a) House property transferred otherwise than for adequate consideration to

spouse - Transferor is deemed owner.

(b) The holder of an impartible estate (a property which is under shared

ownership due to its indivisibility into separate units – say a palace) is

treated as deemed owner of the house property.

(c) A member of co-operative society /company is deemed owner.

(d) Person having control on house, in part performance of a contract U/S 53A

of the Transfer of Property Act.

Ownership: The person on whose name the house is registered. However, in case

the house has been sold (and cost of the house received by the previous owner), but

legal process of transfer of property is pending, the purchaser would be considered

to be the owner of the house for the purposes of income tax. In simple words –

Rightful owner of the house, irrespective of legal status, is considered to be

owner of the house for IT purposes.

Basis of Charge [Section 22]: The annual value of property consisting of any

buildings and any land attached to it, is chargeable to income tax under the head

‘Income from House Property’ in the hands of the owner or the deemed owner.

However, the portions of the property occupied by the assessee for the purposes of

any business or profession carried on by him, the profits of which are chargeable to

income tax, is excluded from the purview of the above Section.

Some Important Concepts to Compute Income from House Property:

(a) Building and/or Lands Attached to it: House Property means constructed

building. The term ‘building’ may take several forms like residential houses,




bungalows, buildings let out for storage or warehousing, auditoria, etc. But

it will be considered to be a House Property when it is worthy of usage in

the form built. Thus, a house without the roof is not a house property but an

open air auditorium is.

(b) Vacant Plots: Income of a vacant land or plot is considered to be income

from other sources and not house property. The reason is that the term

‘building’ does not include vacant plots. Accordingly, any rent received

from a vacant plot of land is assessable under the head ‘income from other

sources.

(c) Transfer of a House Property to Spouse or Minor Child Without

Adequate Consideration [ Section 27(i)]:

(i) Transfer Between Husband and Wife: Suppose a house is in the

name of husband, the husband transfers that house in favour of his

wife. In this case though the house is in the name of transferee (wife)

yet income from that house would be taxable in the hands of

husband (i.e. transferor). Similarly, if any parent transfers his house

in favour of his minor child, the income of that house is taxable in

the hands of the parent (i.e. Transferor).

Exceptions: There are two exceptions to this rule where the

income of a house property is taxable in the hands of the transferee:

(aa) When the transfer of a house is done in connection with an

agreement to live apart (i.e. husband and wife live apart). In

this case the income from house property is taxable in the

hands of the transferee.

(ab) When the house is transferred to a married daughter, the

income of the house is taxable in the hands of the married

daughter.

(d) Impartible Estate – [ Section 27(ii)]: An impartible estate is owned by

the HUF. However, for the purposes of income tax, the holder of such estate

who is the senior most member of the family “Karta” is deemed to be the

owner of the house property so transferred.

(e) Power of Attorney Ownership: Power of Attorney holder is the owner.

(f) Leasehold Property: The person who constructs the building on the leased

property is considered to be the owner of the house property. The land on

which the superstructure has been built will be assessed separately.

(g) Disputed Ownership: The assessment proceedings cannot be held up

because of a dispute relating to the title of the property. The person in actual

possession of the property is the deemed owner of the house.




House Property Income Chargeable under Other Heads: If the house property owned by

the assessee is used by him to carry on business or profession, income from such house

property is not assessable under this head provided the profits of such business are

chargeable to tax. Similarly, where the object of renting of house is to enable

smooth/efficient conduct of business, the rental income from such letting is assessable as

business income. Example – Company owned quarters in vicinity of business rented to its

employees. Such houses are not to be assessed as House Property.

However, a person who buys 10 houses as business purely for rental income is still to be

assessed for income from house property and not income from business.

Method to Compute Income from House Property.

1. Gross Annual Value

2. Less : Municipal Taxes

3. Net Annual Value

4. Less: Deductions U/S 24

(a) Standard Deduction @ 30% Net Annual Value

(b) Interest on Borrowed Capital

5. Income from House Property

Meaning of Gross Annual Value: The annual value of the property is deemed to be

the sum for which the property might reasonably be expected to be let out from year to

year. It is, thus, a notional income to be received from an imaginary tenant on a reasonable

basis. For determining the annual value, the following factors are necessary:

(a) Fair Rent: Fair Rent of an accommodation is that rent which a similar

property located nearby would reasonably command.

(b) Municipal Valuation: Hiring value of property as determined by the

Municipal Corporations/Local authority.

(c) Standard Rent: Rent fixed by the Rent Control Act.

Calculation of Gross Annual Value:

Gross Annual Value is calculated as follows:

Step 1. Find out the expected rent. To find out the expected rent, consider following values

of the property:

(a) Municipal Valuation of the property

(b) Fair rent of the property




(c) Standard rent of the property (as per the Rent Control Act or any other Act

in force).

Out of these three valuations, select higher of (a) and (b) and compare it with (c) (i.e.

standard rent of the property). The higher figure of (a) and (b) so selected should not

exceed the Standard Rent of the property. If the higher of (a) and (b) exceeds the standard

rent, the standard rent will be taken into account. Else, the higher of (a) and (b) is to be

taken into account.

In other words, Expected Rent is the higher of Municipal Valuation and Fair Rent of

the property provided it does not exceed the Standard Rent.

Step 2: Compare the expected rent with actual rent received/receivable. Whichever is

higher, will be selected as Gross Annual Value.

Note: Rent received/ receivable does not include rent of the period for which the property

remains vacant and unrealized rent.

Chart to Compute Gross Annual Value

Municipal Value

V/s Higher of the two

Fair Rent V/s Lesser of the two

Standard Rent V/s Higher of the two

Actual Rent

Example No. 1. Find out the Gross Annual Value:

House 1 House 2 House 3 House 4

Municipal Value (a) 105 105 105 105

Fair rent (b) 107 107 107 107

Control Act Rent(c ) 102 110 85 112

Actual rent (d) N.A 88 88 135

Gross Annual Value 102 107 88 135

Classification of House Property: For determining the annual value, the house property

can be classified into the following categories:

(a) Let out Property (LOP)

(b) Self-occupied property (SOP)

(c) Self-occupied property which could not be occupied by the owner during the

year.

(d) Property occupied by co-owners




Determining Annual Letting Value in Above Cases

(a) Let Out Property: Full Gross Annual Value is to be considered even if it

was let out just for a few days and used as self occupied property for most of

the year. It is also immaterial whether the entire property or a part of the

property was let out. If the actual rent received or receivable is more than

the annual letting value of the entire property, the actual rent shall be

deemed to be the gross annual value. However, if the actual rent is less than

the annual letting value, the annual letting value shall be the gross annual

value.

(i) Treatment on Account of Vacancy: If the property could not be

let out for any reasons for whole or part of the year and due to the

vacancy the actual rent receivable by the owner is less than the

annual letting value, such amount received or receivable will be the

gross annual value.

(ii) Treatment on Account of Unrealized Rent: Unrealized rent is to

be deducted from actual rent in order to determine the gross annual

value subject to certain conditions.

(iii) Loss from House Property: Loss from let out house property can

not be set off from any other income. However, it can be carried

forward and adjusted against income from house property for eight

years.

(iv) Interest on Borrowed Capital: There is no limit on deductible

amount of interest on borrowed capital for Let Out House Property.

(v) Interest on Borrowed Capital for Pre Construction Period: is

allowed to be claimed/ charged off in five equal instalments starting

from the year of completion.

Therefore, the gross annual value is to be determined on the basis of annual letting

value or the actual rent received or receivable, as the case may be.

(b) Self Occupied Property: If any House Property is used by the owner

and his family, Annual Value of such house is taken as NIL. However, this

benefit is restricted to only one house. In other words, where the assessee

occupies two or more self owned houses, the assessee has the option to

decide which house he wants to treat as self-occupied. In that case, the

annual value of the house taken as self-occupied would be NIL and the

annual value of the other house would be determined on the basis of its

annual letting value.

(i) No deductions either on account of Standard Deduction, taxes,

insurance, water/electricity or any other head what so ever, except

Interest on Borrowed Capital, are allowed in such cases.

(ii) Interest on Borrowed Capital. Only interest on any borrowed

capital from banks or financial institutions is allowed to be deducted,




subject to the limit of Rs 1,50,000 or actual interest paid which ever

is less. Thus, Income from Self Occupied House Property will

always be negative (loss). Such loss is allowed to be set off against

any other income.

(iii) Interest on Borrowed Capital for Pre Construction Period: is

allowed to be claimed/charged off in five equal instalments starting

from the year of completion.

Method to Compute Income From Self Occupied House Property.

1. Gross Annual Value NIL

2. Less : Municipal Taxes NIL

3. Net Annual Value NIL

4. Less: Deductions U/S 24

(a) Standard Deduction @ 30% Net Annual Value NIL

(b) Interest on Borrowed Capital XYZ XYZ

5. Income from House Property (-) XYZ

Example No. 4. Mahesh owns a house property. It is used by him throughout the

previous year 2004-05 for his and his family members residence. Municipal value of the

house is Rs 1,66,000 whereas fair rent is Rs 1,76,000 and standard rent is Rs 1,50,000. The

following expenses are incurred by X : Municipal tax - Rs 16000, insurance - Rs 2000,

interest on capital borrowed to construct the property - Rs 180000.

Income of Mr. Mahesh from business is Rs 5,00,000.

Please compute Income from House property.

Solution: Name of Assessee : Mr. Mahesh

Assessment Year : 2005-06

Previous Year : 2004-05

Legal Status : Individual

Residential Status : R. & O.R.

Computation of Income from House Property: (Self Occupied Property (SOP)

SL PARTICULARS Rs Rs

A

B

Gross Annual Value

Less: Municipal taxes

Net Annual Value

NIL

NIL

NIL




C

Less: Deductions U/s. 24

(I) Standard Deduction (30% of NAV)

(II) Interest on Borrowed Capital (Rs 180000)

Taxable Income from House Property

150000

NIL

150000

(-)150000

Net Taxable Income of Mr Mahesh: Rs 500000 – 150000 = 3,50,000

Note – Various valuations of house and insurance cost are given to create confusion and

should be disregarded since it is a self occupied property. In any case, no deduction

is allowed for insurance or any other expenses even for Let Out Property as all these

expenses are deemed to be covered under Standard Deduction.

(c) Self-Occupied House Which Could Not be Occupied by the Owner: If a

property could not be occupied by the owner because he had to reside at

another place in a building not belonging to him by reason of his

employment, business or profession being carried out at that other place, the

annual value of the whole or part of such house property shall be taken to be

NIL.

However, benefits of this Section are available only if following conditions are

fulfilled:

(i) Such house or part of the house should not be let at any time during

the previous year, and

(ii) No other benefit should be derived from that house.

(d) House Property Occupied By Co-Owners [Section 26]: If share of each

co-owner is definite and ascertainable, income/loss from property is to be

divided on pro-rata basis and ascribed to each co-owner for computation.

Annual Value When Furnished House is Let Out: If a furnished house property is let

out, the annual value of such house should be estimated exclusive of the rent of the

furniture. The rent attributable to furniture is to be taxed separately either under the head

‘Profits and gains of business or profession’ or under the head ‘Other sources’ depending

upon the facts of the case. The same principle will apply where the landlord who gives the

house on rent also provides other services like breakfast, dinner, lift services etc.

In the case of house property whose annual value is nil, the amount of deduction on

account of interest on loan would be restricted to Rs 1,50,000 if the loan is taken is taken

on or after 1st April, 1999 and the acquisition or construction is completed within 3 years

from the end of the financial year in which the loan was taken. In cases of loan taken prior

to this period or construction taking more time than prescribed, the deduction allowed is

Rs 30,000 only.




Example No.5. Mr Rakesh takes a loan of Rs 5,00,000 @ 10% per annum for

constructing a house on 10 June 1998. Construction of the house is completed on 20

January 2005. Date of repayment of Loan is 31 March 2009.

Solution: Calculation of pre-construction period interest:

10.06.1998 to 31.03.1999 for 294 days Interest Rs 40274







Total Interest Rs 330685

Every year deductible 330685/5 = Rs 66137

Apart from this, there is current year interest for the period 21.01.2005 to 31.03.2005 for 70

days, which comes at Rs 9585. Total interest liability = Rs 75722/-.

However, Mr Rakesh would be allowed a deduction of Rs 30000/- only as he had taken the

loan prior to 01 Apr 99.

Fresh Loan Raised to Repay Original Loan Taken for Construction: All benefits are

allowed as before.

Example No.6. Mr. Radheshyam is the owner of the house at Mumbai. The house

was let out for Rs 24,000/- a year. The tenant agrees to pay municipal taxes of Rs 4,480/-.

Rateable value of the house was ascertained Rs 18,000/- by Municipal Corporation. The

following expenses were incurred:

Land revenue Rs 300/-

Fire Insurance Premium Rs 800/-

Repairs Rs 4,000/-

Compute the income from this house property for the assessment year 2005-06.

Solution:

Name of Assessee : Mr. Radheshyam





Computation of Income from House Property: (LOP)




SL PARTICULARS Rs

A

B

C

Expected Rent:

(I) (i) Fair Rent

(ii) Municipal Value

(Higher of (i) & (ii)

(II) Standard Rent

(Lower of (I) & (II)

Actual Rent received for the year

Gross Annual Value (Higher of A and B)

Less: Municipal taxes actually paid by the assessee

Net Annual Value (NAV)



(II) Interest on Loan taken


NIL

18000

NA

NIL

7,200

Nil

18,000

18,000

24,000

24,000

24,000

24,000

7,200

16,800

Notes:

1. Taxes of Rs 4480/- have been disregarded as taxes paid by tenant are not

allowed as deductions.

2. No deduction for land revenue, fire insurance premium & repairs is allowed

u/s 24 in case of house property.

Example No.7. Mr. Narayan owns three residential properties in Delhi, details of

which are given below

I II III

(a) Municipal valuation 10,000 10,000 10,000

(b) Rent received/receivable 12,000 12,000 15,000

(c) Fair Rent 14,000 14,000

(d) Standard rent under Delhi Rent 18,000 13,000 Nil

Control Act

Mr Narayan paid the following expenses:

(i) Municipal taxes @10%,

(ii) Collection charges - Rs 210,

(iii) Repairs Rs 570




(iv) Whitewashing and paint Rs 1,240

Compute his “Income from House Property" for the Assessment Year 2005-06.

Solution:

Name of Assessee : Mr. Narayan





Computation of Income from House Property: (Let Out Property)

SL PARTICULARS A B C

A

B

C

Expected Rent:

(I) (i) Fair Rent

(ii) Municipal Value

(Higher of (i) & (ii)

(II) Standard Rent

(Lower of (I) & (II)

Actual Rent received for the year

Gross Annual Value (Higher of A and B)

Less: Municipal taxes paid by the assessee

Net Annual Value



(II) Interest on Loan taken


14000

10000

14000

18000

14000

12000

14000

1000

13000

NIL

3900

NIL

9100

14000

10000

14000

13000

13000

12000

13000

1000

12000

NIL

3600

NIL

8400

NA

10000

10000

NA

10000

15000

15000

1000

14000

NIL

4200

NIL

9800

Note: No deduction are allowed on account of collection charges, white washing or

repairs.




INCOME FROM CAPITAL GAIN

Capital gain arises on transfer of a capital asset. Therefore: -

(a) There must be a capital asset with the transferer.

(b) Transfer means the property should be handed over/registered in the name

of the transferee.

(c) When agreement to sale is made and possession (not necessarily registration

of property in the name of transferee) is transferred it will be deemed that

property has transferred U/S 53A Of TP Act.

What is Capital Asset?

Capital asset means property37 of any kind held by an assessee, whether or not connected

with his business or profession, but does not include

(a) any stock-in-trade, consumable stores or raw materials held for the purposes

of his business or profession;

(b) personal effects, that is to say, movable property (including wearing apparel

and furniture, but excluding jewellery) held for personal use by the assessee

or any member of his family dependent on him.

(c) Agricultural land in India provided it is not situated:

(i) In any area within the jurisdiction of a municipality or a Cantonment

Board having a population of 10000 or more.

(ii) In any notified area.

(d) 6 ½ % Gold Bonds,1977, 7 % Gold Bonds 1980, National Defense Gold

Bonds 1980.

(e) Special Bearer Bonds, 1991

(f) Gold Deposit Bonds issued under the Gold Deposit Scheme,1999.

Types of Capital Asset:

1. Long Term Capital Assets: Any capital asset (except kind of assets which are

traded in Share market, like Equity/Preference Shares, Debentures, Govt. securities,

Units of UTI, Units of mutual funds) held by the assessee for more than 36 months.

2. Short Term Capital Assets: Capital assets (with the exception of stock market

instruments) with holding period of less than 36 months are treated as Short Term

Capital Asset.

Share Market Instruments: In case of Equity/Preference Shares, Debentures,

Govt. securities, Units of UTI, Units of mutual funds, if the holding period is more

http://www.taxmann.com/DitTaxmann/IncomeTaxActs/2005ITAct/ftn37div1s2.htm




than 12 months, these will be regarded as Long Term Capital Asset. If the holding

period is less than 12 months, then these will be regarded as Short Term Capital

Asset. It is not necessary that these instruments should be quoted on the exchanges.

Period of Holding

1. Liquidation of Company: In the case of shares, the period from purchase to

liquidation date of company is only counted. Period subsequent to the date on

which the company goes into liquidation, will not be counted.

2. Gift: When the asset is transferred by way of gift, will or inheritance, the period

for which the asset was held by the previous owner is also counted.

3. Amalgamation: The period for which the share in the amalgamating Company

was held by the assessee should be included.

4. De-merger: The period of holding of shares in the de-merged company shall be

included.

5. Bonus Shares: Date of allotment of Bonus shares to the date of sale.

Why capital assets are divided into short term/long term assets?

The tax liability under the head Capital Gain is different for Short Term Capital Gain and

Long Term Capital Gains. While Short Term Capital Gains are taxed at normal rates, Long

Term Capital Gains are taxed at a lower rate.

Transfer of Capital Asset [Section 2(47)]

“Transfer” includes: -

(a) Sale

(b) Exchange

(c) Relinquishment – to stop holding physically

(d) Extinguishment – to cause to cease burning/to bring to an end.

(e) The compulsory acquisition under any law.

Special Comments-

(a) Insurance claim is not treated as “extinguishment of right” and consequently

it is not treated as transfer.

(b) Amount paid by company to shareholders on reduction of share capital

would be capital gain in the hands of shareholders

(c) Redemption of Preference Shares amounts to “Sale”. Therefore, capital gain

will arise. It is transfer.




Certain Transactions included in definition of transfer: -

(a) Immovable property taken in part performance of a contract u/s 53A of the

Transfer of Property Act, 1882.

(b) Any transaction, which has the effect of transferring any immovable

property. e.g. If a person acquires shares/becomes member in HUF, etc.

(c) Capital asset converted into Stock-in-Trade.

Certain Transactions not included in Transfers: -

(a) Distribution of assets by a company on its liquidation.

(b) Distribution of assets by HUF among its members on partition.

(c) Transfer of Capital asset under a gift or a will or an irrevocable trust.

(d) Transfer of an asset by a holding company to its wholly owned Indian

subsidiary and vice –versa.

(e) Transfer of an asset in the scheme of amalgamation.

(f) Transfer of shares in Indian company held by a foreign company in

pursuance of a scheme of amalgamation to another foreign company.

(g) Transfer of capital asset in de-merger scheme.

(h) Transfer of any work of art, drawing to National Art Gallery,

Govt./University.

(i) Conversion of Debentures into shares.

(j) Transfer of membership right in a stock exchange.

(k) Proprietary concern transfers all assets and liabilities, and the proprietor

holds 50% or more shares.

(l) Any transfer involved in a scheme for lending of any securities under an

agreement, subject to the guidelines issued by the SEBI.

(m) Transfer of land u/s 18 of the Sick Industrial Companies Act, 1985.

Method to Compute Long Term Capital Gain

Step Amount

1. Find out full value of sale/consideration xxxx

2. Deduct the following: -

(a) Expenditure incurred wholly and exclusively

in connection with such transfers xxxx

(b) Indexed Cost of acquisition xxxx

(c) Indexed Cost of Improvement xxxx xxxx

Gross Capital Gain XXX




3. From the resulting sum, deduct the exemptions provided

by Sections 54, 54B, 54EC, 54AD, 54F, 54G xxxx

4. The Balance amount is Long term Capital Gain XXX

What is Indexation?

The purchasing power of rupee keeps falling due to inflation and consequently, the value of

asset keeps appreciating in rupee terms. Such appreciation in rupee term is not a gain for

the assessee and therefore not taxable. To offset such inflation caused appreciation, and

find net gain over and above the inflation, the govt provides an inflation index for each

year. This index is used to find the inflation adjusted current cost of capital asset. This

practice of indexation was started from Assessment Year 1982-83. Therefore, all capital

assets purchased prior to 01 Apr 1981 are to be indexed on the market value basis on that

date.

When the benefit of Indexation is not available in the case of Long Term Capital Asset?

In some exceptional cases only.

Full Value of Consideration

Full value means the whole price without any deduction whatsoever and it cannot refer to

the adequacy or inadequacy of the price bargained for. The consideration for the transfer of

the capital asset is what the transferor receives in lieu of the asset he parts with namely

money and money’s worth.

Expenditure on Transfer: It should be connected with the transfer of a capital asset.

Cost of Acquisition: Cost of acquisition of an asset is the value for which it was

acquired by the assessee.

Notional Cost of Acquisition: In the following instances, the cost of acquisition is

taken at notional figure:

SITUATIONS NOTIONAL COST OF ACQUISITION

1. Additional compensation in the case

of compulsory acquisition

NIL

2. Assets received by a member on

liquidation of a company

Fair market value on the date of distribution.

(NIL capital gain)

3. Stock or shares becoming property

of the assessee on consolidation,

conversion etc,

Cost of acquisition of such stock or shares

from which such asset is derived.

4. Allotment of shares in an

amalgamated company

Cost of acquisition of shares in the

amalgamating company.




5. Conversion of shares into

debentures

Cost at which such asset is acquired by the

assessee.

6. Allotment of shares/debentures by a

company under employees stock

option plan

Actual amount paid by the employee.

7. Allotment of shares in Indian

resulting company to the

shareholders of de-merged company

Cost of acquisition of shares in de-merged

company Net book value of assets

transferred in de-merger Net worth of the

de-merged company

8. Cost of acquisition of original

shares in de-merged company after

de-merger.

Cost of acquisition of such shares MINUS

amount calculated above.

9. Depreciable asset covered by

section 50.

Opening balance + purchase during the year.

10. Depreciable assets of a power

generating unit as covered by

section 50A

WDV minus terminal depreciation plus

balancing charge.

11. Undertaking/division acquired by

way of slump sale

Net worth of such undertaking

12. New asset acquired for claiming

exemption u/s 54, 54B, 54D or

54G if it is transferred within 3

years

Actual cost of acquisition MINUS

exemption claimed under these sections.

13. Goodwill of business or

Trademark or Brand name

associated with business or right to

manufacture, produce or process

any article or thing or right to carry

on any business, tenancy right,

stage permits or loom hours

If these assets were acquired by gift ,

will, etc. : Cost of acquisition to the previous

owner. If the owner has purchased these

assets: Actual cost of acquisition is taken

If these assets are self generated: Cost

of acquisition is ZERO

14. Right Shares Amount actually paid by the assessee.

15. Right to subscribe to shares (i.e.

right entitlement)

NIL

16. Bonus Shares If bonus shares were allotted to the

assessee before 1/4/1981: Fair Market Value

on that date would be the cost of acquisition.

In any other case: NIL

17. Allotment of Equity shares and

right to trade in stock exchange,

allotted to members of stock

exchange under a scheme of

demutualisation or corporatisation

of stock exchanges in India as

approved by SEBI.

Cost of acquisition of shares: Cost of

acquisition of original membership of the

stock exchange. Cost of acquisition of

trading or clearing rights of the stock

exchange: NIL




18. Any other Capital Asset

If it became the property of the

assessee before April 1, 1981 by

gift, will, etc.


assessee before 1/4/1981


assessee after 1/4/1981, by way of

gift or will.


assessee after 1/4/1981

Cost of acquisition to the previous

owner or fair market value as on 1/4/1981,

whichever is higher.

Cost of Acquisition or Fair Market

Value as on 1/4/1981, whichever is more.

Cost of acquisition to the previous

owner

Actual cost of acquisition.

Cost to the Previous Owner [Sec,49(1)]: The cost to the previous owner is deemed to be

the cost of acquisition to the assessee in cases where a capital asset becomes the property of

the assessee under any of the following mode of transfers:

1. Acquisition of property by an Individual on the total partition of a HUF.

2. Acquisition of property by a HUF where one of its members has converted his self

acquired property into joint family property.

3. Acquisition of property under a gift or will

4. Acquisition of property in the following cases:

(a) By succession, inheritance or devolution (to pass on from one person to

another ).

(b) On any distribution of assets on the liquidation of a company.

(c) Under a transfer to a revocable / irrevocable trust.

(d) Transfer between holding and subsidiary company.

(e) Transfer from the amalgamating company to the amalgamated company.

`

Example No. 1. M/s Rakesh and Sons is a HUF. The HUF acquired a residential house

at Mumbai for Rs 4,00,000 on 01 April 2002. The HUF undergoes complete partition on 01

November 2002 and the residential house is allotted to Mr Dinesh, a member of HUF. Mr

Dinesh sells the house on 15 March 2005 for Rs 12,00,000/- Determine the amount of

capital gain in the case of HUF and Mr Dinesh.

Cost of Acquisition Being the Fair Market Value as on 01 April 1981: In the following

cases, the assessee may take at his option, either the actual cost or the fair market value of

the asset as on 01 April 1981 as cost of acquisition:

1. Where the capital asset became the property of the assessee before 01 April 1981.

2. Where the capital asset became the property of the assessee by any mode referred to

in section 49 (1) and the capital asset became the property of the previous owner

before 01 April 1981.

Note : This principle does not apply to a depreciable asset.




How to Find Cost of Acquisition in the Case of Depreciable Asset:

Situation 1: In a case where any block of assets does not cease to exist but full value

of the consideration received as a result of transfer exceeds sum of following amounts:

(a) Expenditure incurred in connection with transfer

(b) The WDV of the block at the beginning of the year

(c) The actual cost of the asset purchased during the year.

Such excess shall be deemed to be short-term capital gain

Situation 2: If all assets in the block are sold during the previous year: The cost of

acquisition in such a case shall be the total of the following:

(a) Expenditure incurred in connection with transfer

(b) The WDV of the block at the beginning

(c ) The actual cost of the asset purchased during the year.

If sale consideration is less than the total cost [i.e. (a)+(b)+(c)] above, there will be short

term capital loss. If the sale consideration is more than the total cost [i.e. (a)+(b)+(c)]

above, there will be short term capital gain.

Example No.2. X Ltd. owns the following assets on 01 April 2004:

(a) Plant A, rate of depreciation 25%, depreciated value on 01 April 2004

Rs 450000.

(b) X Ltd. Purchased plant B on 10th August 2004 for Rs 350000 and sold Plant

A, on 31 December 2004 at Rs 1500000.

Compute capital gain.

Example No.3. Y Ltd. owns the following assets on 01 April 2004:

(a) Building A, rate of depreciation 10%, depreciated value on 01 April 1,2004

Rs 1000000.

(b) Y Ltd. Purchased Building B on 31st December 2004 for Rs 400000 and

sold Building A, on 31 March 2005 at Rs 1500000. Compute capital gain.

Example No.4. Tata Chemicals Limited owns the following assets on 01 April 2004 ( rate

of depreciation 25%)

Assets WDV as on April 1,2004 Date of acquisition

(Amount)

Plant A 300000 01 April 1975

Plant B 200000 10 May 1974

Plant C 500000 13 March 1987

During the previous year 2004-05, following plants were sold:

Plant A on 01 April 2004 for Rs 6,00,000

Plant C on 10 May 2004 for Rs 12,50,000




During the previous year 2004-05, the following plants were purchased:

(a) Plant D on 10 March 2005 for Rs 408000

(b) Plant E on 01 March 2005 for Rs 20000

Expenditure incurred on sale of plant A and C is Rs 10000. Please compute capital gain.

Example No.5. TATA Co. Ltd. owns the following assets on 01 April 2004:

Assets Rate of DEP. W.D.V on 01 April 2004 Plant A 25% 405000

Plant B 25% 195000

Plant C 25% 705700

On 10 June 2004, it acquires plant D for Rs 20,000 (rate of dep.25%). The company sells

the following assets during the year 2004-05:

Assets Sale Consideration Plant A 212000

Plant B 617500

Plant C 430000

Plant D 95000

The company pays brokerage Rs 12200 to sale the assets. Determine depreciation and

capital gain for the assessment year 2005-06.

Is it possible to avoid tax on capital gain?

Cost of Improvement:

1. Expenditure on improvement before 01 April 1981 is not considered in any case.

2. Expenditure on improvement after 01 April 1981 is considered .

3. Cost of improvement in relation to goodwill, like exterior painting, is always taken

as zero whether improvement has been done after 01 April 1981 or before 01 April

1981.

The Central Government has notified the following cost inflation index:

Financial

Year

Cost

Inflation

Index

Financial

Year

Cost

Inflation

Index

Financial

Year

Cost

Inflation

Index

1981-82 100

1982-83 109 1983-84 116 1984-85 125

1985-86 133 1986-87 140 1987-88 150

1988-89 161 1989-90 172 1990-91 182

1991-92 199 1992-93 223 1993-94 244

1994-95 259 1995-96 281 1996-97 305

1997-98 331 1998-99 351 1999-00 389

2000-01 406 2001-02 426 2002-03 447

2003-04 463 2004-05




Computation of Indexed Cost of Acquisition and Indexed Cost of Improvement:

A. How to compute indexed cost of acquisition:

Fair market value as on 01 April 1981 or X Cost inflation index for the year in

Cost of acquisition whichever is more which the asset is transferred.

Cost inflation index for Year of acquisition

B. How to compute indexed cost of improvement:

Cost of Improvement X Cost inflation index for the year in

Cost inflation index for improvement Year which the asset is transferred.

Example No.6. Mr. Mahesh sells his house property during the previous year 2003-04,

the relevant details are as under:

Sale Consideration Rs 7,15,700

Year of purchase 1983-84

Cost of acquisition Rs 18000

Cost of improvement incurred in 1994-95 Rs 1,05,407

You are requested to compute the income from capital gain.

Example No.7. Mr .X sells the following capital asset during the previous year 2004-05:

Sale of shares Rs 400000

He purchased these Shares in 1992-93 at Rs 290000.

Compute capital gain.

Special Cases to Compute Capital Gain

1. Computation of capital gain in the case of conversion of capital asset into stock in

trade: [Section 45(2)]

Rules:

(a) Conversion of investment into “stock in trade” will be treated as transfer

W.E.F. Financial Year 1984 -85 Assessment Year 1985-86.

(b) Conversion of capital asset into stock in trade will be chargeable to tax in

the year in which the stock is sold.

(c) For the purpose of computing the capital gain in such cases, the fair market

value of the asset on the date on which it was converted in stock shall be

deemed to be the full value of the consideration received.

Example No.8. Mr. Mohan converts his capital asset (acquired on 10 June1967 for Rs

70,000, fair market value on 01 April 1981 : Rs 1,80,000 ) into stock in trade on




10 March 1984 (fair market value: Rs 4,80,000) and, subsequently, sells the stock so

converted for Rs 7,30,000 on 10 June 2004. Determine the capital gain.

Example No. 9. In example No.8 assume, that the capital asset is converted into stock

during the previous year relevant to the assessment year 1985-86 (say on 01 April 1984),

other things remaining the same, find out capital gain.

Transfer of a capital asset between a wholly owned subsidiary company and holding

company is not treated as “Transfer”. But there are two cases, where the same is treated as

transfer:

(a) If at any time before the expiry of eight years from the date of transfer of a

capital asset, the transferee company converts it in stock of its business.

(b) The holding company ceases to hold the whole of the share capital of the

subsidiary company before the expiry of eight years

Example No. 10. S Limited is a wholly-owned subsidiary of X Limited. On 10 April

1984 (relevant to the assessment year 1985-86), S Limited transfers a capital asset to A

Limited (acquired on 06 April 1981 for Rs 50000) for Rs 1,50,000. X Limited sells the

asset on 10 May 2004 for Rs 3,40,000.

Please compute the capital gain in the following situations:

(a) Before the sale of asset, A Limited has not converted it into stock in trade

and it does not cease to hold entire share capital of S Limited

(b) A limited has converted the capital asset into stock in trade before its sale on

10 May 2004 (Date of conversion: 10 June 1987, fair market value: Rs

310000 )

Though A Limited does not convert capital asset into stock in trade, it ceases to hold the

entire share capital of S Limited, on 10 June 1988 when 5% shareholding in S Limited is

sold to the public.

Computation of Capital Gains on Transfer of Firm’s Assets to Partners and Vice-

Versa:

1. Transfer of Capital Asset by a Partner to a Firm: Amount recorded in the

books would be the sale consideration irrespective of market value of asset.

2. Transfer of Capital Asset by a Firm to a Partner: Fair market value as on the

date of transfer would be the sale consideration.

Example No.11. Mr. Dinesh and Rajesh form a partnership firm. Soon after formation of

the Firm Mr Dinesh brings on 10 July 2004, the following asset as his capital contribution:

Gold Silver

Fair market value on the date of transfer 5,40,000 72,000

Amount recorded in the books of account 6,00,000 50,000

Actual cost 30,000 12000




Year of purchase 1984-85 2003-04

Please compute the capital gain in the hands of Mr. Dinesh.

Deductions from Capital Gain:

1. Section 54: Capital Gains Arising From the Transfer of Residential House

Property:

Conditions:

(a) The house property is a residential house and transferred by an individual or

HUF.

(b) The house property must be held for a period of more than 36 months before

sale.

(c) The assessee has purchased another house within a period of one year before

the transfer or within 2 years after the date of transfer. The assessee has

constructed a residential house property within 3 years after the date of

transfer.

(d) The house property so purchased/constructed has not been transferred within

the period of three years.

Amount of exemption:

(a) If the amount of the capital gain is less than the cost of the new house

property, the entire amount of capital gain is exempt from tax.

(b) If the amount of capital gains is greater than the cost of the new house

property, the difference is chargeable to tax as capital gains.

Example No.13. Miss Radha has a residential house property which is situated at Delhi.

She sold the house on 10 July 2004 at Rs 20,00,000. She paid brokerage Rs 10,000. She

purchased this house on 06 Oct 1984. On 20 December 2004, she purchased another house

at Rs 2,00,000. Please compute capital gain in the hands of Miss Radha.

2. Section 54 F: Capital gains on transfer of a long term capital asset other than a

house property, and amount must be invested in house property.

(a) It applies to individual / HUF

(b) The asset transferred is any long term capital asset but other than a

residential house.

Exemption:

(a) If the cost of the house is not less than the net consideration in respect of the

capital asset transferred, the entire capital gain arising from the transfer will

be exempt from tax.

(b) If the cost of the new house is less than the net consideration then, amount

exempt would be work out from the following formula:




Cost of new house X Capital gain

Net sale consideration

Capital gain – Tax planning

1. Since long term capital gains bear lower tax, taxpayer should so plan as to transfer

their capital assets normally only 36 months after acquisition.

2. If capital asset is one which becomes the property of the taxpayer by way of gift,

will, inheritance etc , the period for which they were held by the pervious owner is

also be counted in computing 36 months.

3. If a property is transferred by an Individual to his minor son by way of gift, it

should be sold only after the son attains majority in order to avoid clubbing of

Income under section 64.

4. The assessee should take advantage of the exemption under section 54 by investing

the capital gain arising from the sale of a residential house property in the purchase

of another house (EVEN OUT OF INDIA) within the specified period.

5. In order to claim advantage of the exemptions under sections 54B, 54D, 54EC and

54ED it should be ensured that the investment in the new asset is made only after

effecting transfer of capital assets.

6. In order to take the advantage of exemption under sections 54, 54B, 54D, 54EC,

54ED, 54F and 54G the taxpayer should ensure that the newly acquired asset is not

transferred within 3 Years from the date of acquisition. Alternatively, it will be

advisable that instead of selling or converting assets acquired under sections 54,

54B, 54D, 54EC,54ED 54F and 54G into money, the taxpayer should obtain loan

against the security of such asset ( EVEN BY PLEDGE ) to meet the exigency.

7. In two cases, short term capital gain arises:

(a) When the written down value of a block of assets is reduced to nil, though

all the assets falling in that block are not transferred,

(b) When a block of assets ceases to exist.

In these two cases, tax on short- term capital gain can be avoided if:

(i) Another capital asset, falling in that block of asset, is acquired at any

time during the previous year or

(ii) Benefit of section 54G is availed.




INCOME FROM BUSINESS OR PROFESSION

Income from business and profession is charged to tax in accordance with provisions in

Sections 29 to 44DA.

Receipts Taxable Under the Head Income from Business or Profession

1. Income from Business or Profession.

2. Any compensation which relates to business

3. Profit on sale of a licence

4. Cash Assistance

5. Duty of customs/excise/drawbacks received as a refund

6. Interest, salary, bonus, commission, remuneration received by a partner

7. Any sum received for not carrying out any activity in relation to any

business or not to share any know-how, patent copyright, trademark etc.

8. Any sum received under a Key man insurance policy

9. Profits and gains of managing agency

10. Income from speculative transaction

Section 30: Rent, Rates, Repairs and Insurance for Building

Section 31: Repairs and Insurance of Machinery, Plant and Furniture

Section 32: Depreciation

Block of Assets: A group of assets for which same rate of depreciation is prescribed is

known as block of assets.

Calculation of Written Down Value and Depreciation

Block 1 (say - 20% Depreciation Rate)

Opening WDV as on 01 Apr XXXX Xxx

Add: Purchases during the year

Plant M YY

Plant N YY YYY

Less: Sale proceeds xx

Closing WDV XXX

Conditions for Claiming Depreciation U/S 32

(a) Asset must be owned by assessee




(b) It must be used for the purpose of business/profession

(c) It should be used during the relevant previous year

(d) Depreciation is available on tangible as well as intangible assets.

Other Salient Points

(a) Registered ownership is not necessary.

(b) Passive Vs Active user.

(c) Assets used partly for business purpose.

(d) If an asset is purchased after 02 Oct of the previous year (used for less

than 180 days), only 50% depreciation is allowed.

Example No.1. TATA Limited has a plant whose depreciated value on 01 April

2004 is Rs 50,00,000 (Depreciation @ 25%). During the year the company purchased

another plant costing Rs 10,00,000 on 31 Dec 2004. Compute depreciation.

Example No. 2. Birla Limited has two plants (A and B) whose depreciated value on

01 Apr 2004 are Rs 60,00,000 and Rs 30,00,000 respectively (Depreciation @ 25%).

During the year the company purchased another Plant C costing Rs 9,00,000 on 31 Aug 04.

The company sold Plant B at Rs 20,00,000 on 01 Jan 25. Compute depreciation for AY

2005-06.

Different Situations to Compute Depreciation

1. When the Written Down Value of a Block is Reduced to Zero: No

depreciation is admissible, though the block of assets does not cease to exist.

Example No. 3. On 01 Apr 2004, depreciated value of Plant A & B

(deprecation @ 25%) is Rs 80,000. The assessee purchases Plant C on 31 Jul 2004

(Depreciation @ 25%) for 30,000 and sells Plant A on 03 May 2004 for Rs

1,80,000. Compute depreciation for the AY 2005-06.

2. If the Block of Assets Ceases to Exist. If a block of assets ceases to

exist i.e. If all the assets of the block have been transferred and the block of

assets is empty on the last day of the previous year, no depreciation is

admissible in such case.

Example No. 4. Reliance Limited owns two plants – Plant A and Plant B on

01 Apr 04 whose depreciated value is Rs 2,00,000 and Rs 37,000 respectively. The

Company purchases Plant C on 31 May 04 for Rs 20,000 and sells Plant A on 01

Apr 04 at Rs 10,000 and sells Plant B on 12 Dec 04 at Rs 15,000 and sells Plant C

on 01 Mar 2005 at Rs 24,000. Please compute depreciation for the AY 2005-06

In short: No depreciation benefit if either block is empty or WDV = 0

3. Imported Cars: No depreciation is admissible in respect of any Motor Car,

manufactured out of India, where such car is acquired after 28 Feb 1975 but




before 01 Apr 2001. If however, an imported car is used in the business of

running it on hire for tourists or for the purpose of business or profession

outside India, then depreciation is admissible at the usual rate.

Carry Forward and Set Off of Depreciation:

Unabsorbed depreciation may be carried forward to next years for set-off against any

income of the assessee. There is no time limit to carry forward the depreciation in the next

years. It is not necessary that the business should be continued in future. It is not necessary

to submit return of loss in time also

Section 35 (Expenditure of Scientific Research)

1. Revenue expenditure incurred by the assessee himself provided it is on

scientific research related to his business are allowed as business expense.

2. Capital Expenditure incurred by assessee on scientific research related to

business, whole of the expenses, except land cost, is deductible as revenue

expenditure. Such expenses may be done on Plant or Equipment for research

or constructing building.

3. In-House Research and Development: In case of a company engaged

in business of manufacture or production of any drugs, pharmaceuticals or

electronic equipments, computers, telecommunication equipments notified

by the board, deduction equal to 150% of the expenditure incurred on

scientific research shall be allowed.

4. Contribution to National Laboratory: Contributions made to any

institution, approved college or university for the purpose of doing scientific

research whether related or unrelated to business of assessee is deductible,

the deduction being 125% of the amount so contributed.

Section 35 (A): Expenditure on Acquisition of Patent Right/Copy Rights

The expenditure will be written off in 14 instalments and within 14 years. If life of the

patent is less than 14 years, then that patent right will be written off within the life of the

patent itself.

Section 35 (AB): Expenditure on Know How

1. If the Amount is Paid to a Laboratory Owned or Financed by the

Government: The Expenditure is deductible in 03 years equally.

2. In other cases, it is deductible in 06 years.

Here technical know how means any information/technology which help the

assessee in processing of goods/in the working of a mine.

Note: Depreciation is available U/S 32 on expenditure incurred on technical

know how after 31 Mar 1998.

Section 35 (ABB): Amortisation of Telecom License Fee




Conditions:

1. The expenditure is capital in nature.

2. It is acquired to operate telecommunications services.

3. The expenditure may be incurred either before the commencement of

business or at any time thereafter.

4. The payment has been made to obtain license.

Amount of Deduction: The payment will be allowed as deduction in equal

instalments starting from the year in which the payment is made and ending in year

in which license comes to an end.

Section 35 D: Amortization of Preliminary Expenses.

Preliminary expenditure incurred for the following purpose is eligible for deduction: -

1. Commencement of business.

2. After commencement of business, in connection with the Extension of

Existing Undertaking; or

3. Setting up a new industrial undertaking

Subject to a limit of 5% of the cost of the project or the capital employed.

Amount of Deduction: The qualifying amount of preliminary expenditure can be

claimed as a deduction over a period of 5 years in equal installments.

Sec 35DDA: VRS Compensation: Where any expenditure is incurred by way of

payment of any sum to any employee at the time of voluntary retirement in accordance

with any scheme, 1/5th of the amount so paid shall be deducted in computing the

profits and gains of the business for that previous year and balance will be deducted in

4 equal instalments.

Sec (36): Other Deductions

1. Insurance premium paid in respect of stock or stores.

2. Insurance premium paid by Federal Milk Co-Op Society for insurance on

life of cattle.

3. Insurance premium on health of employees.

4. Bonus or Commission paid to employees.

5. Interest on borrowed capital.

6. Contribution to recognized Provident fund.

7. Contribution to approved Gratuity fund.

8. The amount of bad debt written of as irrevocable.




9. In respect of any provision for bad and doubtful debts.

10. Any expenditure incurred by the company for promoting family planning

among employees.

11. Any sum paid by a public financial institution by way of contribution

towards exchange risk administration fund.

Sec 37- General:

1. Any expenditure not being expenditure described in section 30 to 36.

2. Any expenditure not being in the nature of capital expenditure.

3. Any expenditure not being in the nature of personal expenditure of the

assessee.

4. Laid out or expended wholly or exclusively for the purposes of business or

profession

Note: 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.

Share issue expenses and fees paid to registrar of companies for enhancement of capital are

capital expenses in nature and hence not deductible u/s 37(1). However redeemable

debentures issued at a discount, the discount incurred being a revenue expenditure is

allowable as a deduction proportionately each year over the period for redemption.

Travelling expenses which involved business visit which are of revenue nature are

admissible expenses.

When the firm is dissolved and business is discontinued by the firm which is taken over by

the partner, closing stock need to be valued at the Market value and not at cost.

Inadmissible Expenditure:

The provisions of sec 40, 40A and 43B provide for certain disallowances.

Section 40: Amount not Deductible

1. Interest, royalty, fees for technical services payable outside India

without TDS.

2. Income tax/wealth tax/

3. Salary payable outside India without tax deduction

4. Amounts not deductible in respect of payment to relatives.

5. Amount not deductible in respect of expenditure exceeding Rs

20,000/=




6. Provision for payment of gratuity.

7. Contribution to non-statutory funds.

Section 43 B: Unpaid Statutory Liability

Following expenses are deductible ONLY on payment basis: -

1. Sum payable by way of tax duty, fee cess.

2. Sum payable by an employer by way of contribution to PF,

superannuation Fund or any other fund for the welfare of employees.

3. Sum payable as interest to ICICI, IFCI, IDBI, UTI, LIC.

4. Interest on any term loan from any Schedule Bank/Co-operative bank.

5. Any sum payable to an employee in lieu of leave.




INCOME FROM OTHER SOURCES

Steps to Find Out Income From Other Sources:

1. Check whether income is taxable u/s 56. 2. Make deductions provided by section 57 Section 56 - Basis of Charge:

This is the last and residual head of charge of income. A Source of income which does not

specifically fall under anyone of the other four heads of income (Viz: Income from salary,

Income from house property, profits and gains from business or profession, or capital gain)

is to be computed under the head "Income from other sources". This head of income comes

into operation only if the other heads are excluded.

Following incomes are chargeable to tax under the head Income from other sources:

1. Dividends 2. Winnings from lotteries 3. Crossword puzzles 4. Horse races 5. Card games 6. Income from machinery, plant or furniture let on hire 7. Interest on securities 8. Income from subletting

9. Interest on bank deposits

10. Income from royalty

11. Director's fees

12. Ground rent 13. Income from house property 14. Director's commission for standing as a guarantor 15. Director's commission for underwriting shares 16. Examination fees received by a teacher. 17. Rent of a plot of land 18. Insurance commission 19. Mining rent and royalties

20. Interest on foreign Govt. Securities

21. Casual income profits and gains

22. Annuity payable 23. Salary payable to a member of parliament

Gift to the extent of Rs 25,000 are completely exempt from Income Tax.

Receipts without Consideration: That is, Gift in Excess of Rs. 25000




Exceptions to the Gifts:

1. Any sum of money which is received before 01 September 2004.

2. Any sum of money which is received by way of consideration.

3. Any sum of money which is received from any relative.

4. Any sum of money which is received on the occasion of the

marriage of the individual.

5. Any sum of money which is received under a will or by way of

inheritance.

6. Any sum of money which is received in contemplation of death of

the payer.

7. Any sum of money not exceeding Rs. 25,000 (No restriction on

number of transactions).

Example No. 1. Mr. X receives the following Incomes and gifts:-

(i) On 01 January 2005 Rs. 25000 as a gift from his friend.

(ii) On 10 February 2005 Rs. 25001 as a gift from his friend.

(iii) On 05 March 2005 Rs. 40000 from D who is Neighbour of Mr. X

(iv) Rent of a vacant land Rs.60000

(v) Interest on fixed deposit Rs.20000

(vi) Agricultural Income from Sri Lanka Rs.60000. (Mr. X is having agricultural

land in Sri Lanka in his own name.) Compute Income from other sources.

Example No.2. Mr. Y received the following incomes/ gifts

(i) Gift of Rs. 25,00,000 received on 31 August 2004 from a friend.

(ii) Gift of Rs. 6,00,000 received from another friend in foreign currency on

01 September 2004.

(iii) Gift of Rs. 2,80,000 received from a friend on the occasion of his marriage,

on 03 October 2004.

(iv) Income by way of horse race on 05 October 2004 Rs. 10000 (v) Income by way of lottery Rs.50000.

(vi) He purchased lottery ticket worth Rs. 7000 during April 2004 to 31 March

2005.

Compute his income from other sources.

Dividend Income 1. Dividend approved by AGM.

2. Interim Dividend: When it is unconditionally made available by the company to its shareholders.




3. Deemed Dividend: U/S 2(22): The following payments by a company to its shareholders are deemed as dividends to the extent of accumulated profits of the company: -

(a) Any distribution entailing the release of the Company's assets.

(b) Certificates and bonus to preference shareholders.

(c) Distribution on liquidation of the company.

(d) Distribution on reduction of Capital

(e) Any payment made by way of advance or loan to the following:

(i) Shareholder holding not less than 10% of the voting power.

(ii) Any concern in which such shareholder is a member or a partner and

in which he has substantial interest.

Note:

(aa) In case of deemed dividend, No any deduction is available

vis 80-L, 180M. On deemed dividend tax will be deducted at

source under section 194,195, 196C or 196D.

(ab) In case of other dividends, tax will be paid by the domestic

company @ 12.50% +Surcharge.

Deductions (Section 57)

1. Expenses for the purpose of realizing dividend/interest.

2. Family pension: (i) Rs.15000 or (ii) 33.33% of such income, whichever is lower

3. Income from machinery, plant or furniture let on hire:- Repairs, Insurance premium,

and depreciation is deductible.

4. In case of casual and non-recurring income: 30% Tax rate +S.C.

5. In case of winnings from races including horse races:- 30% Tax rate +S.C.




DEDUCTION UNDER CHAPTER VI-A

The deductions specified in sections 80C to 80U are allowed from the gross total income in order to arrive at the net income.

The aggregate amount of the deductions under these sections can not however exceed the gross total income (after excluding

long term capital gain and income refereed to in sections 115A. 115AB 115AC 115AD and 115D) of the assessee.

Section Class of Assessee Nature of Payment Conditions/amount of deduction

80C Individual and HUF Life Insurance Premium, contribution to

PF, Purchase of Infrastructure bonds,

payment of tuition fees, repayment of

principal amount of housing loan, etc.

100% of the qualifying investment or Rs 1,00000

whichever is lower. (Maximum amount deductible

under sections 80C, 80CCC and 80CCD can not

exceed Rs 1 lakh.

80CCC Individuals

(Resident or Non

Resident)

Annuity Plan: Amount paid or

deposited by individual in an annuity

plan of LIC, for receiving pension

(a) Max of Rs 10000.

(b) Surrender before maturity will attract tax.

(c) Pension received is a taxable as income

(d) Payment out of income chargeable to tax

(e) No rebate u/s 88

80 CCD Only Individuals.

Govt employees

joined service after

31 Dec 2003.

Pension Fund: Contribution to

pension fund of Central Government

(a) Employer’s contribution to pension is

included in salary

(b) Deduction will be available in respect of

employer and employer’s contribution.

80 D Individual & HUF Medical Insurance Premium covering

(a) Individual – Self, his spouse,

dependent parents and children

(b) HUF – Any member

(a) The insurance premium paid or Rs 10000

whichever is lower.

(b) Rs 15000 when assessee is senior citizen

(>65 Yrs)

80 DD Resident Individual

or HUF

Disability: Expenditure incurred for

medical treatment of dependent relative

of individual or dependent member of

(a) Max Rs 50000 irrespective of actual

expenditure

(b) Rs 75000 where such dependent is a person




HUF suffering from permanent physical

disability, including blindness, or subject

to mental retardation.

with severe disability.

80 DDB Resident Individual

or HUF

Medical Treatment: Expenditure

incurred on medical treatment of self or

dependent relative or member of HUF.

(a) Amount of deduction is Rs 40000 or the

amount actually paid whichever is lower.

(b) In case of senior citizen, Rs 60000 or actual

expenditure which ever is lower.

80E Individual Educational Loan: Repayment of

principal or interest on educational loan

taken form financial institution or

approved charitable institution for the

purpose of pursuing higher education

(Self)

(a) Maximum deduction Rs 40000 per year

inclusive of Principal and interest

(b) Deduction for max 8 Assessment years

starting from the assessment year relevant to

previous year in which the repayment started.

(c) Payment should be made out of income

chargeable to tax.

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