INCOME TAX

B.Com - 304

B.Com (Distance Mode)

Centre for Distance and Online Education

JAMIA MILLIA ISLAMIA

New Delhi – 110025
EXPERT COMMITTEE

Prof. Najma Akhtar Prof. Jessy Abraham

Patron Vice-Chancellor, Hony. Director,
Jamia Millia Islamia CDOE, Jamia Millia Islamia

Prof. Mohammad Miyan Prof. Y.P. Singh

Hony. Chief Advisor, Founder Department of Commerce,
University of Delhi
CDOE, Jamia Millia Islamia

Prof. Najeeb Uzamman Khan Sherwani Prof. Sunayana

Head, Department of commerce and Business Studies Centre for Management Studies,
Jamia Millia Islamia Jamia Millia Islamia

Prof. Madhu Tyagi Dr. Sabiha Khatoon

School of Management, Assistant Professor, CDOE
IGNOU Jamia Millia Islamia

Dr. Firdous Khanum Dr. Mohd. Afzal Saifi

Assistant Professor, CDOE Jamia Assistant Professor, CDOE
Millia Islamia Jamia Millia Islamia

PROGRAMME COORDINATOR
Dr. Sabiha Khatoon, CDOE, Jamia Millia Islamia
COURSE WRITERS

Balakrishna Parab, Senior Faculty, Department of Management Studies, Jamnalal Bajaj Institute of Management Studies,
University of Mumbai
Block - I [Units 1 - 4]
Block - II [Units 5 - 7]
Block - III [Units 8 - 10]
Block - IV [Units 11 - 14]

All rights reserved. Printed and published on behalf of the CDOE, Jamia Millia Islamia by Hi-Tech Graphics, New Delhi
March, 2023
ISBN: 978-93-5259-451-1
All rights reserved. No part of this book may be reproduced in any form or by any means, electronic or mechanical, including
photocopying, recording or by any information storage or retrieval system, without permission in writing from the CDOE,
Jamia Millia Islamia, New Delhi.
Cover Credits: Anupama Kumari, Faculty of Fine Arts, Jamia Millia Islamia
 SYLLABI-BOOK MAPPING TABLE
Income Tax
Syllabi Mapping in Book

Block I Fundamentals of Income Tax Unit-1: Basic Concepts - I

(Pages 3-12);
Unit-2: Basic Concepts - II
(Pages 13-22);
Unit-3: Residential Status
and Tax Liability
(Pages 23-32);
Unit-4: Exempted Income
(Pages 33-66)

Block II Salaries Unit-5: Salaries - I

(Pages 69-86);
Unit-6: Salaries - II
(Pages 87-120);
Unit-7: Salaries - III
(Pages 121-130)

Block III Other Heads of Income Unit-8: Income from House Property
(Pages 133-150);
Unit-9: Income from Capital Gain
(Pages 151-174);
Unit-10: Income from Other Sources
(Pages 175-192)

Block IV Assessment of Individual Unit-11: Deduction from Gross Total Income

(Pages 195-216);
Unit-12: Computation of Total Income
(Pages 217-226);
Unit-13: Filing of Return and Tax Authorities
(Pages 227-268);
Unit-14: Value Added Tax
(Pages 269-288)
 CONTENTS

BLOCK-I : FUNDAMENTALS OF INCOME TAX

UNIT 1 BASIC CONCEPTS - I 3-12

1.1 Introduction
1.2 Introduction to Taxation
1.3 Tax System, Evasion, Avoidance and Planning
1.4 Summary
1.5 Key Words
1.6 Answers to ‘Check Your Progress’
1.7 Self-Assessment Questions
1.8 Further Readings

UNIT 2 BASIC CONCEPTS - II 13-22

2.1 Introduction
2.2 Characteristics of Income Tax
2.3 Gross Total Income
2.4 Summary
2.5 Key Words
2.6 Answers to ‘Check Your Progress’
2.7 Self-Assessment Questions
2.8 Further Readings

UNIT 3 RESIDENTIAL STATUS AND TAX LIABILITY 23-32

3.1 Introduction
3.2 Residential Status of an Assessee
3.3 Scope of Total Income
3.4 Summary
3.5 Key Words
3.6 Answers to ‘Check Your Progress’
3.7 Self-Assessment Questions
3.8 Further Readings

UNIT 4 EXEMPTED INCOME 33-66

4.1 Introduction
4.2 Income Exempted Under Section 10 of ITA
4.3 Agricultural Income
4.4 Newly Established 100 Percent EOU
4.5 Summary
4.6 Key Words
4.7 Answers to ‘Check Your Progress’
4.8 Self-Assessment Questions
4.9 Further Readings

BLOCK-II : SALARIES

UNIT 5 SALARIES - I 69-86

5.1 Introduction
5.2 Salary
5.3 Annuity
5.4 Summary
5.5 Key Words
5.6 Answers to ‘Check Your Progress’
5.7 Self-Assessment Questions
5.8 Further Readings

UNIT 6 SALARIES - II 87-120

6.1 Introduction
6.2 Allowances
6.3 Valuation of Perquisites
6.4 Summary
6.5 Key Words
6.6 Answers to ‘Check Your Progress’
6.7 Self-Assessment Questions
6.8 Further Readings

UNIT 7 SALARIES - III 121-130

7.1 Introduction
7.2 Deductions from Salary
7.3 Relief Under Section 89
7.4 Summary
7.5 Key Words
7.6 Answers to ‘Check Your Progress’
7.7 Self-Assessment Questions
7.8 Further Readings

BLOCK-III : OTHER HEADS OF INCOME

UNIT 8 INCOME FROM HOUSE PROPERTY 133-150

8.1 Introduction
8.2 House Property Income
8.3 Annual Value and Ownership of Property
8.4 Deductions from Income from House Property
8.5 Summary
8.6 Key Words
8.7 Answers to ‘Check Your Progress’
8.8 Self-Assessment Questions
8.9 Further Readings

UNIT 9 INCOME FROM CAPITAL GAIN 151-174

9.1 Introduction
9.2 Capital Gains
9.3 Cost of Acquisition of the Asset
9.4 Computation of Long Term Capital Gains Tax
9.5 Summary
9.6 Key Words
9.7 Answers to ‘Check Your Progress’
9.8 Self-Assessment Questions
9.9 Further Readings

UNIT 10 INCOME FROM OTHER SOURCES 175-192

10.1 Introduction
10.2 What Constitutes Income from Other Sources?
10.3 Deductions from Income from Other Sources
10.4 Method of Accounting
10.5 Taxation of Gifts
10.6 Summary
10.7 Key Words
10.8 Answers to ‘Check Your Progress’
10.9 Self-Assessment Questions
10.10 Further Readings

BLOCK-IV : ASSESSMENT OF INDIVIDUAL

UNIT 11 DEDUCTION FROM GROSS TOTAL INCOME 195-216

11.1 Introduction
11.2 Categories of Deductions
11.3 Contribution to Pension Funds
11.4 Payment of House Rent
11.5 Summary
11.6 Key Words
11.7 Answers to ‘Check Your Progress’
11.8 Self-Assessment Questions
11.9 Further Readings
UNIT 12 COMPUTATION OF TOTAL INCOME 217-2226
12.1 Introduction
12.2 Meaning of Total Income
12.3 Computation of Total Income and Tax Liability of Individuals
12.4 Summary
12.5 Key Words
12.6 Answers to ‘Check Your Progress’
12.7 Self-Assessment Questions
12.8 Further Readings

UNIT 13 FILING OF RETURN AND TAX AUTHORITIES 227-268

13.1 Introduction
13.2 Permanent Account Number (PAN)
13.3 Income Tax Return
13.4 Payment of Tax
13.5 Assessment
13.6 Summary
13.7 Key Words
13.8 Answers to ‘Check Your Progress’
13.9 Self-Assessment Questions
13.10 Further Readings

UNIT 14 VALUE ADDED TAX 269-288

14.1 Introduction
14.2 Origin of VAT
14.3 VAT Rates and Classification of Goods
14.4 Summary
14.5 Key Words
14.6 Answers to ‘Check Your Progress’
14.7 Self-Assessment Questions
14.8 Further Readings
 Basic Concepts - I

BLOCK-I
FUNDAMENTALS OF INCOME TAX

This block provides a basic introduction to the concepts of income tax. It is well known that
taxation has a long and influential history in the shaping of civilisations as the system of tax
has been prevalent since decades and has evolved with the changing scenario of the world.
The block elaborates on tax liability and exempted income so as to make the various
concepts easy to comprehend. It explains the application of income tax and its various
aspects.
The first unit provides an in-depth understanding of taxation and its canons such as equity,
efficiency, convenience and certainty. The unit discusses the two types of taxes, namely,
direct and indirect. The concepts of tax system, evasion, avoidance and planning are also
explained. It also gives an account of the guiding principles of tax policy.
The second unit enlists the characteristics of income tax. The definition of an assessee and a
person, provided in the unit, helps in distinguishing between the two terms. The unit assesses
the concept of income, thus, providing an overview of income and its categorisation under
the five heads. The meaning of accrual concept and the arising concept of income is also
given in this unit.
The third unit analyses the concept of residential status and tax liability. It also explains the
tests for residence for individuals; Hindu undivided family, firms and other association of
persons; and companies. Further, the unit elaborates on the meaning and concept of not
ordinarily resident and non-resident. Scope of total income of an assessee is also discussed
in the unit.
The fourth unit presents an account of income that is exempted from tax. It helps in
identifying the types of income that are exempted under Section 10 of ITA along with the
deductions that are to be made from total income. Agricultural income is also defined in this
unit.

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 Basic Concepts - I

UNIT–1 BASIC CONCEPTS - I

Objectives
After going through this unit, you will be able to:
 Define income tax
 Identify the canons of taxation
 Differentiate between direct tax and indirect tax
 Discuss tax base and tax system
 Explain the goals of tax planning

Structure
1.1 Introduction
1.2 Introduction to Taxation
1.3 Tax System, Evasion, Avoidance and Planning
1.4 Summary
1.5 Key Words
1.6 Answers to ‘Check Your Progress’
1.7 Self-Assessment Questions
1.8 Further Readings

1.1 INTRODUCTION

The unit will begin with an introduction to the basic concepts of taxation.
The government has a big budget. It has to pay for facilities and services like
schools, roads, hospitals, military, government employees, national parks, and so
forth. The only way to pay for these is for people and companies to give money to
the government. Taxes are one of the most important sources of revenue for the
government.
Taxation has a long and influential history in the shaping of civilisations
throughout the world. In Egypt, tax collectors are depicted on tomb paintings dated
2000 BC. Ancient Egyptians taxed many aspects of daily life, including even the use
of cooking oil in preparing family meals. Ancient Rome had an elaborate tax system
which included sales tax, inheritance tax, and taxes on imports and exports.

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Basic Concepts - I

1.2 INTRODUCTION TO TAXATION

A tax is defined as a compulsory financial charge imposed by a public authority on

an individual or a legal entity, or on services, products, or activities. In Principles of
Public Finance, Hugh Dalton defined tax as ‘a compulsory contribution imposed by
a public authority, irrespective of the exact amount of service rendered to the tax
payer in return, and not imposed as a penalty for any legal offence’.
Four aspects of a tax emerge from the above definition:
1. Compulsion: When a public authority lawfully imposes a tax, the person
on whom the tax is imposed has no option but to pay the tax. Non-
payment of taxes or evading taxes is a punishable offence.
2. Public authority: Taxes can be levied only by a public authority and that
too only if it is empowered to do so by the Constitution of India and the
Parliament.
3. No direct benefit to the taxpayer: The essence of a tax is the absence
of a quid pro quo between the tax payer and the public authority. The
amount of tax a person pays is not linked to the amount of benefits he
receives from the public authority.
4. Taxes are not penalties: Taxes and penalties are both ‘compulsory
contributions imposed by a public authority’, but, there is a significant
difference. The motive for imposition of taxes is to earn revenue; penalties
are imposed to deter certain acts.

Canons of Taxation
The government needs to impose taxes to generate revenue. But, how should it
design the tax system? In 1776, Adam Smith in his book The Wealth of Nations
first established the principles of a good tax system as the canons of taxation. When
evaluating the relative merits and demerits of alternative forms of taxation it is often
worth coming back to these principles. The four canons of taxation enumerated by
Adam Smith are efficiency, equity, benefit and certainty.

(i) Equity
Taxes should be fair and based on people’s ‘ability to pay’.
Adam Smith said: ‘The subjects of every state ought to contribute towards the
support of the government, as nearly as possible, in proportion to their respective
abilities; that is, in proportion to the revenue which they respectively enjoy under the
protection of the state.’
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 Basic Concepts - I

(ii) Certainty
Taxpayers should understand how the system works and should be able to plan their
tax affairs with a reasonable degree of certainty. Taxes should also be difficult to
evade. Collection costs should be kept at an acceptable level so that the costs of
collection are very low relative to the total tax revenues collected.
Adam Smith said: ‘The tax which each individual is bound to pay ought to be
certain, and not arbitrary. The time of payment, the manner of payment, the quantity
to be paid, ought all to be clear and plain to the contributor, and to every other
person.’

(iii) Convenience
A tax should be levied and collected at an appropriate time and place.
Adam Smith said: ‘Every tax ought to be levied at the time, or in the manner, in
which it is most likely to be convenient for the contributors to pay it.’

(iv) Efficiency
A tax system should raise sufficient revenue to pay for government spending, without
creating negative distortions such as reducing incentives towards work for
individuals and towards investment incentives for companies.
Adam Smith said: ‘Every tax ought to be so contrived as both to take out and
to keep out of the pockets of the people as little as possible over and above what it
brings into the public treasury of the state’.
These canons or principles of taxation are as relevant today as they were two
hundred and thirty years ago.

Guiding Principles of Tax Policy

The American Institute of Certified Public Accountants (AICPA), a premier
professional organization for certified public accountants in the United States,
recommends a ten-principle framework to analyse proposals to change a tax rule, as
well as to change an entire tax system. The ten principles are:
1. Equity and fairness: Similarly situated taxpayers should be taxed similarly.
2. Certainty: The tax rules should clearly specify when the tax is to be paid,
how it is to be paid, and how the amount to be paid is to be determined.
3. Convenience of payment: A tax should be due at a time or in a manner
that is most likely to be convenient for the taxpayer.

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Basic Concepts - I

4. Economy in collection: The costs to collect a tax should be kept to a

minimum for both the government and taxpayers.
5. Simplicity: The tax law should be simple so that taxpayers understand the
rules and can comply with them correctly and in a cost-efficient manner.
6. Neutrality: The effect of the tax law on a taxpayer’s decisions as to how
to carry out a particular transaction or whether to engage in a transaction
should be kept to a minimum.
7. Economic growth and efficiency: The tax system should not impede or
reduce the productive capacity of the economy.
8. Transparency and visibility: Taxpayers should know that a tax exists
and how and when it is imposed upon them and others.
9. Minimum tax gap: A tax should be structured to minimise noncompliance.
10. Appropriate government revenues: The tax system should enable the
government to determine how much tax revenue is likely to be collected
and when.

Direct VS Indirect Taxes

Broadly, there are two types of taxes: direct and indirect. A direct tax is one that is
paid directly to the government by the persons on whom it is imposed. Examples
include: income tax and wealth tax. In this sense, a direct tax is contrasted with an
indirect tax (such as sales tax).
An indirect tax is one which is collected by intermediaries (such as a retailer)
who turn over the proceeds to the government. Thus, we can say that if a tax is
levied directly on personal or corporate income or wealth, then it is a direct tax; if it
is levied on the price of a good or service, it is called an indirect tax.
Taxes are categorised on the basis of their incidence. Incidence of a tax is said
to ‘fall’ upon the group that, at the end of the day, bears the burden of the tax. A
person who pays tax to the government may not actually bear the burden; he may
pass it on to someone else (perhaps customers). Direct taxes are ones where the
person who pays the tax also bears its burden. Indirect taxes are ones where the
person who pays the tax shifts the burden to his customers.
Another way of looking at the distinction between direct and indirect tax is that
indirect taxes are those levied on goods and services and all other taxes are direct.

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 Basic Concepts - I

Tax Bases
A tax base is something that is liable to tax. Taxes may be classified by tax base, that
is, by what is being taxed. Taxes may be based on: (i) income; (ii) capital; (iii)
wealth; (iv) manufacture or production; (v) services; and (vi) transactions.
The following are some examples of taxes and the basis of their charge:
1. Central excise duty: Central excise duties are taxes levied on the
manufacture or production of excisable goods in India.
2. State excise duty: State excise duties are taxes levied on the manufacture
or production of commodities such as liquor.
3. Income tax: Income taxes are annual levies against personal or corporate
income.
4. Sales tax: Sales taxes are imposed on the sale and consumption of goods
and services. They may be a general tax on the retail price of all goods and
services sold or they may be imposed only on the sale of selected goods
and services.
5. Service tax: Service tax is imposed on taxable services.

Check Your Progress - 1

1. What is a tax?
................................................................................................................
................................................................................................................
................................................................................................................

2. What are central excise duties?

................................................................................................................
................................................................................................................
................................................................................................................

3. What are the types of taxes levied by the central government?

................................................................................................................
................................................................................................................
................................................................................................................

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Basic Concepts - I

1.3 TAX SYSTEM, EVASION, AVOIDANCE AND PLANNING

Tax Systems
Tax systems may be progressive, regressive or proportional.
1. Progressive tax: A progressive tax is a tax imposed in a way that the tax
rate increases as the amount to which the rate is applied increases. The
term ‘progressive’ refers to the way the rate of tax progresses from low to
high; it can be applied to any type of tax. It is frequently applied with
reference to income taxes, where people with higher disposable income
pay a higher percentage of that income in tax than do those with less
income.
2. Regressive tax: A regressive tax is a tax imposed in such a way that the
tax rate decreases as the amount to which the rate is applied increases. The
term ‘regressive’ refers to the way the rate progresses from high to low; it
can be applied to any type of tax. It is frequently applied in reference to
indirect taxes, where every person has to pay the same amount of money.
3. Proportional tax: In between progressive tax system and regressive tax
system is the proportional tax, where the tax rate is fixed; as the amount to
which the rate is applied increases.
Tax Evasion
Tax evasion refers to a deliberate failure to pay taxes. Various illegal practices are
adopted by those liable to pay taxes to intentionally evade paying them. Broadly,
these illegal practices can take two forms: the evasion of assessment and the evasion
of payment. Illegal acts of evasion include evading taxes by placing assets in
another’s name, dealing in cash, and having receipts or debts paid through and in the
name of another person. The keeping of a double set of books or the making of false
invoices or documents can be proof of tax evasion. The following are four of the
most common devices use to evade taxes:
 A failure to report substantial amounts of income
 A claim for fictitious or improper deductions on a return
 Accounting irregularities, such as a business’s failure to keep adequate
records, or a discrepancy between amounts reported on the tax return and
amounts reported on its financial statements.
 Improper transfer of income to a related person who is in a lower tax
bracket
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 Basic Concepts - I

Tax evasion is a criminal offence and is punishable by fine, imprisonment and

sometimes, both. The courts have ruled that an overt act is necessary to give rise to
the crime of tax evasion. An overt act is anything done to mislead the government or
conceal funds to avoid payment of an admitted and accurate deficiency. Therefore,
the government must show that the taxpayer deliberately attempted to evade the tax
rather than having passively neglected to file a return, which could be prosecuted
merely as a misdemeanour.

Tax Avoidance
Tax avoidance is a process whereby an entity plans his finances so as to apply all
exemptions and deductions provided by tax laws to reduce his tax liability. Through
tax avoidance, an assessee takes advantage of all legal opportunities to minimise his
taxes. Many court decisions have affirmed the legitimacy of tax avoidance. Justice
Shah, in CIT v. A. Raman & Company (1968) 67 ITR 11, 17 (SC), said:
‘Avoidance of tax liability by so arranging commercial affairs that charge of tax
is so distributed is not prohibited. A taxpayer may resort to a device to divert the
income before it accrues or arises to him. Effectiveness of the device depends not
upon considerations of morality, but on the operation of the (law).’
Tax avoidance may be considered as the dodging of one’s duties to society, or
alternatively the right of every citizen to structure one’s affairs in a manner allowed
by law, to pay no more tax than what is required. Attitudes vary from approval
through neutrality to outright hostility. Justice Jagadisan, in Aruna Group of Estates v.
State of Madras (1965) 55 ITR 642, 648, said:
‘Avoidance of tax is not tax evasion and it carries no ignominy with it, for, it is
sound law and, certainly, not bad morality, for anybody to so arrange his affairs as
to reduce the brunt of taxation to a minimum.’
However, in recent years the legitimacy of tax avoidance has been questioned by
the Supreme Court. In McDowell v. CTO 154 ITR 148, the court divided tax
avoidance in two categories: legitimate and illegitimate.
Legitimate tax avoidance involves use of devices which are in conformity with
the intentions of the Parliament, such as donations to charity or investments in certain
assets which qualify for tax relief. In this sense, tax avoidance may be called as ‘tax
mitigation’. When taxpayers adopt unfair means to avoid taxes it is illegitimate tax
avoidance and is as reprehensible as tax evasion.

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Basic Concepts - I

Tax Planning
Tax planning is a process of looking at various tax options in order to determine
when, whether, and how to conduct business and personal transactions so that taxes
are eliminated or reduced.
The goal of tax planning is to arrange one’s financial affairs so as to minimise the
taxes. There are four basic ways to reduce taxes, and each of these methods might
have several variations. These tax planning methods include:
 Reducing the amount of taxable income
 Reducing the applicable tax rate
 Controlling the time when the tax must be paid
 Claiming any available tax credits
Check Your Progress - 2

1. What are the three different types of tax systems?

................................................................................................................
................................................................................................................
................................................................................................................

2. Define tax evasion.

................................................................................................................
................................................................................................................
................................................................................................................

1.4 SUMMARY

 A tax is defined as a compulsory financial charge imposed by a public

authority on an individual or a legal entity, or on services, products, or
activities.
 In 1776, Adam Smith in his book The Wealth of Nations first established
the principles of a good tax system as the canons of taxation.
 When evaluating the relative merits and demerits of alternative forms of
taxation it is often worth coming back to these principles.
 The four canons of taxation enumerated by Adam Smith are: efficiency,
equity, benefit and certainty.

10
 Basic Concepts - I

 Broadly, there are two types of taxes: direct and indirect. A direct tax is one
that is paid directly to the government by the persons on whom it is imposed.
 An indirect tax is one which is collected by intermediaries (such as a
retailer) who turn over the proceeds to the government.
 A tax base is something that is liable to tax. Taxes may be classified by tax
base, that is, by what is being taxed. Taxes may be based on: (i) income;
(ii) capital; (iii) wealth; (iv) manufacture or production; (v) services; and (vi)
transactions.
 Tax systems may be progressive, regressive or proportional. A progressive
tax is a tax imposed in a way that the tax rate increases as the amount to
which the rate is applied increases. A regressive tax is a tax imposed in
such a way that the tax rate decreases as the amount to which the rate is
applied increases. In between progressive tax system and regressive tax
system is the proportional tax, where the tax rate is fixed; as the amount to
which the rate is applied increases.
 Tax evasion refers to a deliberate failure to pay taxes. Various illegal
practices are adopted by those liable to pay taxes to intentionally evade
paying them. Broadly, these illegal practices can take two forms: the
evasion of assessment and the evasion of payment.
 Tax planning is a process of looking at various tax options in order to
determine when, whether, and how to conduct business and personal
transactions so that taxes are eliminated or reduced.

1.5 KEY WORDS

 Tax evasion: The illegal non-payment or underpayment of tax is known as

tax evasion.
 Progressive tax system: A progressive tax takes a larger percentage of
income from high-income groups than from low-income groups and is
based on the concept of ability to pay.

1.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress – 1

1. A tax is defined as a compulsory financial charge imposed by a public authority
on an individual or a legal entity, or on services, products, or activities.

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Basic Concepts - I

2. Central excise duties are taxes levied on the manufacture or production of

excisable goods in India.
3. The central government is empowered to levy the following taxes:
 Income tax (except tax on agricultural income)
 Customs duties
 Central excise
 Central Sales tax (tax on inter-state sale of goods)
 Service tax
Check Your Progress – 2
1. Tax systems may be progressive, regressive or proportional.
2. Tax evasion refers to a deliberate failure to pay taxes. Various illegal
practices are adopted by those liable to pay taxes to intentionally evade
paying them. Broadly, these illegal practices can take two forms: the
evasion of assessment and the evasion of payment.

1.7 SELF-ASSESSMENT QUESTIONS

1. Who has the authority to impose tax? What are the types of taxes that can
be levied by the state and central government?
2. Discuss the canons of taxation.
3. What is tax planning? What are its goals?
4. Explain the guiding principles of tax policy.
5. What is tax avoidance? How is it different from tax evasion?
6. Differentiate between a progressive, regressive and proportional tax system.

1.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India. New
Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
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 Basic Concepts - II

UNIT–2 BASIC CONCEPTS - II

Objectives
After going through this unit, you will be able to:
 Identify the characteristics of income tax
 Define and distinguish between an assessee and a person
 Explain the concept of previous year and assessment year
 Discuss the concept of income
 Describe the terms accrual and arising of income

Structure
2.1 Introduction
2.2 Characteristics of Income Tax
2.3 Income
2.4 Summary
2.5 Key Words
2.6 Answers to ‘Check Your Progress’
2.7 Self-Assessment Questions
2.8 Further Readings

2.1 INTRODUCTION

This unit will focus on the characteristics of Income Tax wherein it will further
elaborate on the concept of Income.
Income tax is charged on an assessee in relation to the income earned by him in
the previous year at rates fixed for the assessment year by the annual Finance Act.
The above statement is a paraphrase of Section 4, which is the ‘charging’ section of
the Income Tax Act, 1961 (hereafter referred as ITA). This unit attempts to
demystify the various terms used in the charging section.

2.2 CHARACTERISTICS OF INCOME TAX

Income tax has certain characteristic features. Everyone is subject to income tax.
The amount of taxes one has to pay is based on his income. Income tax must be
paid throughout the year on a pay-as-you-go system. People who earn more
income have higher tax rates than those who earn less; this means tax rates get

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Basic Concepts - II

progressively higher the more one earns. An assessee can reduce his taxes by taking
advantage of various tax benefits. These features of income tax are discussed below:
(1) Everyone is subject to income tax: First of all, every person,
organization, company, or non-profit organization is subject to income tax.
Being ‘subject to income tax’ means that people and organizations must
report their income and calculate their taxes. Some organizations are
exempt from tax. But they still have to file a return, and their tax-exempt
status could be revoked if the organization fails to meet certain criteria.
(2) Income tax is levied on an assessee with respect to his income:
Secondly, one is taxed with respect to his income. Income is any money
one earns by working or by investing. Income includes wages, interest,
dividends, profits on investments, pensions, so on and forth. Income does
not include gifts. You are not taxed on gifts you receive, such as inheritances
and scholarships.
(3) Payment of taxes throughout the year: Thirdly, taxes must be paid
throughout the year. This is called ‘pay-as-you-go’. People who make
certain payments are required to deduct tax at source from this payment
and deposit the tax with the treasury. Further, persons having a tax liability
of 5,000 or more are required to pay advance tax at regular intervals.
(4) Income taxes are progressive: Fourthly, the income tax system is
progressive. That means that people who make more money have a higher
tax rate, and people who make less money have a lower tax rate. For
example, individuals having a taxable income of less than 1,35,000 do
not pay any income tax at all. Those having income above 1,35,000 but
less than 1,50,000 pay income tax at the rate of 10 per cent, and those
having income more than 2,50,000 pay income tax at the rate of 30 per
cent. Individuals having income above 10.00,000 have to pay surtax in
addition to income tax.
(5) Voluntary: Finally, the income tax system is voluntary. That is because
people are free to arrange their financial affairs in such a way as to take
advantage of any tax benefits. Voluntary does not mean that the tax laws do
not apply to you. Voluntary means you can choose to pay less tax by
managing your finances in a way to minimise your taxes.

Assessee (U/S 2(7))

Income tax is not a tax on income, but rather a tax on the assessee in relation to the
income earned by him (Re. Patiala State Bank 9 ITR 95, 112-3). Section 2 (7) of
14
 Basic Concepts - II

ITA defines an assessee as a person by whom any tax or any other sum of money is
payable under ITA, and includes:
 Every person in respect of whom any proceeding under ITA has been
taken for the assessment of his income or of the income of any other person
in respect of which he is assessable, or of the loss sustained by him or by
such other person, or of the amount of refund due to him or to such other
person;
 Every person who is deemed to be an assessee under any provision of
ITA;
 Every person who is deemed to be an assessee in default under any
provision of ITA.
Thus, the term assessee is defined to include three categories of persons: Firstly, an
assessee is a person by whom any tax, penalty or interest is payable under ITA,
whether or not any proceeding has been initiated against the person. Secondly,
persons against whom any proceedings have been initiated under ITA, whether or
not such a person is liable to pay any tax, penalty or interest. Lastly, an assessee
includes a person who is assessable in respect of income of other person or who is
deemed to be an assessee in default.
The last category of assessee, referred above, is also known as a representative
assessee. This category includes, a person who is bound to deduct tax at source and
who does not deduct, or, having deducted the tax at source does not deposit it with
the treasury.

Person (U/S 2(3))

An assessee was defined in para 2.3 as a person. But who is a person? Section 2
(31) of ITA defines a person to include the following:
 An individual
 A Hindu Undivided Family (HUF)
 A company
 A firm
 An association of persons or a body of individuals, whether incorporated or not
 A local authority
 Every artificial juridical person, not falling within any of the above
A Hindu Undivided Family (HUF) is usually represented by the karta (or manager)
of the family. An association of persons or a body of individuals or a local authority
or an artificial juridical person is deemed to be a person, whether or not such person
or body or authority or juridical person was formed or established or incorporated
with the object of deriving income, profits or gains.
15
Basic Concepts - II

The definition of a person given above is an inclusive definition, which means that
the above list of persons is in addition to the ordinary meaning of the word ‘person’.

Previous Year
Income tax is levied on an assessee in relation to the total income earned by him in
the previous year. This is generally a period of 12 months ending on 31 March just
prior to the commencement of the assessment year. The previous year is also called
as financial year and accounting year.
In case a source of income comes into existence in the middle of the year, then,
for this source of income, the previous year is the period when the source of income
first comes into existence till 31 March of the following year. For example, if one
takes up employment for the first time on 1 February 2007, then the previous year
for this person, as far as salary income is concerned, is the period from 1 February
2007 to 31 March 2007.
Each previous year is a distinct unit of time for the purpose of assessment and
the income earned or a loss suffered before or after the previous year is immaterial
in assessing the income tax of the previous, unless there is a statutory provision to
the contrary.
Assessment year (AY) is the year in which you file returns. It is the year in which
the income that you have earned in the financial year that just ended will be
evaluated. For example, if you have had an income between 1 April 2015 and 31
March 2016, 2015–2016 will be the AY. Simply put, it is the year in which your tax
liability will be calculated on the previous year’s income. Considering that only when
a financial year is complete can the Income Tax (I-T) department evaluate your
income, you pay tax for the year that has just gone by in the current year.
Check Your Progress - 1

1. Who is an assessee?
................................................................................................................
................................................................................................................
................................................................................................................

2. Define representative assessee.

................................................................................................................
................................................................................................................
................................................................................................................

16
 Basic Concepts - II

2.3 GROSS TOTAL INCOME

The definition of income is at the heart of income tax law. ‘Income’ is difficult and
perhaps impossible to define in any precise general formula. It is a word with the
broadest connotations.
Richard Goode (1976) has defined income as follows:
‘Income is the accretion of the power to consume. It consists of a person’s
actual consumption plus, or minus, any increase or decrease in the value of his
power to consume in the future as measured by his net worth.’
To collect income taxes, governments have to specify what counts as income
and what kinds of income they will tax. The most widely accepted definition of
income was developed by American economists Robert M. Haig and Henry C.
Simons in the 1920s and 1930s. According to this definition, income is the money
value of the net (overall) increase over a period of time in a person’s potential to
consume. Consumption, in economics, refers broadly to the purchase or acquisition
of goods and services of any kind. The increase in potential to consume equals
actual consumption plus saving.
An income tax system designed to collect all forms of income would face a
number of practical problems. For example, a parent who stays at home taking care
of a child is producing valuable services for the family. In principle, these services
have value as income, but what is their precise money value in terms of their
potential to increase consumption? Is it the same as the cost of a professional child-
care service, and if so, at what wage? Because the government cannot make these
determinations, it does not count the value of some types of work as income.
According to the Haig-Simons definition, the measurement of income should
take into account the expenses of earning, such as business expenses. Indeed, the
tax code allows people and corporations to subtract the costs of doing business. But
the differences between earning expenses and consumption may sometimes be
unclear. For example, if someone buys a computer for working at home but also
uses the computer to play video games, how much of the computer should count as
an expense of earning income and how much as consumption?
Section 2 (24) of ITA elaborately defines the term ‘income’. However, even this
definition is an inclusive definition, which means that in addition to the ordinary
meaning of the word ‘income’, certain transactions, which would not ordinarily be
considered income, are deemed as such. Income, in the context of ITA, connotes a
periodical monetary return ‘coming in’ with some sort of regularity, or expected

17
Basic Concepts - II

regularity, from definite sources (CIT v. Shaw Wallace 59 IA 206, 6 ITC 178).
However, income need not always be recurrent from definite sources; it may
well be in the form of a series of receipts, as in the case of professional earnings. The
multiplicity of forms which ‘income’ may assume is beyond enumeration
(Kamakshya Narayan Singh v. CIT (11 ITR 513,521, 522, 523)). Even a casual,
non-recurrent receipt may be income. Income may be received in the form of
money’s worth as well as money, in kind as well as cash.
The law requires that the income of a person be categorised under five heads,
namely:
 Income from house property
 Profits and gains of business
 Capital gains
 Income from other sources
The Accrual Concept
The Oxford English Dictionary defines ‘accrue’ as ‘to fall as a natural growth or
increment; to come … as an accession or advantage’. The accrual concept is a
fundamental accounting concept that means that income must be considered in the
accounts for the period for which it is earned, rather than the period in which the
money is actually received. Income is said to be accrued only when the assessee
acquires a right to receive that income.

The Arising Concept

The Oxford English Dictionary defines ‘arise’ as ‘to spring up’, or ‘to come into
existence’. Income may arise at one place, but may be received in another. The
arising concept means that all income arising in the previous year is taken into
account to calculate the total income, irrespective of the fact whether the income has
been, or will be received in India, or not.

Income Deemed to Accrue or Arise in India

Section 9 of ITA contains a list of income that is deemed to accrue or arise in India.
Some of these items are as follows:
 All income accruing or arising, whether directly or indirectly, through or
from any business connection in India, or through or from any property in
India, or through or from any asset or source of income in India, or through
the transfer of a capital asset situated in India.

18
 Basic Concepts - II

 Income which falls under the head Salaries, if it is earned in India.

 Income chargeable under the head Salaries payable by the Government to
a citizen of India for service outside India.
 Dividend paid by an Indian company outside India.
 Income by way of interest payable by:
(a) the government; or
(b) a person who is a resident, except where the interest is payable in
respect of any debt incurred, or money borrowed and used, for the
purposes of a business or profession carried on by such person
outside India or for the purposes of making or earning any income
from any source outside India ; or
(c) a person who is a non-resident, where the interest is payable in
respect of any debt incurred, or money borrowed and used, for the
purposes of a business or profession carried on by such person in
India ;
 Income by way of royalty payable by:
(a) the government; or
(b) a person who is a resident, except where the royalty is payable in
respect of any right, property or information used or services utilized
for the purposes of a business or profession carried on by such person
outside India or for the purposes of making or earning any income
from any source outside India; or
(c) a person who is a non-resident, where the royalty is payable in
respect of any right, property or information used or services utilized
for the purposes of a business or profession carried on by such person
in India or for the purposes of making or earning any income from any
source in India.

Check Your Progress - 2

1. Define what is income.

................................................................................................................
................................................................................................................
................................................................................................................

19
Basic Concepts - II

2. What is the major feature of income tax?

................................................................................................................
................................................................................................................
................................................................................................................

3. What does the term ‘voluntary’ mean in relation to income tax?

................................................................................................................
................................................................................................................
................................................................................................................

4. What is the accrual concept?

................................................................................................................
................................................................................................................
................................................................................................................

2.4 SUMMARY

 Everyone is subject to income tax. The amount of taxes one has to pay is
based on his income. Income tax must be paid throughout the year on a
pay-as-you-go system.
 Being ‘subject to income tax’ means that people and organizations must
report their income and calculate their taxes.
 Some organizations are exempt from tax. But they still have to file a return,
and their tax-exempt status could be revoked if the organization fails to
meet certain criteria.
 One is taxed with respect to his income. Income is any money one earns by
working or by investing.
 Taxes must be paid throughout the year. This is called ‘pay-as-you-go’.
 The income tax system is progressive. That means that people who make
more money have a higher tax rate, and people who make less money have
a lower tax rate.
 The income tax system is voluntary. That is because people are free to arrange
their financial affairs in such a way as to take advantage of any tax benefits.
 Income tax is not a tax on income, but rather a tax on the assessee in
relation to the income earned by him.
20
 Basic Concepts - II

 The term assessee is defined to include three categories of persons: Firstly,

an assessee is a person by whom any tax, penalty or interest is payable
under ITA, whether or not any proceeding has been initiated against the
person.
 Secondly, persons against whom any proceedings have been initiated under
ITA, whether or not such a person is liable to pay any tax, penalty or
interest.
 Lastly, an assessee includes a person who is assessable in respect of
income of other person or who is deemed to be an assessee in default.
 An association of persons or a body of individuals or a local authority or an
artificial juridical person is deemed to be a person, whether or not such
person or body or authority or juridical person was formed or established
or incorporated with the object of deriving income, profits or gains.
 Income tax is levied on an assessee in relation to the total income earned by
him in the previous year. This is generally a period of 12 months ending on
31 March just prior to the commencement of the assessment year.
 The previous year is also called as financial year and accounting year.

2.5 KEY WORDS

 Income: It is the consumption and savings opportunity gained by an entity

within a specified time frame.
 Profit: It is the positive gain from an investment or business operation after
subtracting for all expenses.
 Consumption: It refers broadly to the purchase or acquisition of goods
and services of any kind.
 Assessment year: It is the period of twelve months commencing on 1st
April every year and ending on 31st March of the next year.

2.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress- 1

1. Section 2(7) of ITA defines an assessee as a person by whom any tax or
any other sum of money is payable under ITA.

21
Basic Concepts - II

2. A person who is assessable in respect of income of other person or who is

deemed to be an assessee in default is known as a representative assessee.
This category includes, a person who is bound to deduct tax at source and
who does not deduct, or, having deducted the tax at source does not
deposit it with the treasury.

Check Your Progress- 2

1. Income is the accretion of the power to consume.
2. The major feature of income tax is that everyone is subject to income tax.
3. The term ‘voluntary’ in relation to income tax means that you can choose to
pay less tax by managing your finances in a way to minimise your taxes.
4. The accrual concept is a fundamental accounting concept that means that
income must be considered in the accounts for the period for which it is
earned, rather than the period in which the money is actually received.

2.7 SELF-ASSESSMENT QUESTIONS

1. What is the difference between assessee and person?

2. Discuss the characteristics of income tax.
3. Write a short note explaining the arising concept.
4. Write short notes on:
(a) Previous year and assessment year
5. Give a list of income that is deemed to accrue or arise in India.

2.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
22
 Residential Status
and Tax Liability

UNIT–3 RESIDENTIAL STATUS AND TAX LIABILITY

Objectives
After going through this unit, you will be able to:
 Discuss the residential status of an assessee
 Define a resident person
 Describe not ordinarily resident and non-resident
 Explain the scope of total income of an assessee

Structure
3.1 Introduction
3.2 Residential Status of an Assessee
3.3 Scope of Total Income
3.4 Summary
3.5 Key Words
3.6 Answers to ‘Check Your Progress’
3.7 Self-Assessment Questions
3.8 Further Readings

3.1 INTRODUCTION

There are two types of taxpayers – resident in India and non-resident in India. Indian
income is taxable in India whether the person earning the income is a resident or a non-
resident. Conversely, foreign income of a person is taxable in India only if such a
person is a resident in India. Foreign income of a non-resident is not taxable in India.
It is not necessary that a person who is a resident in India cannot be a resident
in any other country, for the same assessment year. A person may be a resident in
two (or more) countries at the same time. It is therefore, not necessary that a person
who is a resident in India will not be a resident in any other county for the same
assessment year.
This unit will elaborate this concept of residential status of an assessee.

3.2 RESIDENTIAL STATUS OF AN ASSESSEE

The incidence of income tax on an assessee depends on his residential status. All
taxable entities are classified in three categories: resident, not ordinarily resident and
23
Residential Status
and Tax Liability

non-resident. Alternative tests for residence are provided for (i) individuals; (ii) HUF,
firms and other association of persons; and (iii) companies.
The tests of residence are with respect to the previous year; the residential status
of a person during the assessment year is irrelevant. The question of residence must
be determined with reference to each year. Merely because a person was resident in
one year does not mean we can assume that he would be resident in the next year
too.
If a person is resident in India in a previous year relevant to an assessment year
in respect of any source of income, he shall be deemed to be resident in India in the
previous year relevant to the assessment year in respect of each of his other sources
of income.

Resident Person
As stated earlier the tests for residence are provided for (i) individuals; (ii) HUF,
firms and other association of persons; and (iii) companies.
1. Residence test for an individual: An individual is said to be resident in
India in any previous year if he is in India in the previous year for a period
(or periods) amounting in all to 182 days or more.
Alternatively, a person can be said to be a resident if (i) he stayed in India
for at least 365 days during the four years preceding the previous year; and
(ii) stayed in India for at least 60 days during the previous year.
In the case of an Indian citizen of India, who leaves India in any previous
year as a member of the crew of an Indian ship or for the purposes of
employment outside India, the condition of stay in India during the previous
year is increased from 60 days to 182 days. Further, in the case of an
Indian citizen, or a person of Indian origin, who, being outside India, comes
on a visit to India in any previous year, the condition of stay in India during
the previous year is increased from 60 days to 182 days.
2. Residence test for a HUF, firm or other association of persons: A
Hindu undivided family, firm or other association of persons is said to be
resident in India in any previous year if the control and management of its
affairs is situated wholly, or in part, in India.
The test emphasises the importance of control and management. The
residence of individual members of the HUF, or partners, members of the
association of persons is immaterial for the purpose of determining the
residence of a HUF, firm or other association of persons.
24
 Residential Status
and Tax Liability

Control of business does not necessarily mean carrying on of the business.

It is possible that the business is substantially carried on in one place but the
control is somewhere else. Control and management signifies the controlling
and directive power, the head and the brain of the entity.
The term control and management means de facto, or actual, control and
management and not merely the right or power to control and manage (Erin
Estate v. CIT (34 ITR 1, 5).
3. Residence test for a company: Section 2(17) of ITA defines a company
to include:
 An Indian company; or
 Any corporate incorporated by or under the laws of a country outside
India; or
 Any institution, association or body which is or was assessable or was
assessed as a company for any assessment year under the Indian
Income-tax Act, 1922, or which is or was assessable or was assessed
under ITA as a company for any assessment year commencing on or
before April 1, 1970; or
 Any institution, association or body, whether incorporated or not and
whether Indian or non-Indian, which is declared by general or special
order of the Central Board of Direct Taxes (CBDT) to be a company.
The test of residence for a company is different for an Indian company and
a non-Indian company.
Under Section 2(26) of ITA, an Indian company means a company formed
and registered under the Companies Act, 1956, and includes: (i) a
corporation established by or under a Central, State or Provincial Act; and
(ii) any institution, association or body which is declared by the CBDT to
be a company. Further, for an entity to be considered as an Indian
company its registered office (or principal office) must be located in India.
An Indian company is automatically considered resident in India. No other
factor needs to be taken into consideration. A non-Indian company is
considered resident if, during the previous year, the control and
management of its affairs is situated wholly in India.
4. Residence test for persons not covered above: Every other person,
not being an individual, HUF, firm, association of persons or a company, is
said to be resident in India in any previous year if the control and
management of his affairs is situated wholly, or in part, in India.
25
Residential Status
and Tax Liability

Not Ordinarily Resident

The second category in which taxable entities are categorised is whether the entity is
ordinarily resident or not ordinarily resident. This concept of ordinarily resident or
not ordinarily resident is only applicable to an assessee who is an individual or a
HUF. Further, the question of an individual or a HUF being ordinarily resident arises
only if such an individual or HUF is a resident in the first instance.
An individual is said to be not ordinarily resident in India in any previous year if
such person has been a non-resident in India in nine out of the ten previous years
preceding that year, or has during the seven previous years, preceding the previous
year, been in India for a period of, or periods amounting, in all to 729 days or less.
A Hindu undivided family is said to be not ordinarily resident in India in any
previous year if the manager of the HUF has been a non-resident in India in nine out
of the ten previous years preceding that year, or has during the seven previous years
preceding that year been in India for a period of, or periods amounting in all to, 729
days or less.

Non-Resident
An individual who fails the test of residence is considered a non-resident. A HUF,
firm, or an association of persons is considered non-resident if its control and
management is wholly situated outside India. Similarly, a non-Indian company is
considered non-resident if its control and management is wholly situated outside
India.

Check Your Progress - 1

1. State one condition that needs to be satisfied to check if an Individual is

a resident in India.
................................................................................................................
................................................................................................................
................................................................................................................

2. What does an Indian company mean?

................................................................................................................
................................................................................................................
................................................................................................................

26
 Residential Status
and Tax Liability

3.3 SCOPE OF TOTAL INCOME

The components of total income of an assessee depend upon his, or its, residential
status.
1. Total income of a resident assessee: The total income of any previous
year of a person who is a resident includes all income from whatever
source derived which:
 Is received or is deemed to be received in India in such year by or on
behalf of such person; or
 Accrues or arises or is deemed to accrue or arise to him in India
during such year; or
 Accrues or arises to him outside India during such year.
2. Total income of an assessee who is not ordinarily resident: The total
income of any previous year of a person who is a not-ordinarily resident
includes all income from whatever source derived which:
 Is received or is deemed to be received in India in such year by or on
behalf of such person; or
 Accrues or arises or is deemed to accrue or arise to him in India
during such year; or
 Accrues or arises to him outside India during such year provided it is
derived from a business controlled, or a profession set up, in India.
3. Total income of a non-resident assessee: The total income of any
previous year of a person who is a non- resident includes all income from
whatever source derived which:
 Is received or is deemed to be received in India in such year by or on
behalf of such person; or
 Accrues or arises or is deemed to accrue or arise to him in India
during such year.
It is explained that income accruing or arising outside India shall not be deemed
to be received in India by reason only of the fact that it is taken into account in a
balance sheet prepared in India. It is further declared that income which has been
included in the total income of a person on the basis that it has accrued or arisen or
is deemed to have accrued or arisen to him shall not again be so included on the
basis that it is received or deemed to be received by him in India.
27
Residential Status
and Tax Liability

Tax Liability
Tax liability refers to the amount legally owed to a taxing authority as the result of a
taxable event. It may also be called a ‘tax obligation. A tax authority — such as a
local, state or national government – imposes taxes upon individuals, organizations
and corporations to fund social programs and administrative roles. Taxable events
include earning taxable income, having sales, receiving or issuing payroll, etc. These
taxes are legally binding. The liability is generally calculated by multiplying the taxable
event by the tax rate. The taxing authority has various legal options to enforce these
payments. Taxes are important to maintaining all types of government and ruling
systems. Entities can be fined, assets liquidated and even jailed for failing to pay their
tax obligations. Many entities attempt to minimize their liability each year using tax
credits, donations, tax shelters and the like. Tax havens are countries that enforce
little to no tax liability.

Check Your Progress - 2

1. What does the components of total income of an assessee depend upon?

................................................................................................................
................................................................................................................
................................................................................................................

2. What does the total income of a resident assesse include?

................................................................................................................
................................................................................................................
................................................................................................................

3.4 SUMMARY

 There are two types of taxpayers – resident in India and non-resident in

India.
 The incidence of income tax on an assessee depends on his residential
status.
 All taxable entities are classified in three categories: resident, not ordinarily
resident and non-resident.

28
 Residential Status
and Tax Liability

 Alternative tests for residence are provided for (i) individuals; (ii) HUF,
firms and other association of persons; and (iii) companies.
 An individual is said to be resident in India in any previous year if he is in
India in the previous year for a period (or periods) amounting in all to 182
days or more.
 Alternatively, a person can be said to be a resident if (i) he stayed in India
for at least 365 days during the four years preceding the previous year; and
(ii) stayed in India for at least 60 days during the previous year.
 In the case of an Indian citizen of India, who leaves India in any previous
year as a member of the crew of an Indian ship or for the purposes of
employment outside India, the condition of stay in India during the previous
year is increased from 60 days to 182 days.
 A Hindu undivided family, firm or other association of persons is said to be
resident in India in any previous year if the control and management of its
affairs is situated wholly, or in part, in India.
 The residence of individual members of the HUF, or partners, members of
the association of persons is immaterial for the purpose of determining the
residence of a HUF, firm or other association of persons.
 Control of business does not necessarily mean the carrying on of the
business. It is possible that the business is substantially carried on in one
place but the control is somewhere else.
 Control and management signifies the controlling and directive power, the
head and the brain of the entity.
 The term control and management means de facto, or actual, control and
management and not merely the right or power to control and manage (Erin
Estate v. CIT (34 ITR 1, 5).
 The test of residence for a company is different for an Indian company and
a non-Indian company.
 Under Section 2(26) of ITA, an Indian company means a company formed
and registered under the Companies Act, 1956, and includes: (i) a
corporation established by or under a Central, State or Provincial Act; and
(ii) any institution, association or body which is declared by the CBDT to
be a company.

29
Residential Status
and Tax Liability

 An Indian company is automatically considered resident in India. No other

factor needs to be taken into consideration.
 A non-Indian company is considered resident if, during the previous year,
the control and management of its affairs is situated wholly in India.
 The second category in which taxable entities are categorized is whether
the entity is ordinarily resident or not ordinarily resident. This concept of
ordinarily resident or not ordinarily resident is only applicable to an
assessee who is an individual or a HUF.
 A Hindu undivided family is said to be not ordinarily resident in India in any
previous year if the manager of the HUF has been a non-resident in India
in nine out of the ten previous years preceding that year, or has during the
seven previous years preceding that year been in India for a period of, or
periods amounting in all to, 729 days or less.
 An individual who fails the test of residence is considered a non-resident. A
HUF, firm, or an association of persons is considered non-resident if its
control and management is wholly situated outside India.
 It is explained that income accruing or arising outside India shall not be
deemed to be received in India by reason only of the fact that it is taken
into account in a balance sheet prepared in India.

3.5 KEY WORDS

 Non-resident: An individual who fails the test of residence is considered a

non-resident.

3.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress- 1

1. An individual is said to be resident in India in any previous year if he is in
India in the previous year for a period (or periods) amounting in all to 182
days or more.
2. Indian company means a company formed and registered under the
Companies Act, 1956, and includes: (i) a corporation established by or

30
 Residential Status
and Tax Liability

under a Central, State or Provincial Act; and (ii) any institution, association
or body which is declared by the CBDT to be a company.
Check Your Progress- 2

1. The components of total income of an assessee depend upon his, or its,

residential status.
2. The total income of any previous year of a person who is a resident
includes all income from whatever source derived which:
(a) Is received or is deemed to be received in India in such year by or on
behalf of such person; or
(b) Accrues or arises or is deemed to accrue or arise to him in India
during such year; or
(c) Accrues or arises to him outside India during such year.

3.7 SELF-ASSESSMENT QUESTIONS

1. Discuss the residential status of an assessee.

2. What do you mean by ‘not ordinarily resident?’
3. Write a note on the residence test for a HUF, firm or other association of
persons.
4. What is the scope of total income of the following persons?
(a) Resident person
(b) Resident, but not ordinarily resident, person
(c) Non-resident person
5. Explain the residence test for a company.

3.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.

31
Residential Status
and Tax Liability

Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

32
 Exempted Income

UNIT–4 EXEMPTED INCOME

Objectives
After going through this unit, you will be able to:
 Identify the types of income exempted under Section 10 of ITA
 Define agricultural income
 Discuss the tax exemption provided by ITA
 Discuss the deductions from total income under ITA

Structure
4.1 Introduction
4.2 Income Exempted Under Section 10 of ITA
4.3 Agricultural Income
4.4 Newly Established 100 Percent EOU
4.5 Summary
4.6 Key Words
4.7 Answers to ‘Check Your Progress’
4.8 Self-Assessment Questions
4.9 Further Readings

4.1 INTRODUCTION

Income tax is charged on an assessee in relation to the income earned by him in the
previous year. However, certain types of income need not be considered as such
while computing an assessee’s total income. Chapter III of Income Tax Act (ITA)
contains a list of various kinds of ‘income’ that should be disregarded for
determining the total income of an assessee for the purpose of income tax.

4.2 INCOME EXEMPTED UNDER SECTION 10 OF ITA

The types of income exempted under section 10 of ITA are as follows:

 Agricultural Income (Section 10(1) of ITA)
 Receipts from a Hindu Undivided Family being paid out of family’s income
or in the case of an impartible estate belonging to family being paid out of
such estate’s income (Section 10(2) of ITA)

33
Exempted Income

 Share of partner in total income of a firm which is assessed separately as

such. (Section 10(2A) of ITA)
 Receipts being in the nature of casual and non-recurring nature not
exceeding 5,000 ( 2,500 in the case of winnings from horse races, etc.).
(Section 10(3) of ITA)
 Interest on securities and bonds including premium on redemption of bonds
by Non Resident as notified by Central Government. (Section 10(4)(i) of
ITA)
 Interests on amounts in Non-resident (External) Account in any bank in
India by an individual. (Section 10(4)(ii) of ITA)
 Interest on specified Central Government savings certificates which were
subscribed to in convertible foreign exchange remitted from a country
outside India as per FERA and rules thereunder by an individual citizen or
a person of Indian Origin. (Section 10(4B) of ITA)
 Value of leave travel concession or assistance not exceeding the amount
actually spent. (Section 10(5) of ITA)
 Specified remuneration to a foreigner and non-resident individual for
shooting of film in India who comes solely for such purpose. (Section
10(5A) of ITA)
 Income-tax paid by the employer carrying on scientific research in respect
of the salary income of certain technicians from abroad. (Section 10(5B) of
ITA)
 Incomes of foreigners as passage money. (Section 10(6)(i) of ITA)
 Remuneration received by an ambassador, diplomats, etc. (Section
10(6)(ii) of ITA)
 Remuneration received by employees of foreign companies in respect of
services rendered during stay in India subject to conditions as specified.
(Section 10(6)(vi) of ITA)
 Remuneration received from foreign philanthropic institutions etc. in respect
of services rendered in India subject to both the institutions and the
purposes thereof being approved by the Central Government. (Section
10(6)(via) of ITA)
 Salaries to non-resident employed on a foreign ship subject to aggregate stay
of not more than 90 days in the previous year. (Section 10(6)(viii) of ITA)
 Salaries to non-residents professors or teachers. (Section 10(6)(ix) of ITA)

34
 Exempted Income

 Income of individuals engaged in research work in India under duly

approved research schemes. (Section 10(6)(x) of ITA)
 Remuneration received from foreign government for training in a
government office or undertaking as employee. (Section 10(6)(xi) of ITA)
 Death-cum-retirement gratuity payable to specified members of civil or
defence services. (Section 10(10)(i) of ITA)
 Gratuity not exceeding 3,50,000 payable under the Payment of Gratuity
Act, 1972 (Section 10(10)(ii) of ITA)
 Any other gratuity not exceeding 250,000 received by employee on
retirement or termination of his services or by legal heirs on death of
employee limited to 15 days salary for each completed year of service.
(Section 10(10)(iii) of ITA)
 Receipt in respect of commutation of pension as per specified limits.
(Section 10(10A) of ITA)
 Leave encashment not exceeding eight months’ salary and subject to
specified conditions and limits. (Section 10(10AA) of ITA)
 Compensation paid to employees on account of retrenchment under
Industrial Disputes Act, 1947: the limit of the amount is a minimum of
50,000 or as per the said Act. (Section 10(10B) of ITA)
 Payments made under Bhopal Gas Leak Disaster Act, 1985. (Section
10(10BB) of ITA)
 Receipt of amount on voluntary retirement up to 5,00,000 subject to
specified scheme and guidelines and necessary approval. (Section 10(10c)
of ITA)
 Payment on a life insurance policy, including bonus thereon but excluding
there from amounts received u/s 80DDA(3). (Section 10(10D) of ITA)
 Receipt of payment from public provident fund or statutory provident fund.
(Section 10(11) of ITA)
 Payment to employee from recognised provident fund in respect of
accumulated balance standing to the credit thereof. (Section 10(12) of
ITA)
 Receipt of payment from superannuation fund subject to specified
conditions and limits. (Section 10(13) of ITA)
 House rent allowance received by an employee. (Section 10(13A) of ITA)
 Receipt of premium on account of exchange risk from borrower of foreign
currency. (Section 10(14A) of ITA)
35
Exempted Income

 Receipt of interest or premium on redemption, etc. on notified securities,

bonds etc. such as monthly payment on 15-year annuity certificates subject
to specified condition and limits. (Section 10(15)(i) of ITA)
 Interest on the new Capital Investment Bonds. (Section 10 (15)(iib) of
ITA)
 Interest income from notified relief bonds. (Section 10 (15)(iic) of ITA)
 Interest on notified bonds owned by a non-resident etc. and bought in
foreign exchange subject to certain conditions. (Section 10 (15)(iid) of
ITA)
 Interest on securities under the Ceylon Monetary Law Act, 1949. (Section
10 (15)(iii) of ITA)
 Interest payable to any bank incorporated outside India and approved by
RBI. (Section 10(15)(iiia) of ITA)
 Receipt of interest from government, etc. on moneys lent to them from
sources outside India. (Section 10 (15)(iv)(a) of ITA)
 Receipt of interest from industrial undertaking in India being approved
foreign financial institutions in respect of moneys lent to it. (Section 10
(15)(iv)(b)of ITA)
 Receipt of interest from industrial undertaking in India in respect of moneys
lent to it outside India for purchases of raw materials, plant & machinery,
etc. from abroad. (Section 10 (15)(iv)(c) of ITA)
 Receipt of interest from specified financial institution in India in respect of
moneys lent to it from sources outside India. (Section 10 (15)(uv)(d) of
ITA)
 Receipt of interest from financial institutions other than those covered by
15(iv)(d) above in respect of moneys lent to it from sources outside India
for the purposes as specified. (Section 10 (15)(iv)(e) of ITA)
 Receipt of interest from industrial undertaking in India in respect of money
lent to it in foreign currency from sources outside India. (Section 10
(15)(iv)(f) of ITA)
 Receipt of interest from scheduled bank in respect of deposits made in
foreign currency subject to same being duly approved by the RBI. (Section
10(15) (iv)(fa) of ITA)
 Receipt of interest from public company having been formed and registered
in India to provide long-term finances for construction/purchase of houses

36
 Exempted Income

in respect of moneys lent to it in foreign currency from sources outside

India. (Section 10 (15)(iv)(g) of ITA)
 Receipt of interest from a public sector company in respect of bonds and
debentures as notified. (Section 10 (15)(iv)(h) of ITA)
 Receipt of interest from government in respect of deposits made in its
specified schemes from funds due on retirement. (Section 10 (15)(iv)(i) of
ITA)
 Receipt of interest on securities held by Bhopal Gas Victims’ Welfare
Commissioner as also on deposits made with RBI or a public Bank for the
benefit of such victims. (Section 10 (15)(v) of ITA)
 Receipt of payment from an Indian company carrying on business of
operation of aircraft, to acquire an aircraft or aircraft engine excluding
spares etc., on lease from foreign Govt. or enterprise under an agreement
entered into before 1-4-1997 and being duly approved. (Section 10(15A)
of ITA)
 Scholarships granted to meet the cost of education. (Section 10(16) of
ITA)
 Daily allowances received by MPs, MLAs and MLCs. (Section 10(17)(ii)
of ITA)
 Receipt of allowances by MPs under the Member of Parliament
[Constituency Allowance] Rules, 1986. (Section 10(17)(ii) of ITA)
 Receipt of allowances by MLAs up to 2,000 per month. (Section
10(17)(iii) of ITA)
 Receipt of any amount in connection with an award, including award in
kind, for literary, scientific or artistic work, etc. instituted by the
government, etc. (Section 10(17A)(i) of ITA)
 Receipt of amount in connection with a reward including award in kind from
government in respect of public interest purposes. (Section 10 (17A)(ii) of
ITA)
 Receipt of ex-gratia payments from government to ex-rulers in respect of
abolition of their privy purses. (Section 10(18A) of ITA)
 Amount calculated as annual value being the notional value in respect of any
one palace to be treated for the purpose as residence by ex-ruler. Section
10(19A) of ITA)
 Income of a local authority as specified. (Section 10(20) of ITA)

37
Exempted Income

 Income of a development or housing improvement authority in a city and or

village. (Section 10(20A) of ITA)
 Income of approved scientific and research association. (Section 10(21) of
ITA)
 Income of a university or other educational institution. (Section 10(22) of
ITA)
 Income of a hospital or other such institution working exclusively for
philanthropic purposes and not for profit. (Section 10(22A) of ITA)
 Income of news agency having been set up in India for the sole purpose of
collection and distribution of news provided its income in any way is not
distributed to its members. (Section 10(22B) of ITA)
 Income of associations for promotion of sports, etc. as specified. (Section
10(23) of ITA)
 Any income of associations or institutions for controlling professions of law,
medicine, engineering, accountancy, architecture, etc., except incomes
derived from house property or for rendering any specified services or
interest on/dividends from its investments. (Section 10(23A) of ITA)
 Income of regiment fund or non-public fund of armed forces established for
welfare of past and present members. (Section 10(23AA) of ITA)
 Income of a fund established for welfare of employees or their dependents,
the employees being members thereof subject to fulfilment of conditions as
to approval and otherwise. (Section 10 (23AAA) of ITA)
 Income of fund set up by LIC in respect of pension scheme subject to
conditions as specified. (Section 10 (23AAB) of ITA)
 Income of a charitable trust or registered society, etc. working exclusively
for development of khadi and village industries and not for profit as per
conditions specified. (Section 10(23B) of ITA)
 Income of Khadi and Village Board, etc. (Section 10(23BB) of ITA)
 Income received by a statutory public religious or charitable trust or
endowment. (Section 10 (23BBA) of ITA)
 Income of European Economic Community derived in India in the shape of
interest, dividends or capital gains arising out of investments from its funds
under such schemes as notified. (Section 10(23BBB) of ITA)
 Any income of SAARC Fund having been established under Colombo
Declaration by Heads of State or Government of member countries for the
38
 Exempted Income

purposes of development of regional projects. (Section 10 (23BBC) of

ITA)
 Income on behalf of Prime Minister’s National Relief Fund. (Section 10
(23C)(i) of ITA)
 Income on behalf of Prime Minister’s Fund (Promotion of Folk Art).
(Section 10 (23C)(ii) of ITA).
 Income on behalf of Prime Minister’s Aid to Students Fund. (Section
10(23C)(iii) of ITA).
 Income of National Foundation for Communal Harmony. (Section 10
(23C) (iii)(a) of ITA)
 Income of any fund or institution established for charitable cause. (Section
10 (23c)(iv) of ITA)
 Income of any trust or institution established wholly for public religious and
or charitable purposes subject to specified conditions. (Section 10(23c)(v)
of ITA)
 Income of specified mutual funds registered and, or, set up under SEBI
Act, 1992; public-sector bank, financial institution or RBI fulfilling such
conditions as specified. (Section 10(23D) of ITA)
 Income of Exchange Risk Administration Fund having been set up by public
financial institutions either jointly or separately as per specified conditions.
(Section 10(23E) of ITA)
 Income in the shape of dividends or long-term capital gains derived by a
venture capital fund/company from its investments in the equity of a venture
capital undertaking. (Section 10(23F) of ITA)
 Income in the shape of dividends, interest or long-term capital gains derived
by a infrastructure capital fund/company from its investments in the equity
or long-term finance of any infrastructure facility oriented enterprise fulfilling
such conditions as specified. (Section 10(23G) of ITA)
 Income of registered trade-union relating to ‘income from house property’
and ‘income from other sources’ as specified. (Section 10(24) of ITA)
 Income received by trustees of provident, superannuation and gratuity
funds relating to interest on securities and capital gains resulting from sale or
exchange of such securities as specified. (Section 10(25) of ITA)
 Income of Employees State Insurance Fund as specified. (Section 10(25A)
of ITA)

39
Exempted Income

 Income of member of scheduled tribes as specified. (Section 10(26) of

ITA)
 Income accruing to any person from any source of income in the district of
Ladakh or outside India subject to the person being resident in the said
district in the relevant previous year and satisfying other conditions as
specified. (Section 10(26A) of ITA)
 Income of any statutory corporation formed for promoting the interests of
scheduled castes or scheduled tribes, etc., as specified. (Section 10(26B)
of ITA)
 Income of any statutory corporation formed for promoting the interests of
the members of any minority community. (Section 10(26BB) of ITA)
 Income of any cooperative society formed for promoting the interests of
members of scheduled caste and tribes. (Section 10(27) of ITA)
 Income of an authority from letting of godowns or warehouses for storage,
processing or facilitating marketing of goods as specified. (Section 10(29)
of ITA)
 Receipt by way of subsidy received from Tea Board as specified. (Section
10(30) of ITA)
 Receipt by way of subsidy received from the concerned Board by an
assessee growing or manufacturing rubber, coffee, cardamom and other
notified commodities. (Section 10(31) of ITA)
 Income relating to minor child if clubbed under Section 64(1A) in the hands
of the assessee not exceeding 1500 in respect of each minor child.
(Section 10(32) of ITA)
 Any income by way of dividends (whether interim or otherwise) declared,
distributed or paid by a domestic company. (Section 10(33) of ITA).
Exemption of capital gains on compensation received on compulsory
acquisition of agricultural land situated within specified urban limits [Section
10(37)]
Any capital gain (whether short-term or long-term) arising to an individual or a
Hindu undivided family from transfer of agricultural land by way of compulsory
acquisition shall be exempt provided the compensation or the enhanced
compensation or consideration, as the case may be, is received on or after 1-4-
2004. The exemption is available only when such land has been used for agricultural

40
 Exempted Income

purposes during the period of two years immediately preceding the date of
compulsory acquisition by such individual or a parent of his or by such Hindu
undivided family.
Where the compulsory acquisition has taken place before 1-4-2004 but the
compensation is received after 31-3-2004, it shall be exempt. But if part of the
original compensation in the above case has already been received before 1-4-
2004, then exemption shall not be available even though balance original
compensation is received after 31-3-2004.
However, enhanced compensation received on or after 1-4-2004 against
agricultural land compulsory acquired before 1-4-2004 shall be exempt.

Exemption of long-term capital gain arising from sale of shares and units
[Section 10(38)
Any income arising on or after 1-10-2004 from the transfer of a long-term capital
asset, being an equity share in a company or a unit of an equity oriented fund shall
be exempt, provided:
(a) such equity shares are sold through recognised stock exchange, whereas
units of an equity oriented fund may either be sold through the recognised
stock exchange or may be sold to the mutual fund.
(b) such transaction is chargeable to securities transaction tax.
1. Although the above long-term capital gain is exempt but such long-
term capital gain in case of a company assessee shall be taken in
account in computing book profits and income tax payable under
Section 115JB.
2. ‘Equity oriented fund’ means a fund:
(i) where the investible funds are invested by way of equity shares in
domestic companies to the extent of more than 65 per cent of the total
proceeds of such fund; and
(ii) which has been set up under a scheme of a Mutual Fund
specified under clause (23D):
The percentage of equity share holding of the fund shall be computed with
reference to the annual average of the monthly averages of the opening and
closing figures.

41
Exempted Income

Exemption of specified income from international sporting event held in

India [Section 10(39)]

[W.e.f. assessment year 2006-07]

Any specified income arising, from any international sporting event held in India,
to the person or persons notified by the Central Government in the Official Gazette,
shall be exempt if such international sporting event:
(a) is approved by the international body regulating the international sport
relating to such event;
(b) has participation by more than two countries;
(c) is notified by the Central Government in the Official Gazette for the
purpose of this clause.
The specified income means the income, of the nature and to the extent,
arising from the international sporting event, which the Central Government
may notify in this behalf.
Exemption in respect of grant, etc. received by a subsidiary company from its
holding company engaged in the business of generation, etc. of distribution of power
[Section 10(40)].
Exemption of capital gain on transfer of an asset of an undertaking engaged in
the business of generation, etc. of power [Section 10(41)].
Exemption of specified income of certain bodies or authorities [Section 10(42)].
Exemption of amount received as loan in case of a reverse mortgage
transaction [Section 10(43)] [W.r.e.f. 2008-09]
The Finance Act, 2008 has introduced a new clause (43) to Section 10 to provide
that any amount received by an individual as a loan, either in lump sum or in
instalment, in a transaction of reverse mortgage referred to in Section 47(xvi) shall be
exempt.

Check Your Progress - 1

1. Give one condition for the exemption of specified income from

international sporting event held in India.
................................................................................................................
................................................................................................................
................................................................................................................
42
 Exempted Income

2. What does ‘equity oriented fund’ mean?

................................................................................................................
................................................................................................................
................................................................................................................

4.3 AGRICULTURAL INCOME

Agricultural income is fully exempt from income tax. But, what is agricultural
income? Is it really tax-free? These questions are discussed below:

What is Agricultural Income?

Agricultural income is defined as follows:
 Any rent or revenue derived from land which is situated in India and is used
for agricultural purposes; or
 Any income derived from such land by agriculture; or
 The performance by a cultivator or receiver of rent-in-kind of any process
ordinarily employed by a cultivator or receiver of rent-in-kind to render the
produce raised or received by him fit to be taken to market; or
 The sale by a cultivator or receiver of rent-in-kind of the produce raised or
received by him, in respect of which no process has been performed other
than a process of the nature described above; or
 Any income derived from any building owned and occupied by the receiver
of the rent or revenue of any such land, or occupied by the cultivator or the
receiver of rent-in-kind, of any land with respect to which, or the produce
of which, any process mentioned above is carried on. This is subject to the
following conditions:
(a) The building is on or in the immediate vicinity of the land, and is a
building which the receiver of the rent or revenue or the cultivator, or
the receiver of rent-in-kind, by reason of his connection with the land,
requires as a dwelling house, or as a storehouse, or other out-building,
and
(b) The land is either assessed to land revenue in India or is subject to a
local rate assessed and collected by officers of the Government as
such or where the land is not so assessed to land revenue or subject

43
Exempted Income

to a local rate, it is not situated in any area which is comprised within

the jurisdiction of a municipality (whether known as a municipality,
municipal corporation, notified area committee, town area committee,
town committee or by any other name) or a cantonment board and
which has a population of not less than ten thousand according to the
last preceding census of which the relevant figures have been
published before the first day of the previous year; or in any area
within such distance, not being more than 8 kilometres, from the local
limits of any municipality or cantonment board.

Consideration of Agricultural Income for Determination of Tax Rates

Although, agricultural income is exempted from income tax, it is required to be
considered for the determination of income tax rate for individuals and HUFs
assesses. If the agricultural income of individuals and HUFs is in excess of 5,000,
it is added to the total income for the purposes of computing tax on the total income.

Newly Established Industrial Undertakings in FTZ

Under Section 10A of ITA, any profits and gains of newly-established industrial
undertakings in Free Trade Zones (FTZ), Electronic Hardware Technology Park
(EHTP), Software Technology Parks (STP) are exempted from income tax for a
period of ten consecutive assessment years commencing from the previous year in
which production started, subject to fulfilling all the conditions as specified.
The amount of exemption is worked out as follows:
(Profit of the Undertaking × Export Turnover) / Total Turnover of the Undertaking
1. Income from export of articles, computer software, etc.: Subject to
the provisions of this Section, a deduction of such profits and gains as are
derived by an undertaking from the export of articles or things or computer
software, as the case may be, shall be allowed from the total income of the
assessee.
2. Assessees who are eligible for deduction: Deduction under this Section
is available to all categories of assessees viz., individuals, firms, companies,
etc. who derive any profits or gains from an undertaking engaged in the
export of articles or things or computer software.
3. Essential conditions to claim deduction: The deduction shall apply to an
undertaking which fulfils all the following conditions:

44
 Exempted Income

(i) It has begun or begins to manufacture or produce articles or things or

computer software during the previous year, relevant to the
assessment year:
(a) 1981–82 or thereafter, in any free trade zone;
(b) 1994–95 or thereafter, in any electronic hardware technology
park, or as the case may be, software technology park;
(c) 2001–02 or thereafter in any special economic zone. [However,
units established on or after 1-4-2002 shall be eligible for exemption
as per sub-Section (1 A)].
(ii) It should not be formed by splitting up or reconstruction of an existing
business. However, exemption is provided if the unit is formed as a
result of the re-establishment, reconstruction or revival by the assessee
of the business of the undertaking as is referred to and satisfying the
conditions in Section 33B.
(iii) It should also not be formed by the transfer of machinery or plant,
previously used for any purpose, to a new business. However, the
following are the two exceptions to this condition:
(1) Machinery or plant which was used outside India by any person
other than the assessee shall not be regarded as machinery or plant
previously used for any purpose, if the following conditions are
fulfilled:
(a) The machinery or plant should not be previously used in India.
(b) The machinery or plant should be imported into India from a
foreign country.
(c) No deduction on account of depreciation in respect of such
machinery or plant has been allowed or is allowable under the
provisions of this Act to any person previously.
(2) Deduction u/s 10A will, be available if the total value of the
second hand machinery or plant transferred to the new undertaking
does not exceed 20 per cent of the total value of the machinery or
plant used in the industrial unit.
(iv) The sale proceeds of articles or things or computer software exported
out of India should be received in, or brought into, India by the
assessee in convertible foreign exchange, within a period of six months
45
Exempted Income

from the end of the previous year or, within such further period RBI
may allow in this behalf.
(v) The assessee should furnish along with the return of income, the report
of a chartered accountant in Form No. 56F certifying that the
deduction has been correctly claimed in accordance with the
provisions of this Section.
(vi) The provisions of sub-Section (8) (relating to inter-unit transfer) and
sub-Section (10) (relating to showing excess profit from such unit) of
Section 80-IA shall, so far as may be, apply in relation to the
undertaking referred to in this Section as they apply for the purposes
of the undertaking referred to in Section 80-IA.
1. The sale proceeds referred to in this sub-Section shall be
deemed to have been received in India where such sale proceeds are
credited to a separate account maintained for the purpose by the
assessee with any bank outside India with the approval of the Reserve
Bank of India.
2. ‘Computer software’ means:
(a) any computer program recorded on any disc, tape,
perforated media or other information storage device; or
(b) any customized electronic data or any product or service
of similar nature, as may be notified by the Board which is
transmitted or exported from India to any place outside India by any
means.
3. ‘Manufacture or produce’ shall include the cutting and polishing
of precious and semi-precious stones.
4. Period of tax holiday: The profits and gains from the exports of such
undertaking shall not be included in the total income of the assessee in
respect of any ten consecutive assessment years beginning with the
assessment year relevant to the previous year in which the undertaking
begins to manufacture or produce articles or things or computer
software. However, no deduction under this Section shall be allowed
to any undertaking for the assessment year 2010–11 and thereafter. In
other words, deduction shall be allowed maximum up to assessment year
2009–10.

46
 Exempted Income

Thus, all undertakings set up on or before 31-3-2000 shall be entitled to a

deduction for a period of ten years, that set up during the period 1-4-2000
to 31-3-2001 for a period of nine years, that set up in 2001–02 for a
period of eight years and so on.
The Finance Act, 2008 has extended the deduction by one more year.
Hence, now deduction shall be allowed maximum up to assessment year
2010–11 instead of assessment year 2009–10.
5. Units established in a Special Economic Zone on or after 1-4-2002
[Section 10A(lA)]: An undertaking, which begins to manufacture or
produce articles or things or computer software on or after 1-4-2002 in
any special economic zone, shall be allowed a deduction of 100 per cent of
profits and gains derived from the export of such articles or things or
computer software for a period of five consecutive assessment years
beginning with the assessment year relevant to the previous year in which
the undertaking begins to manufacture or produce such articles or things or
computer software, as the case may be, and thereafter 50 per cent of such
profits and gains for further two assessment years.
Besides this, a further deduction for three years beyond the period of seven
years, mentioned above, shall be allowed as under:
Quantum of deduction for next three years: The amount of deduction shall
be so much of the amount not exceeding 50 per cent of the profit as is
debited to the profit and loss account of the previous year in respect of
which the deduction is to be allowed and credited to a reserve account (to
be called the ‘Special Economic Zone Re-investment Allowance Reserve
Account’) to be created and utilized for the purposes of the business of the
assessee in the manner laid down in sub-Section (IB). Conditions to be
satisfied before deduction for three years is allowed [Section 10A(lB)]
(1) The amount credited to the Special Economic Zone Reinvestment
Allowance Reserve Account is to be utilized:
(a) for the purposes of acquiring new machinery or plant which is
first put to use before the expiry of a period of three years next
following the previous year in which the reserve was created; and
(b) until the acquisition of new machinery or plant as aforesaid, for
the purposes of the business of the undertaking other than for

47
Exempted Income

distribution by way of dividends or profits or for remittance outside

India as profits or for the creation of any asset outside India.
(2) The particulars, as may be prescribed in this behalf, should be
furnished by the assessee in respect of new machinery or plant along
with the return of income for the assessment year relevant to the
previous year in which such plant or machinery was first put to use.
6. How to compute profit and gains from exports of such undertakings
[Section 10A(4)]: For the purpose of the exemption under this Section,
the profits derived from export of articles or things or computer software
shall be the amount which bears to the profits of the business of the
undertaking, the same proportion as the export turnover in respect of such
articles or things or computer software bears to the total turnover of the
business carried on by the undertaking. In other words it will be as under:
Profits from business of the undertaking ×
ETof the undertaking of such articles/things or computer software
Total turnover ot business earned on by the undertaking

1. The profits and gains derived from on-site development of

computer software (including services for development of software)
outside India shall be deemed to be the profits and gains derived from
the export of computer software outside India.
2. ‘Export turnover’ means the consideration in respect of export by the
undertaking of articles or things or computer software received in, or
brought into India by the assessee in convertible foreign exchange in
accordance with sub-Section (3), but does not include freight,
telecommunication charges or insurance attributable to the delivery of
the articles or things or computer software outside India or expenses,
if any, incurred in foreign exchange in providing the technical services
outside India.
7. Existing undertaking will get benefit for unexpired period [Proviso 1
to Section 10A]
8. Shifting of the undertaking from EPZ/FTZ to ‘Special Economic
Zone’ [Proviso 2 to Section 10A]: Where an undertaking initially located
in any free trade zone or export processing zone is subsequently located in
a special economic zone by reason of conversion of such free trade zone or
export processing zone into a Special Economic Zone, the period, often
48
 Exempted Income

consecutive assessment years referred to in this sub-Section, shall be

reckoned from the assessment year relevant to the previous year in which
the undertaking was first set up in such free trade zone or export
processing zone.
9. Treatment of unabsorbed depreciation and brought forward losses,
etc.
(1) If the deduction under Section 10A pertains to the assessment year
2001–02 or any subsequent years, then unabsorbed depreciation,
unabsorbed capital expenditure on scientific research, unabsorbed
family planning expenditure relating to such undertaking will be
allowed to be carried forward and set off as per the provisions of
Income-tax Act.
(2) Similarly, brought forward losses under Sections 72(1), 74(1) and
74(3) of such undertaking with respect to assessment year 2001–02
and onwards shall be carried forward and set off as per the provisions
of the Income-tax Act.
(3) Deduction under Section 80-IA or 80-IB shall not be allowed.
10. WDV after tax holiday period: It shall be presumed that during the tax
holiday period under Section 10A, the assessee had claimed and had been
allowed depreciation allowance, and hence the written down value of the
depreciable assets shall be computed accordingly, after the conclusion of
the tax holiday period.
11. Option not to claim benefit of tax holiday [Section 10A(8)]: An
assessee may, before the due date for filing the return of income under
Section 139(1) furnish a declaration in writing that the provisions of the
Section may not be made applicable to him for the said year forming part
of the relevant assessment years. On such declaration, provisions of
Section 10A shall not apply to the assessee for any of the said relevant
assessment year.
12. Deduction under this Section allowable in case of amalgamation and
demerger [Section 10A(7A)]: Where any undertaking of an Indian
company which is entitled to the deduction under this Section is transferred
to another Indian company under a scheme of amalgamation or demerger,
the deduction shall be allowable in the hands of the amalgamated or the
resulting company. However, no deduction shall be admissible under this
49
Exempted Income

Section to the amalgamating company or the demerged company for the

previous year in which the amalgamation or demerger takes place.
13. Deduction is not to be allowed if return of income is not submitted
by due date [inserted w.e.f. assessment year 2006-07): No deduction
under this Section shall be allowed to an assessee who does not furnish a
return of his income on or before the due date specified under Section
139(1).
14. New units established in Special Economic Zone not to be allowed
deduction under this Section [Section 10A(7B)]: The new units
established on or after 1-4-2005 in Special Economic Zone shall not be
entitled to benefit under this Section. These units shall be entitled to benefit
under newly inserted Section 10AA.

Newly Established Industrial Normal Undertakings in SEZ

Under Section 10AA of ITA, any profits and gains of newly-established industrial
undertakings in a Special Economic Zone (SEZ) are exempted from income tax for
a period of fifteen consecutive assessment years (on a sliding scale) commencing
from the previous year in which production started subject to fulfilling all the
conditions as specified.
The period of exemption is as follows:
1. First Five Years: For the first five years the exemption is 100 per cent of
the profit and gain derived from export of articles, things or services, that is:
(Profit of the Undertaking × Export Turnover) / Total Turnover
2. Years Six to Ten: For years between sixth and tenth, the exemption is 50
per cent of the profit and gain derived from export of articles, things or
services, that is:
(0.50) × (Profit of the Undertaking X Export Turnover) / Total Turnover
3. Years Eleven to Thirteenth: For years between eleventh and thirteenth,
the exemption is 50 per cent of the profit and gain derived from export of
articles, things or services, provided an equivalent amount is transferred to
a separate account called ‘Special Economic Zone Reinvestment
Allowance Reserve Account’. Thus, provided the condition is satisfied, the
exemption is:
(0.50) × (Profit of the Undertaking × Export Turnover) / Total Turnover

50
 Exempted Income

1. Deduction for entrepreneur from the export of articles: Subject

to the provisions of this Section, a deduction of such profits and gains
as are derived by an assessee being an entrepreneur from the export
of articles or things or providing any service, as the case may be, from
his unit shall be allowed from the total income of the assessee.
2. Assessees who are eligible for deduction: Deduction under this
Section is available to all categories of assessees being entrepreneurs,
viz., individuals, firms, companies, etc. who derive any profits or gains
from an undertaking being a unit engaged in the export of articles or
things or providing any service.
(i) ‘export’ in relation to the Special Economic Zones means taking
goods or providing services out of India from a Special Economic
Zone by land, sea, air, or by any other mode, whether physical or
otherwise;
(ii) ‘export turnover’ means the consideration in respect of export by
the undertaking, being the Unit of articles or things or services
received in, or brought into, India by the assessee but does not include
freight, telecommunication charges or insurance attributable to the
delivery of the articles or things outside India or expenses, if any,
incurred in foreign exchange in rendering of services (including
computer software) outside India.
3. Essential conditions to claim deduction: The deduction shall apply to an
undertaking which fulfils the following conditions:
(i) It has begun or begins to manufacture or produce articles or things or
provide any service during the previous year relevant to any
assessment year commencing on or after 1-4-2006 in any Special
Economic Zone.
(ii) It should not be formed by the splitting up or reconstruction of a
business already in existence. However, deduction is provided if the
unit is formed as a result of the re-establishment, reconstruction or
revival by the assessee of the business of the undertaking as is referred
to and satisfying the conditions in Section 33B.
(iii) It should also not be formed by the transfer of machinery or plant,
previously used for any purpose, to a new business. However, the
following are the two exceptions to this condition:
51
Exempted Income

(1) Machinery or plant which was used outside India by any person
other than the assessee shall not be regarded as machinery or plant
previously used for any purpose, if the following conditions are
fulfilled:
(a) The machinery or plant should not be previously used in India.
(b) The machinery or plant should be imported into India from a
foreign country.
(c) No deduction on account of depreciation in respect of such
machinery or plant has been allowed or is allowable under the
provisions of this Act to any person previously.
(2) Deduction under Section 10AA will, be available if the total value
of the second hand machinery or plant transferred to the new
undertaking does not exceed 20 per cent of the total value of the
machinery or plant used in the industrial unit.
(iv) The assessee should furnish in the prescribed form [Form No. 56F],
alongwith the return of income, the report of a chartered accountant
certifying that the deduction has been correctly claimed in accordance
with the provisions of this Section.
(v) The conditions laid down in sub-Section (8) (relating to inter-unit
transfer) and sub-Section (10) (relating to showing excess profit from
such unit) of Section 80-1A shall, so far as may be, apply in relation to
the undertaking referred to in this Section as they apply for the
purposes of the undertaking referred to in Section 80-IA.
1. ‘Manufacture’ means to make, produce, fabricate, assemble,
process or bring into existence, by hand or by machine, a new product
having a distinctive name, character or use and shall include processes
such as refrigeration, cutting, polishing, blending, repair, remaking, re-
engineering and includes agriculture, aquaculture, animal husbandry,
floriculture, horticulture, pisciculture, poultry, sericulture, aviculture and
mining. [Section 2(i) of the Special Economic Zones Act, 2005].
2. ‘Special Economic Zone’ means each Special Economic Zone
notified under the proviso to sub-section (4) of Section 3 and sub-
section (1) of Section 4 of the Special Economic Zones Act, 2005
(including Free Trade and Warehousing Zone) and includes an existing

52
 Exempted Income

Special Economic Zone [Section 2(za) of the Special Economic Zones

Act, 2005].
4. Period for which deduction is available: The deduction under this
Section shall be allowed as under for a total period of 15 relevant
assessment years.
1. For the first five consecutive assessment years 100 per cent of the profits and gains derived from
beginning with the assessment year relevant to the export of such articles or things or from services
the previous year in which the unit begins to
manufacture such articles or things or provide
services
2. Next five consecutive assessment years 50 per cent of such profits or gains
3. Next five consecutive assessment years So much of the amount not exceeding 50 per cent of
the profits as is debited to profit and loss account of
the previous year in respect of which the deduction
is to be allowed and credit to Special Economic
Zone Reinvestment Reserve Account to be created
and utilized for me purpose of the business of the
assessee in the manner laid down in sub-section(2).

Conditions to be satisfied for claiming deduction for further 5 years

(after 10 years) [Section 10AA(2)\
(1) The amount credited to the Special Economic Zone Reinvestment
Reserve Account is to be utilized:
(i) for the purposes of acquiring new machinery or plant which is
first put to use before the expiry of a period of three years next
following the previous year in which the reserve was created; and
(ii) until the acquisition of new machinery or plant as aforesaid, for
the purposes of the business of the undertaking other than for
distribution by way of dividends or profits or for remittance outside
India as profits or for the creation of any asset outside India.
(2) The particulars, as may be prescribed in this behalf, should be
furnished in Form No. 56FF, by the assessee in respect of new
machinery or plant along with the return of income for the assessment
year relevant to the previous year in which such plant or machinery
was first put to use.
Consequences of mis-utilization/non-utilization of reserve
[Section 10AA(3)]: Where any amount credited to the Special
Economic Zone Re-investment Reserve Account:
(a) has been utilized for any purpose other than the purchase of new
machinery or plant as mentioned above, the amount so utilized shall be
53
Exempted Income

deemed to be the profits of the year in which it was so utilized and

shall be charged to tax; or
(b) has not been utilized before the expiry of the aforesaid period of
5 years, the amount not so utilized shall be deemed to be the profits of
the year immediately following the period of said three years and
charged to tax.
5. How to compute profit and gains from exports of such undertakings
[Section 10AA(7)]: For the purpose of the exemption under this Section,
the profits derived from export of articles or things or services (including
computer software) shall be the amount which bears to the profits of the
business of the undertaking, being the unit, the same proportion as the
export turnover in respect of such articles or things or computer software
bears to the total turnover of the business carried on by the assessee.
In other words, it will be as under:
Profits from business of the undertaking being the unit ×
ET of the undertaking of such articles/things or services
Total turnover of business carred on by the assesses

1. Profit from business is to be computed as per provisions of computing

the income under the head profits and gains of business or profession.
2. ‘Export turnover’ means the consideration in respect of export by the
undertaking, being the unit of articles or things or services received in,
or brought into, India by the assessee but does not include freight,
telecommunication charges or insurance attributable to the delivery of
the articles or things outside India or expenses, if any, incurred in
foreign exchange in rendering of services (including computer
software) outside India. [Explanation 1(i) to Section 10AA]
3. The profits and gains derived from on-site development of computer
software (including services for development of software) outside
India shall be deemed to be the profits and gains derived from the
export of computer software outside India. [Explanation 2 to
Section 10AA].
6. Section 10A not applicable for units referred to clause (zc) of
Section 2 of the Special Economic Zones Act, 2005 |Section 10(7B)].
Sub-section (7B) has been inserted in Section 10A to provide as under:

54
 Exempted Income

‘The provisions of Section 10A shall not apply to any undertaking, being a
Unit referred to in clause (zc) of Section 2 of the Special Economic Zones
Act, 2005, which has begun or begins to manufacture or produce articles
or things or computer software during the previous year relevant to the
assessment year commencing on or after the 1-4-2006 in any Special
Economic Zone.’
‘Unit’ as per Section 2(zc) of the Special Economic Zones Act, 2005
means unit set up by an entrepreneur in a Special Economic Zone and
includes an existing Unit, an Offshore Banking Unit and a Unit in an
International Financial Services Centre, whether established before or
established after the commencement of this Act.
7. Existing unit will get benefit for unexpired period [Proviso 1 to
Section 10AA]: Where in computing the total income of the unit for any
assessment year, its profits and gains had not been included by application
of the provisions of sub-section (7B) of Section 10A, the undertaking,
being the unit shall be entitled to deduction only for the unexpired period of
ten consecutive assessment years and thereafter it shall be eligible for
deduction from income for next five assessment years as provided in
Section 10AA(l).
Explanation.—For the removal of doubts, it is hereby declared that an
undertaking, being the unit, which had already availed, before the
commencement of the Special Economic Zones Act, 2005 the deductions
referred to in Section 10A for ten consecutive assessment years, such unit
shall not be eligible for deduction from income under this Section.
8. Conversion of EPZ/FTZ into ‘Special Economic’ Zone [Proviso 2 to
Section 10AA]: Where a unit initially located in any free trade zone or
export processing zone is subsequently located in a special economic zone
by reason of conversion of such free trade zone or export processing zone
into a Special Economic Zone, the period of ten consecutive assessment
years referred to in this sub-section shall be reckoned from the assessment
year relevant to the previous year in which the unit began to manufacture,
or produce or process such articles or things or services in such free trade
zone or export processing zone.
However, where a unit initially located in any free trade zone or export
processing zone is subsequently located in a Special Economic Zone by

55
Exempted Income

reason of conversion of such free trade zone or export processing zone into
a Special Economic Zone and has completed the period of ten consecutive
assessment years referred to above, it shall not be eligible for deduction
from income as provided in clause (ii) of sub-section (1) with effect from
the 1-4-2006.
9. Ban on enjoyment of other tax benefits:
(1) The following allowances or expenditure shall be deemed to have been
allowed and absorbed during the course of the relevant assessment
years ending before 1-4-2006:
(i) depreciation allowance under Section 32;
(ii) expenditure on scientific research under Section 35; and
(iii) expenditure in relation to family planning under Section 36(l)(a).
The aforesaid expenditure/allowance even if, unabsorbed during the
relevant assessment years ending before 1-4-2006, shall be deemed
to have been fully claimed and allowed. However, unabsorbed
depreciation, unabsorbed expenditure on scientific research and capital
expenditure on family planning pertaining to assessment year 2006-07
or any subsequent assessment year shall be allowed to be carried
forward and set off.
(2) No portion of the losses pertaining to business under Section 72(1) or
capital gains under Section 74(1) or Section 74(3) with respect to any
assessment year ending before 1-4-2006 forming part of the tax
holiday period, to the extent pertaining to the undertaking, being the
unit shall be claimed in any assessment year subsequent to the last of
the assessment year forming part of the tax holiday period. However,
as per Section 10AA(6) losses referred to in Section 72(1) or Section
74(1) and (3) in so far as such losses relate to the business of the
undertaking being the unit, shall be allowed to be carried forward and
set off.
10. WDV after tax holiday period: It shall be presumed that during the tax
holiday period under Section 10AA, the assessee had claimed and had
been allowed depreciation allowance, and hence the written down value of
the depreciable assets shall be computed accordingly, after the conclusion
of the tax holiday period.

56
 Exempted Income

11. Deduction allowable in case of amalgamation and demerger [Section

10AA(5)]: Where any undertaking, being the unit of an Indian company
which is entitled to the deduction under this Section is transferred to
another Indian company under a scheme of amalgamation or demerger, the
deduction shall be allowable in the hands of the amalgamated or the
resulting company. However, no deduction shall be admissible under this
Section to the amalgamating company or the demerged company for the
previous year in which the amalgamation or demerger takes place.

Check Your Progress - 2

1. What is agricultural income?

................................................................................................................
................................................................................................................
................................................................................................................

2. How is the amount of exemption worked out in newly established

industrial undertakings in FTZ?
................................................................................................................
................................................................................................................
................................................................................................................

4.4 NEWLY ESTABLISHED 100 PERCENT EOU

Under Section 10B of ITA, any profits and gains of newly established 100 per cent
export-oriented business approved by the CBDT, are exempted from income tax for
a period of ten consecutive assessment years commencing from the previous year in
which production started subject to fulfilling all the conditions as specified.
The amount of exemption is worked out as follows:
(Profit of the Undertaking × Export Turnover)/Total Turnover of the Undertaking

Special Provision
1. Deduction of profits and gains derived by 100 per cent EOUs: As per
this Section, a deduction of such profits and gains as are derived by a 100
per cent export-oriented undertaking from the export of articles or things or
computer software for a period of ten consecutive per cent assessment
57
Exempted Income

years beginning with the assessment year relevant to the previous year in
which the undertaking begins to manufacture or produce articles or things
or computer software, as the case may be, shall be allowed from the total
income of the assessee.
2. Assessees who are eligible for deduction: Deduction under this
provision is applicable to all categories of assessees viz., individuals, firms,
companies, etc. who derive any profits or gains from 100 per cent EOU.
3. Essential conditions to claim deduction:
(i) The undertaking should be an approved 100 per cent export
oriented undertaking. It must be approved as a 100 per cent EOU by
the Board appointed by the Central Government in this behalf.
(ii) It manufactures or produces any article or thing or computer
software.
The other conditions for claiming deduction under this Section are
same as are given under Section 10A except that the report of an
accountant shall be furnished in Form No. 56G instead of 56F.
4. Period of tax holiday: Same as given under Section 10A. Also see
amendment under Section 10A.
5. How to compute profits and gains from exports of such
undertakings: Same as given under Section 10 A of ITA.
6. Existing undertaking will get benefit for unexpired period: Same as
given under Section 10A of ITA.
7. Ban on enjoyment of other tax benefits: Same as given under Section
10A of ITA.
8. WDV of assets after tax holiday period: Same as given under Section
10A of ITA.
9. Option not to claim benefit of tax holiday: Same as given under Section
10A of ITA.
10. Deduction allowable in case of amalgamation and demerger: Same
as given under Section 10A of ITA.
11. Deduction is not to be allowed if return of income is not submitted
by due date: Same as given under Section 10A of ITA.

58
 Exempted Income

Unit Exporting Hand-Made Wooden Articles

Under Section 10BA of ITA, any profits and gains of an undertaking manufacturing
or producing hand-made wooden articles, having artistic value, are exempted from
income tax for a period of six consecutive assessment years commencing from the
previous year in which production started subject to fulfilling all the conditions as
specified.
The amount of exemption is worked out as follows:
(Profit of the Undertaking × Export Turnover)/Total Turnover of the Under-
taking

Special Provisions
1. Subject to the provisions of this Section, a deduction of such profits and
gains as are derived by an undertaking from the export out of India of
eligible articles or things, shall be allowed from the total income of the
assessee:
However, where in computing the total income of the undertaking for any
assessment year, deduction under Section 10A or. Section 10B has been
claimed, the undertaking shall not be entitled to the deduction under this
Section.
2. Assessees who are eligible for deduction: All assessees owning an
undertaking which derives any profit and gains from the export out of India
of eligible articles or things.
3. Essential conditions to claim deduction: The deduction shall be
available to an undertaking which fulfils the following conditions:
(a) it manufactures or produces the eligible articles or things without the
use of imported raw materials;
Eligible articles or things means all hand-made articles or things, which
are of artistic value and which requires the use of wood as the main
raw material.
(b) it is not formed by the splitting up, or the reconstruction, of a business
already in existence;
However, this condition shall not apply in respect of any undertaking
which is formed as a result of the re-establishment, reconstruction or
revival by the assessee of the business of any such undertaking as is

59
Exempted Income

referred to in Section 33B, in the circumstances and within the period

specified in that Section.
(c) it is not formed by the transfer to a new business of machinery or plant
previously used for any purpose. However, the following are the two
exceptions to this condition:
(1) machinery or plant which was used outside India by any person
other than the assessee shall not be regarded as machinery or plant
previously used for any purpose, if the following conditions are
fulfilled:
(a) The machinery or plant should not be previously used in India.
(b) The machinery or plant should be imported into India from a
foreign country.
(c) no deduction on account of depreciation in respect of such
machinery or plant has been allowed or is allowable under the
provisions of this Act to any person previously.
(2) Deduction u/s 10BA will be available if the total value of the
second hand machinery or plant transferred to the new undertaking
does not exceed 20 per cent of the total value of the machinery or
plant used in the industrial unit;
(d) 90 per cent or more of its sales during the previous year relevant
to the assessment year are by way of exports of the eligible articles or
things;
(e) it employs 20 or more workers during the previous year in the
process of manufacture or production;
(f) the sale proceeds of the eligible articles or things exported out of
India are received in, or brought into, India by the assessee in
convertible foreign exchange, within a period of six months from the
end of the previous year or, within such further period as the
competent authority may allow in this behalf;
(g) the assessee should furnish in the prescribed form, along with the
return of income, the report of a chartered accountant, certifying that
the deduction has been correctly claimed in accordance with the
provisions of this Section;

60
 Exempted Income

(h) the provisions of sub-section (8) and sub-section (10) of Section

80-IA shall, so far as may be, apply in relation to the undertaking
referred to in this Section as they apply for the purposes of the
undertaking referred to in Section 80-IA.
4. Deduction not allowed after assessment year 2009–10: No deduction
under this Section shall be allowed to an undertaking for the assessment
years 2010–11 and thereafter.
5. How to compute profits and gain from export of such undertaking:
For the purposes of sub-section (1), the profits derived from export out of
India of the eligible articles or things shall be the amount which bears to the
profits of the business of the undertaking, the same proportion as the export
turnover in respect of such articles or things bears to the total turnover of
the business carried on by the undertaking.
1. Export turnover means the consideration in respect of export by the
undertaking of eligible articles or things received in, or brought into,
India by the assessee in convertible foreign exchange in accordance
with sub-section (3), but does not include freight, telecommunication
charges or insurance attributable to the delivery of the articles or things
outside India.
2. Export out of India shall not include any transaction by way of sale or
otherwise, in a shop, emporium or any other establishment situate in
India, not involving clearance of any customs station as defined in the
Customs Act, 1962.
3. Notwithstanding anything contained in any other provision of this Act,
where a deduction is allowed under this Section in computing the total
income of the assessee, no deduction shall be allowed under any other
Section in respect of its export profits.

Property Held under Charitable Trusts

Income of any person from the property held under trust wholly or in part for
charitable or religious purposes as specified in detail and subject to the provisions of
Sections 60 to 63 of ITA.

Voluntary Contributions Received By Charitable Trusts

Receipt of any voluntary contributions by a trust/institution created/ established
wholly for charitable or religious purposes excluding the contributions made to it with
61
Exempted Income

specific direction to form part of corpus: Such voluntary contributions be deemed to

be income from property in terms of Section 11.

Specified Income of Political Parties

Income of political party chargeable as income from house property or other
sources or by way of voluntary contributions received by it from any person subject
to conditions as specified.

 Incomes which are exempt [Section 13A]

The following incomes derived by a political party are not included in computing its
total income:
(i) Income which is chargeable under the head ‘Income from house property;
or
(ii) Income chargeable under the head ‘Income from other sources’;
(iii) Any income by way of voluntary contribution from any person.
The Finance Act, 2003 has also exempted the income from capital gains in the hands
of political parties w.r.e.f. assessment year 1979-80 i.e. right from the date of
insertion of Section 13A.
 Requisite conditions: The exemption of the above income shall be
available only when the following conditions are satisfied:
(i) The political party keeps and maintains such books of accounts and
other documents as will enable the Assessing Officer to properly
deduce its income therefrom;
(ii) Where the voluntary contributions from a person exceeds 20,000, it
keeps and maintains a record of such contribution and the name and
address of the person who has made such contribution;
(iii) The accounts of the political party are audited by a Chartered
Accountant.
(iv) The treasurer of such political party or any person authorised by the
political party in this behalf must submit a report under Section 29C(3)
of the Representation of People Act, 1951 for the relevant financial
year.
Political party for the purpose of this Section means a political party
registered under Section 29A of the Representation of the People Act,
1951.
62
 Exempted Income

1. If the report under Section 29C (3) of the Representation of the

People Act, 1951 is not submitted, no exemption under this Section
shall be available for that political party for such financial year.
2. Every political party is obliged to file every year a return of its total
income voluntarily in terms of Section 139(4B). As regards filing of
returns by the units of a political party at State or District level is
concerned, it will depend upon whether these units are only branches
of the national party and their receipt and expenditure form part of the
national party. If so, the units need not file separate returns of income.
In the case where units are separately registered as political parties
with the Election Commission of India, the requirement of filing return
by these units will apply as in the case of parent unit. [Circular No.
412, dated 2nd March, 1985].

Check Your Progress - 3

1. What is the duration of exemption of profits and gains of newly

established 100 per cent export-oriented business from income tax?
................................................................................................................
................................................................................................................
................................................................................................................

2. What is the duration of exemption of profits and gains of unit exporting

hand-made wooden articles from income tax?
................................................................................................................
................................................................................................................
................................................................................................................

4.5 SUMMARY

 Income tax is charged on an assessee in relation to the income earned by

him in the previous year.
 Agricultural income is fully exempt from income tax.
 Agricultural income is defined as any rent or revenue derived from land
which is situated in India and is used for agricultural purposes.

63
Exempted Income

 Although, agricultural income is exempted from income tax, it is required to

be considered for the determination of income tax rate for individuals and
HUFs assesses.
 The amount credited to the Special Economic Zone Reinvestment
Allowance Reserve Account is to be utilized:
(a) for the purposes of acquiring new machinery or plant which is first put
to use before the expiry of a period of three years next following the
previous year in which the reserve was created; and
(b) until the acquisition of new machinery or plant as aforesaid, for the
purposes of the business of the undertaking other than for distribution
by way of dividends or profits or for remittance outside India as
profits or for the creation of any asset outside India.
 The profits and gains derived from on-site development of computer
software (including services for development of software) outside India
shall be deemed to be the profits and gains derived from the export of
computer software outside India.
 The following incomes derived by a political party are not included in
computing its total income:
(i) Income which is chargeable under the head ‘Income from house
property; or
(ii) Income chargeable under the head ‘Income from other sources’;
(iii) Any income by way of voluntary contribution from any person.

4.6 KEY WORDS

 Capital gains: These are the gains from the transfer of capital assets.
 Undertaking: It refers to a task that is taken on; an enterprise.

4.7 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. Any specified income arising, from any international sporting event held in
India, to the person or persons notified by the Central Government in the
Official Gazette, shall be exempt if such international sporting event is
64
 Exempted Income

approved by the international body regulating the international sport relating

to such event.
2. ‘Equity oriented fund’ means a fund where the investible funds are invested
by way of equity shares in domestic companies to the extent of more than
65 per cent of the total proceeds of such fund; and which has been set up
under a scheme of a Mutual Fund specified under clause (23D).

Check Your Progress - 2

1. Agricultural income is defined as any rent or revenue derived from land
which is situated in India and is used for agricultural purposes; or any
income derived from such land by agriculture.
2. The amount of exemption worked out in newly established industrial
undertakings in FTZ is as follows:
(Profit of the Undertaking × Export Turnover) / Total Turnover of the
Undertaking

Check Your Progress - 3

1. Under Section 10B of ITA, any profits and gains of newly established 100
per cent export-oriented business approved by the CBDT, are exempted
from income tax for a period of ten consecutive assessment years
commencing from the previous year in which production started subject to
fulfilling all the conditions as specified.
2. Under Section 10BA of ITA, any profits and gains of an undertaking
manufacturing or producing hand-made wooden articles, having artistic
value, are exempted from income tax for a period of six consecutive
assessment years commencing from the previous year in which production
started subject to fulfilling all the conditions as specified.

4.8 SELF-ASSESSMENT QUESTIONS

1. Enumerate any five items of income exempted from income tax.

2. Discuss the taxability of agricultural income.
3. What is agricultural income. How does it help in determining tax rates?
4. What tax benefits are available to the following entities?
(a) Unit in a Free Trade Zone (FTZ)

65
Exempted Income

(b) Unit in an Electronic Hardware Technology Park (EHTP)

(c) Unit in a Software Technology Park (STP)
(d) Unit in a Special Economic Zone (SEZ)
(e) 100 per cent Export-oriented Unit (EOU)
(f) Unit exporting hand-made wooden articles

4.9 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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 Salaries - I

BLOCK-II
SALARIES

In this block, you will learn the meaning of salary as understood in the context of income tax.
The units in this block will provide a comprehensive understanding of the importance of
various aspects attributed to salary. It is imperative that a clear understanding of the concept
of salary is focussed upon for a better knowledge of income tax.
The fifth unit explains the term salary as used in income tax. It discusses the concepts of
advance salary, arrears of salary and leave salary. The unit further provides the meaning of
annuity, gratuity and pension. Provident fund and its type, and approved superannuation fund
is also discussed in the later section of the unit.
The sixth unit goes on to discuss the concept of allowances and perquisites. The valuation of
perquisites is also discussed in detail in the unit, accompanied by illustrations in order to
make the students well versed with the application of the concept.
The seventh unit focusses on the deductions from salary under the provisions of section 80C.
It also explains tax relief under section 89.

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 Salaries - I

UNIT–5 SALARIES - I

Objectives
After going through this unit, you will be able to:
 Define the term salary as used in income tax
 Discuss the concepts of advance salary, arrears of salary and leave salary
 Explain the terms annuity, gratuity and pension
 Discuss provident fund and its types
 Describe approved superannuation fund

Structure
5.1 Introduction
5.2 Salary
5.3 Annuity
5.4 Summary
5.5 Key Words
5.6 Answers to ‘Check Your Progress’
5.7 Self-Assessment Questions
5.8 Further Readings

5.1 INTRODUCTION

Salary is said to be the remuneration received by or accruing to an individual for

service rendered as a result of an express or implied contract. The statute gives an
inclusive but not exhaustive definition of salary. Section 17(1) gives an account of
what salary includes, for example wages, annuity or pension, gratuity, perquisites or
profits in lieu of salary, advance salary, leave encashment and so on and so forth.
This unit will discuss these topics is detail, explaining how these terms are taxable
under income tax. A set of examples are also employed in the unit to make it easier
for the students to understand and thus, discuss the taxation of the said concepts.

5.2 SALARY

The meaning of the term ‘salary’ for purposes of income tax is much wider than
what is normally understood. Every payment made by an employer to his employee
for service rendered would be chargeable to tax as income from salaries. The term
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Salaries - I

‘salary’ for the purposes of Income-tax Act, 1961 will include both monetary
payments (e.g. basic salary, bonus, commission, allowances etc.) as well as non-
monetary facilities (e.g. housing accommodation, medical facility, interest free loans
etc.).
(1) Employer-employee relationship: Before an income can become
chargeable under the head ‘salaries’, it is vital that there should exist
between the payer and the payee, the relationship of an employer and an
employee. Consider the following examples:
(a) Sujatha, an actress, is employed in Chopra Films, where she is paid a
monthly remuneration of 2 lakh. She acts in various films produced
by various producers. The remuneration for acting in such films is
directly paid to Chopra Films by the different producers. In this case,
2 lakh will constitute salary in the hands of Sujatha , since the
relationship of employer and employee exists between Chopra Films
and Sujatha.
(b) In the above example, if Sujatha acts in various films and gets fees
from different producers, the same income will be chargeable as
income from profession since the relationship of employer and
employee does not exist between Sujatha and the film producers.
(c) Commission received by a Director from a company is salary if the
Director is an employee of the company. If, however, the Director is
not an employee of the company, the said commission cannot be
charged as salary but has to be charged either as income from
business or as income from other sources depending upon the facts.
(d) Salary paid to a partner by a firm is nothing but an appropriation of
profits. 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. The same is to be charged as income from profits
and gains of business or profession. This is primarily because the
relationship between the firm and its partners is not that of an
employer and employee.
(2) Full-time or part-time employment: It does not matter whether the
employee is a full- time employee or a part-time one. Once the relationship
of employer and employee exists, the income is to be charged under the
head ‘salaries’. If, for example, an employee works with more than one
70
 Salaries - I

employer, salaries received from all the employers should be clubbed and
brought to charge for the relevant previous years.
(3) Foregoing of salary: Once salary accrues, the subsequent waiver by the
employee does not absolve him from liability to income-tax . Such waiver
is only an application and hence, chargeable to tax.
Example: Mr. A, an employee instructs his employer that he is not
interested in receiving the salary for April 2013 and the same might be
donated to a charitable institution. In this case, Mr. A cannot claim that he
cannot be charged in respect of the salary for April 2013. It is only due to
his instruction that the donation was made to a charitable institution by his
employer. It is only an application of income. Hence, the salary for the
month of Apr il 2013 will be taxable in the hands of Mr. A. He is however,
entitled to claim a deduction under section 80G for the amount donated to
the institution. [The concept of deductions is explained in detail in unit 11].
(4) Surrender of salary: However, if an employee surrenders his salary to
the Central Government under section 2 of the Voluntary Surrender of
Salaries (Exemption from Taxation) Act, 1961, the salary so surrendered
would be exempt while computing his taxable income.
(5) Salary paid tax-free: This, in other words, means that the employer
bears the burden of the tax on the salary of the employee. In such a case,
the income from salaries in the hands of the employee will consist of his
salary income and also the tax on this salary paid by the employer.

Definition of Salary
The term ‘salary’ has been defined differently for different purposes in the Act. The
definition as to what constitutes salary is very wide. It is an inclusive definition and
includes monetary as well as non-monetary items. There are different definitions of
‘salary’, say for calculating exemption in respect of gratuity, house rent allowance
etc.
‘Salary’ under section 17(1), includes the following:
(i) wages,
(ii) any annuity or pension,
(iii) any gratuity,
(iv) any fees, commission, perquisite or profits in lieu of or in addition to any
salary or wages,
71
Salaries - I

(v) any advance of salary,

(vi) any payment received in respect of any period of leave not availed by him
i.e. leave salary or leave encashment,
(vii) the portion of the annual accretion, in any previous year, to the balance at
the credit of an employee participating in a recognised provident fund to
the extent it is taxable and
(viii) transferred balance in recognised provident fund to the extent it is taxable,
(ix) the contribution made by the Central Government or any other employer in
the previous year to the account of an employee under a pension scheme
referred to in section 80CCD.

Basis of charge
1. Section 15 deals with the basis of charge. Salary is chargeable to tax either
on ‘due’ basis or on ‘receipt’ basis, whichever is earlier.
2. However, where any salary, paid in advance, is assessed in the year of
payment, it cannot be subsequently brought to tax in the year in which it
becomes due.
3. If the salary paid in arrears has already been assessed on due basis, the
same cannot be taxed again when it is paid.

Examples:
(i) If A draws his salary in advance for the month of April 2014 in the month
of March 2014 itself, the same becomes chargeable on receipt basis and
is to be assessed as income of the P.Y. 2013-14 i.e., A .Y. 2014-15.
However, the salary for the A.Y. 2015-16 will not include that of Apr il
2014.
(ii) If the salary due for March 2014 is received by A later in the month of
April 2014, it is still chargeable as income of the P.Y. 2013-14 i.e., A.Y.
2014-15 on due basis. Obviously, salary for the A.Y. 2015-16 will not
include that of March 2014.

Place of accrual of salary

Under section 9(1)(ii), salary earned in India is deemed to accrue or arise in India
even if it is paid outside India or it is paid or payable after the contract of
employment in India comes to an end.

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 Salaries - I

Example: If an employee gets pension paid abroad in respect of services

rendered in India, the same will be deemed to accrue in India. Similarly, leave salary
paid abroad in respect of leave earned in India is deemed to accrue or arise in
India.
Suppose, for example, A, a citizen of India is posted in the United States as our
Ambassador. Obviously, he renders his services outside India. He also receives his
salary outside India. He is also a non-resident. The question, therefore, arises
whether he can claim exemption in respect of his salary paid by the Government of
India to him outside India. Under general principles of income tax such salary
cannot be charged in his hands. For this purpose, section 9(1)(iii) provides that
salaries payable by the Government to a citizen of India for services outside India
shall be deemed to accrue or arise in India. However, 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.

Profits in lieu of salary [Section 17(3)]

It includes the following:
(i) The amount of any compensation due to or received by an assessee from
his employer or former employer at or in connection with the termination of
his employment.
(ii) The amount of any compensation due to or received by an assessee from
his employer or former employer at or in connection with the modification
of the terms and conditions of employment. Usually, such compensation is
treated as a capital receipt. However, by virtue of this provision, the same
is treated as a revenue receipt and is chargeable as salary.
Note: It is to be noted that merely because a payment is made by an
employer to a person who is his employee does not automatically fall
within the scope of the above provisions. 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 considerations totally unconnected with
employment, such payment is not profit in lieu of salary.
Example: A was an employee in a company in Pakistan. At the time of
partition, he migrated to India. He suffered loss of personal movable
property in Pakistan due to partition. He applied to his employer for
compensating him for such loss. Certain payments were given to him as
compensation. It was held that such payments should not be taxed as
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Salaries - I

‘profit in lieu of salary’ - Lachman Dass Vs. CIT[1980] 124 ITR 706
(Delhi).
(iii) Any payment due to or received by an assessee from his employer or
former employer from a provident or other fund, to the extent to which it
does not consist of employee’s contributions or interest on such
contributions.
Example: If any sum is paid to an employee from an unrecognised
provident fund it is to be dealt with as follows :
(a) that part of the sum which represents the employer’s contribution to
the fund and interest thereon is taxable under salaries.
(b) that part of the sum which represents employee’s contribution and
interest thereon is not chargeable to tax since the same has already
been taxed under the head ‘salaries’ and ‘other sources’ respectively
on a yearly basis.
Note: It does not include exempt payments from superannuation
fund, gratuity, commuted pension, retrenchment compensation, HRA.
(iv) Any sum received by an assessee under a Keyman Insurance policy
including the sum allocated by way of bonus on such policy.
(v) Any amount, whether in lumpsum or otherwise, due to the assessee or
received by him, from any person -
(a) before joining employment with that person, or
(b) after cessation of his employment with that person.
(vi) Any other sum received by the employee from the employer.

Advance Salary
Advance salary is taxable when it is received by the employee irrespective of the
fact whether it is due or not. It may so happen 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) provides for relief in these types of cases.

Loan or Advance against salary

Loan is different from salary. When an employee takes a loan from his employer,
which is repayable in certain specified instalments, the loan amount cannot be
brought to tax as salary of the employee.
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 Salaries - I

Similarly, advance against salary is different from advance salary. It is an

advance taken by the employee from his employer. This advance is generally
adjusted with his salary over a specified time period. It cannot be taxed as salary.

Arrears of salary
Normally speaking, salary arrears must be charged on due basis. However, there
are circumstances when it may not be possible to bring the same to charge on due
basis. For example if the Pay Commission is appointed by the Central Government
and it recommends revision of salaries of employees, the arrears received in that
connection will be charged on receipt basis. Here, also relief under section 89(1) is
available.

Check Your Progress - 1

1. What does the term salary connotes in income tax?

................................................................................................................
................................................................................................................
................................................................................................................

2. When is advance salary taxable?

................................................................................................................
................................................................................................................
................................................................................................................

5.3 ANNUITY

1. As per the definition, ‘annuity’ is treated as salary. Annuity is a sum payable

in respect of a particular year. It is a yearly grant. If a person invests some
money entitling him to series of equal annual sums, such annual sums are
annuities in the hands of the investor.
2. Annuity received by a present employer is to be taxed as salary. It does
not matter whether it is paid in pursuance of a contractual obligation or
voluntarily.
3. Annuity received from a past employer is taxable as profit in lieu of salary.
4. Annuity received from person other than an employer is taxable as ‘income
from other sources’.
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Salaries - I

Gratuity [Section 10(10)]

Gratuity is a voluntary payment made by an employer in appreciation of services
rendered by the employee. Now-a-days gratuity has become a normal payment
applicable to all employees. In fact, Payment of Gratuity Act, 1972 is a statutory
recognition of the concept of gratuity. Almost all employers enter into an agreement
with employees to pay gratuity.

Pension
Concise Oxford Dictionary defines ‘pension’ as a periodic payment made
especially by the Government or a company or other employers to the employee in
consideration of past service payable after his retirement.
Commuted pension: Commutation means inter-change. Many persons convert
their future right to receive pension into a lumpsum amount receivable immediately.
For example, suppose a person is entitled to receive a pension of say 2000 p.m.
for the rest of his life. He may commute one-fourth i.e., 25 per cent of this amount
and get a lumpsum of say 30,000. After commutation, his pension will now be the
balance 75 per cent of 2,000 p.m. = 1,500 p.m.

Leave Salary [Section 10(10AA)]

If leave standing to the employee’s credit is not taken within a year, as per the
service rules it may lapse or it may be encashed or it may be accumulated.
The accumulated leave standing to the credit of an employee may be availed by
the employee during his service time; or, subject to service rules, such leaves may be
encashed at the time of retirement or leaving the job. Encashment of leave by
surrendering leave standing to one’s credit is known as ‘leave salary’.

Taxation of leave salary

If leave encashment is received during the continuity of employment, it is chargeable
to tax, irrespective of the fact whether the employee is in government service or
private service. The employee can, however, claim relief in terms of Section 89.
Leave encashment at the time of retirement on superannuation or otherwise -
even such leave encashment is taxable, however, subject to the exemptions provided
by Section 10(10AA) as follows:

Leave salary at the time of retirement to central/state government

employees:
In the case of central/state government employee, any amount received as cash
equivalent of leave salary in respect period of earned leave at his credit at the time
of retirement/superannuation, is exempt from tax [Section 10(10AA)(i)].
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 Salaries - I

Leave salary at the time of retirement to other employees:

In the case of a non-government employee, leave salary is exempt from tax to the
extent of the least of the following under the Section 10(10AA)(ii):
 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
(earned leave entitlements cannot exceed 30 days for every year of actual
service rendered for the employer from whose service he has retired); or
 10 months’ ‘average salary’; or
 300,000 (applicable from April 1, 1998)
 The amount of leave encashment actually received at the time of retirement.

Retrenchment Compensation [Section 10(10B)]

Retrenchment compensation will be exempt from tax subject to the following limits:
(a) amount calculated in accordance with the provisions of clause (b) of section
25F of the Industrial Disputes Act, 1947; or
(b) an amount not less than 5,00,000 as may be notified by the Central
Government in this behalf;
whichever is less.
The retrenchment compensation for this purpose means the compensation
received by a workman under the Industrial Disputes Act, 1947 (14 of
1947 ), or under any other Act or Rules, orders or notifications issued
thereunder or under any standing orders or under any award, contract of
service or otherwise, at the time of his retrenchment.

Compensation received on Voluntary Retirement [Section 10(10C)]

Any compensation received by an employee of a public sector company or of any
other company or other specified bodies at the time of his voluntary retirement or
termination of his service is exempt upto a maximum limit of 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, a scheme of voluntary separation. Such
schemes should be in accordance with prescribed guidelines. These guidelines may
include economic viability as one of the criteria.

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Salaries - I

Provident Fund
Provident fund scheme is a scheme intended to give substantial benefits to an
employee 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 the same amount out of his pocket, to the fund.
The contribution of the employer and the employee are invested in approved
securities. Interest earned thereon is also credited to the account of the employee.
Thus, the credit balance in a provident fund account of an employee consists of the
following:
(i) employee’s contribution
(ii) interest on employee’s contribution
(iii) employer’s contribution
(iv) interest on employer’s contribution.
The accumulated balance is paid to the employee at the time of his retirement or
resignation. In the case of death of the employee, the same is paid to his legal heirs.
The provident fund represents an important source of small savings available to
the Government. Hence, the Income-tax Act. 1961 gives certain deductions on
savings in a provident fund account.
There are four types of provident funds:
(i) Statutory Provident Fund (SPF)
(ii) Recognised Provident Fund (RPF)
(iii) Unrecognised Provident Fund (URPF)
(iv) Public Provident Fund (PPF)
The tax treatment is given below:

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 Salaries - I

Notes:
(1) Amount received on the maturity of RPF is fully exempt in case of an employee who
has rendered continuous service for a period of 5 years or more. In case the maturity
of RPF takes place within 5 years then the amount received would be fully exempt
only if the service had been terminated due to employee’s ill-health or
discontinuance or contraction of employer’s business or other reason beyond
control of the employee. In any other case, the amount received will be taxable in the
same manner as that of an URPF.
(2) If, after termination of his employment with one employer, the employee 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 individual
account in a recognised 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.
(3) Employee’s contribution is not taxable but interest thereon is taxable under ‘Income
from Other Sources’. Employer’s contribution and interest thereon is taxed as Salary.
(4) Salary for this purpose means basic salary and dearness allowance - if provided in
the terms of employment for retirement benefits and commission as a percentage of
turnover.

(1) Statutory Provident Fund (SPF): The SPF is governed by Provident

Funds Act, 1925. It applies to employees of government, railways , semi-
government institutions, local bodies, universities and all recognised
educational institutions.
(2) Recognised Provident Fund (RPF): Recognised provident fund means a
provident fund recognised by the Commissioner of Income-tax for the
purposes of income-tax. It is governed by Part A of Schedule IV of the
Income-tax Act, 1961. This schedule contains various rules regarding the
following:
(a) Recognition of the fund
(b) Employee’s and employer’s contribution to the fund
(c) Treatment of accumulated balance etc.
A fund constituted under the Employees’s Provident Fund and
Miscellaneous Provisions Act, 1952 will also be a Recognised
Provident Fund.
(3) Unrecognised Provident Fund (URPF) : A fund not recognised by the
Commissioner of Income-tax is Unrecognised Provident Fund.
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Salaries - I

(4) Public Provident Fund (PPF): Public provident fund is operated under
the Public Provident Fund Act, 1968. A membership of the fund is open to
every individual though, it is ideally suited to self-employed people. A
salaried employee may also contribute to PPF in addition to the fund
operated by his employer. An individual may contribute to the fund on his
own behalf as also on behalf of a minor of whom he is the guardian.
For getting a deduction under section 80C, a member is required to
contribute to the PPF a minimum of 500 in a year. The maximum amount
that may qualify for deduction on this account is 1,00,000 as per PPF
rules.
A member of PPF may deposit his contribution in as many installments in
multiples of 500 as is convenient to him. The sums contributed to PPF
earn interest at 8%. The amount of contribution may be paid at any of the
offices or branch offices of the State Bank of India or its subsidiaries and
specified branches of Nationalised Banks or any Head Post Office.
Illustration 1
Mr. A retires from service on December 31, 2013, after 25 years of service.
Following are the particulars of his income/investments for the previous year
2013-14:

Particulars

Basic pay @ 16,000 per month for 9 months 1,44,000

Dearness pay {50% forms part of the retirement benefits) 8,000 per month for 12,000
9 months
Lumpsum payment received from the Unrecognised Provident Fund 6,00,000
Deposits in the PPF account 40,000

Out of the amount received from the provident fund, the employer’s share was
2,20,000 and the interest thereon 50,000. The employee’s share was
2,70,000 and the interest thereon 60,000. What is the taxable portion of
the amount received from the unrecognized provident fund in the hands of Mr.
A for the assessment year 2014-15?

Solution
Taxable portion of the amount received from the URPF in the hands of Mr. A for
the A.Y . 2014-15 is computed hereunder:

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 Salaries - I

Note: Since the employee is not eligible for deduction under section 80C for contribution to
URPF at the time of such contribution, the employee’s share received from the URPF is not
taxable at the time of withdrawal as this amount has already been taxed as his salary income.

Illustration 2
Will your answer be any different if the fund mentioned above was a
recognised provident fund?
Solution
Since the fund is a recognised one, and the maturity is taking place after a service of
25 years, the entire amount received on the maturity of the RPF will be fully exempt
from tax.

Illustration 3
Mr. B is working in XYZ Ltd. and has given the details of his income for the P
Y. 2013-14. You are required to compute his gross salary from the details given
below:
Basic Salary 10,000 p.m.

D.A. (50% is for retirement benefits) 8,000 p.m.

Commission as a percentage of turnover 1%
Turnover during the year 5,00,000
Bonus 40,000
Gratuity 25,000
His own contribution in the RPF 20,000
Employer’s contribution to RPF 20% of his basic salary
Interest accrued in the RPF @ 13% p.a. 13,000

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Solutions
Computation of Gross Salary of Mr. B for the A.Y.2014-15

Note 1: Gratuity received during service is fully taxable.

Note 2: Employee’s contribution to RPF is not taxable. It is eligible for deduction under section
BOC.
Note 3: Employers contribution in the RPF is exempt up to 12% of the salary.
i.e. 12% of [B.S + D.A. for retirement benefits + Commission based on turnover!
= 12% of [ 1,20,000 + (50% × 96,000) + 5,000] = 12% of 1,73,000 = 20,760

Approved Superannuation Fund

It means a superannuation fund which has been and continues to be approved by
the Commissioner in accordance with the rules contained in Part B of the Fourth
Schedule of the Income-tax Act, 1961.
The tax treatment of contribution and exemption of payment from tax are as
follows:
(i) Employer’s contribution is exempt from tax in the hands of employee (upto
1,00,000 per employee per annum). Only such contribution exceeding
1,00,000 is taxable in the hands of the respective employee;
(ii) Employee’s contribution qualifies for deduction under section 80C;
(iii) 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
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(c) by way of refund of contribution on the death of the beneficiary, or

(d) by way of refund of contribution to an employee on his leaving the
service in connection with which the fund is established otherwise than
in the circumstances mentioned in (b), to the extent to which such
payment does not exceed the contribution made prior to April 1,
1962. For example,where the amount received by an employee does
not include any contribution made prior to 1.4.1962, the whole
amount is taxable.

Salary from United Nations Organisation

Section 2 of the United Nations (Privileges and Immunities) Act, 1947 grants
exemption from income-tax to salaries and emoluments paid by the United Nations
to its officials. Besides salary, any pension covered under the United Nations
(Privileges and Immunities) Act and received from UNO is also exempt from tax.

Check Your Progress - 2

1. Define annuity.
................................................................................................................
................................................................................................................
................................................................................................................

2. What is gratuity?
................................................................................................................
................................................................................................................
................................................................................................................

5.4 SUMMARY

 Every payment made by an employer to his employee for service rendered

would be chargeable to tax as income from salaries.
 The term ‘salary’ for the purposes of Income-tax Act, 1961 will include
both monetary payments (e.g. basic salary, bonus, commission, allowances
etc.) as well as non-monetary facilities (e.g. housing accommodation,
medical facility, interest free loans etc.).

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 Before an income can become chargeable under the head ‘salaries’, it is

vital that there should exist between the payer and the payee, the
relationship of an employer and an employee.
 It does not matter whether the employee is a full-time employee or a part-
time one. Once the relationship of employer and employee exists, the
income is to be charged under the head ‘salaries’.
 Once salary accrues, the subsequent waiver by the employee does not
absolve him from liability to income-tax.
 Advance salary is taxable when it is received by the employee irrespective
of the fact whether it is due or not.
 When an employee takes a loan from his employer, which is repayable in
certain specified instalments, the loan amount cannot be brought to tax as
salary of the employee.
 Advance against salary is an advance taken by the employee from his
employer. This advance is generally adjusted with his salary over a
specified time period. It cannot be taxed as salary.
 As per definition, ‘annuity is treated as salary. It is a sum payable in respect
of a particular year.
 Gratuity is a voluntary payment made by an employer in appreciation of
services rendered by the employee.
 Pension is defined as a periodic payment made especially by the
Government or a company or other employers to the employee in
consideration of past service payable after his retirement.
 Provident fund scheme is a scheme intended to give substantial benefits to
an employee at the time of his retirement.
 The provident fund represents an important source of small savings
available to the Government. There are four types of provident funds,
namely, statutory provident fund, recognised provident fund, unrecognised
provident fund and public provident fund.
 Approved superannuation fund means a superannuation fund which has
been and continues to be approved by the Commissioner in accordance
with the rules contained in Part B of the Sixth Schedule of the Income-tax
Act, 1961.

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5.5 KEY WORDS

 Exempt: It refers to a person who is exempt from something, especially

the payment of tax.
 Pension: It is a periodic payment made especially by Government or a
company or other employers to the employee in consideration of past
service payable after his retirement.
 Loan: It refers to a thing that is borrowed, especially a sum of money that
is expected to be paid back with interest.

5.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. The term ‘salary’ for the purposes of income-tax Act, 1961 will include
both monetary payments (e.g. basic salary, bonus, commission, allowances
etc.) as well as non-monetary facilities (e.g. housing accommodation,
medical facility, interest free loans etc.).
2. Advance salary is taxable when it is received by the employee irrespective
of the fact whether it is due or not.

Check Your Progress - 2

1. Annuity is treated as salary. It is a sum payable in respect of a particular
year. It is a yearly grant.
2. Gratuity is a voluntary payment made by an employer in appreciation of
services rendered by the employee.

5.7 SELF-ASSESSMENT QUESTIONS

1. What do you understand by salary? On what conditions does income

become chargeable to tax under the head ‘salaries’?
2. What is the difference between advance salary and loan or advance against
salary?
3. Briefly explain the following terms:
(a) Arrears of salary

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(b) Annuity
(c) Gratuity
(d) Pension
4. What is provident fund scheme? Discuss the types of provident funds in
detail.
5. Write a short note on approved superannuation fund.

5.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
http://www.icai.org/ (Accessed on 10 September 2016)

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UNIT–6 SALARIES - II

Objectives
After going through this unit, you will be able to:
 Examine the various types of allowances
 Define perquisites
 Describe the types of perquisites
 Discuss and examine the valuation of perquisites

Structure
6.1 Introduction
6.2 Allowances
6.3 Valuation of Perquisites
6.4 Summary
6.5 Key Words
6.6 Answers to ‘Check Your Progress’
6.7 Self-Assessment Questions
6.8 Further Readings

6.1 INTRODUCTION

In the previous units you studied different aspects of salary and how income is
taxable under the head ‘salaries’. You also studied the types of salaries. The units
also gave a detailed explanation of the provident fund scheme and its various types
and approved superannuation fund.
This unit will further explain the concept of salary, thus discussing allowances,
perquisites and valuation of perquisites.

6.2 ALLOWANCES

Different types of allowances are given to employees by their employers. Generally,

allowances are given to employees to meet some particular requirements like house
rent, expenses on uniform, conveyance etc. Under the Income-tax Act, 1961,
allowance is taxable on due or receipt basis, whichever is earlier. Various types of
allowances normally in vogue are discussed below:

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Allowances which are fully taxable:

(1) City compensatory allowance: City Compensatory Allowance is
normally intended to compensate the employees for the higher cost of
living in cities. It is taxable irrespective of the fact whether it is given as
compensation for performing his duties in a particular place or under
special circumstances.
(2) Entertainment allowance: This allowance is given to employees to meet
the expenses towards hospitality in receiving customers etc. The Act gives
a deduction towards entertainment allowance only to a Government
employee. The details of deduction permissible are discussed later on in
this Unit.

Allowances which are partially taxable:

(1) House rent allowance [Section 10(13A)]
(2) Special allowances [Section 10(14)]

Allowance s which are fully exempt:

(1) Allowance to High Court Judges: Any allowance paid to a Judge of a
High Court under section 22A(2) of the High Court Judges (Conditions of
Service) Act, 1954 is not taxable.

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(2) Allowance received from United Nations Organisation (UNO):

Allowance paid by the UNO to its employees is not taxable by virtue of
section 2 of the United Nations (Privileges and Immunities) Act. 1974.
(3) 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-
Bishamber Dayal v. C/T[1976] 103 ITR 813 (MP).
(4) 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
(1) 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
modern times, the salary package of an employee normally includes
monetary salary and perquisite like housing, car etc.
(2) Perquisite may be provided in cash or in kind.
(3) Reimbursement of expenses incurred in the official discharge of duties is
not a perquisite.
(4) Perquisite may arise in the course of employment or in the course of
profession. If it arises from a relationship of employer-employee, then the
value of the perquisite is taxable as salary. However, if it arises during the
course of profession, the value of such perquisite is chargeable as profits
and gains of business or profession.
(5) Perquisite will become taxable only if it has a legal origin. An unauthorised
advantage taken by an employee without his employer’s sanction cannot
be considered as a perquisite under the Act. For example, suppose A, an
employee, is given a house by his employer. On 31.3.2013, he is
terminated from service. But he continues to occupy the house without the
permission of the employer for six more months after which he is evicted
by the employer. The question arises whether the value of the benefit
enjoyed by him during the six months period can be considered as a
perquisite and be charged to salary. It cannot be done since the
relationship of employer-employee ceased to exist after 31.3.2013.

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However, the definition of income is wide enough to bring the value of the
benefit enjoyed by employee to tax as ‘income from other sources’.
(6) 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) The value of rent free accommodation provided to the assessee by his
employer [section 17(2)(i)];
(b) The value of any concession in the matter of rent respecting any
accommodation provided to the assessee by his employer [section
17(2)(ii)];
(i) Under section 17(2)(ii), the value of any concession in the matter of
rent arising to an employee in respect of any accommodation
provided by his employer is considered as “perquisite” chargeable to
tax in the hands of the employee.
(ii) Rule 3(1) of the Income-tax Rules provides the basis of valuation of
perquisites in respect of accommodation provided to an employee, as
under:
(a) 15% of salary in cities having population exceeding 25 lakh.
(b) 10% of salary in cities having population above 10 lakh up to
25 lakh.
(c) 7.5% of salary in cities having population up to 10 lakh.
(iii) In case of furnished accommodation provided by an employer, the
value arrived as above was to be further increased by 10 per cent
of the cost of furniture, where the same is owned by the employer, or
the actual hire charges paid by the employer in case the furniture is
hired.
(iv) This method of perquisite valuation resulted in genuine hardship to
employees availing facility of residential accommodation in remote
areas, as the value of perquisite was determined as a percentage of
salary of the employee, irrespective of the fair rental value of the
property (which may be much lower than 15%/10%/7.5% of salary in
such cases) .
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(v) Rule 3(1) was challenged as ultra vires before the Supreme Court in
the case of Arun Kumar v. UGI (2006) 286 /TR 89. The Apex
court, while holding that the provisions of Rule 3(1) were
constitutionally valid, observed that the same would be applicable
only if ‘concession in the matter of rent’ with respect to the
accommodation provided by an employer accrues to the employee
under the substantive provisions of section 17(2)(ii). The Assessing
Officer, before applying Rule 3(1), was required to establish that there
was ‘concession in the matter of rent’ provided to the employee.
(vi) Further, as per the Apex court, the difference between the value as
per Rule 3(1) and the rent recovered from the employee, could not
per se be considered as ‘concession in the matter of rent’ provided to
the employee.
(vii) In order to clarify the correct intent of law, Explanations have been
inserted in section 17(2)(ii) to provide that the difference between the
specified rate (as shown in column 2 of the table below) and the
amount of rent recoverable/recovered from the employee would be
deemed to be the concession in the matter of rent in case of
accommodation owned by the employer. In case of accommodation
taken on lease or rent by the employer, the difference between the
actual lease rent or 15% of salary, whichever is lower, and rent
recovered/recoverable from the employee would be deemed to be the
concession in the matter of rent.

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(viii) This deeming provision is applicable to employees other than

Government employees . In case of furnished accommodation
provided to such employees, the excess of hire charges paid or 10%
p.a. of cost of furniture, as the case may be, over and above the
charges paid or payable by the employee would be added to the
value determined in column (2) above for determining whether there is
a concession in the matter of rent.
Note: Once there is a deemed concession, the provisions of
Rule 3(1) would be applicable in computing the taxable
perquisite.
(ix) ‘Salary’ includes pay, allowances, bonus or commission payable
monthly or otherwise, or any monetary payment, by whatever name
called, from one or more employers, as the case may be. However, it
does not include the following , namely-
(1) dearness allowance or dearness pay unless it enters into the
computation of superannuation or retirement benefits of the employee
concerned;
(2) employer’s contribution to the provident fund account of the
employee;
(3) allowances which are exempted from the payment of tax;
(4) value of the perquisites specified in section 17(2);
(5) any payment or expenditure specifically excluded under the
proviso to section 17(2) i.e.. medical expenditure/payment of medical
insurance premium specified therein.
(x) In case of Government employees, the excess of licence fees
determined by the employer as increased by the value of furniture and
fixture over and above the rent recovered/recoverable from the
employee and the charges paid or payable for furniture by the
employee would be deemed to be the concession in the matter of
rent.
(c) The value of any benefit or amenity granted or provided free of cost or at
concessional rate in any of the following cases (i.e. in case of specified
employees) :
(i) by a company to an employee in which he is a director;

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(ii) by a company to an employee being a person who has substantial

interest in the company (i.e. 20% or more of the voting rights of the
company);
(iii) by any employer (including a company) to an employee to whom the
provisions of (i) & (ii) do not apply and whose income under the head
‘salaries’ (whether due from, or paid or allowed by, one or more
employers) exclusive of the value of all benefits or amenities not
provided for by way of monetary benefits exceeds 50,000 [Section
17(2)(iii)];
(d) Any sum paid by the employer in respect of any obligation which, but for
such payment, 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 recognised 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)];
(f) The value of any specified security or sweat equity shares allotted or
transferred, directly or indirectly, by the employer or former employer, free
of cost or at concessional rate to the assessee [Section 17(2)(vi)];
Specified security means ‘securities’ as defined in section 2(h) of the
Securities Contracts (Regulation) Act, 1956. It also includes the securities
offered under employees stock option plan or scheme. Sweat equity
shares means equity shares issued by a company to its employees or
directors at a discount or for consideration other than cash for providing
know-how or making available rights in the nature of intellectual property
rights or value additions, by whatever name called.
The value of specified security or sweat equity shares shall be the fair
market value of such security or shares on the date on which the option is
exercised by the assessee, as reduced by any amount actually paid by, or
recovered from, the assessee in respect of such security or shares. The fair
market value means the value determined in accordance with the method
as may be prescribed by the CBDT. ‘Option’ means a right but not an
obligation granted to an employee to apply for the specified security or
sweat equity shares at a pre-determined price.

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(g) The amount of any contribution to an approved superannuation fund by the

employer in respect of the assessee, to the extent it exceeds 1 lakh
[Section 17(2)(vii)];
(h) The value of any other fringe benefit or amenity as may be prescribed by
the CBDT [Section 17(2)(viii)].
It can be noted that the aforesaid definition of perquisite is an inclusive one.
More terms can be added in.
Types of perquisites: Perquisites may be divided into three broad categories:
(1) Perquisites taxable in the case of all employees
(2) Perquisites exempt from tax in the case of all employees
(3) Perquisites taxable only in the hands of specified employees.
(1) Perquisites taxable in the case of all employees: The following
perquisites are chargeable to tax in all cases:
(i) Value of rent-free accommodation provided to the assessee by his
employer [Section 17(2)(i)].
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.
(ii) Value of concession in rent in respect of accommodation provided to
the assessee by his employer [Section 17(2)(ii)].
(iii) Amount paid by an employer in respect of any obligation which
otherwise would have been payable by the employee [Section
17(2)(iv)]. For example, if a domestic servant is engaged by an
employee and the employer reimburses the salary paid to the servant,
it becomes an obligation which the employee would have discharged
even if the employer did not reimburse the same. This perquisite will
be covered by section 17(2)(iv) and will be taxable in the hands of all
employees.
(iv) Amount payable by an employer directly or indirectly to effect an
assurance on the life of the assessee or to effect a contract for an
annuity, other than payment made to RPF or approved
superannuation fund or deposit-linked insurance fund established

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under the Coal Mines Provident Fund or Employees’ Provident Fund

Act. However, there are schemes like group annuity scheme,
employees state insurance scheme and fidelity insurance scheme,
under which insurance premium is paid by employer on behalf of the
employees. Such payments are not regarded as perquisite in view of
the fact that the employees have only an expectancy of the benefit in
such schemes.
(v) The value of any specified security or sweat equity shares allotted or
transferred, directly or indirectly, by the employer or former employer,
free of cost or at concessional rate to the assessee.
(vi) The amount of any contribution to an approved superannuation fund
by the employer in respect of the assessee, to the extent it exceeds
1 lakh.
(vii) The value of any other fringe benefit or amenity as may be prescribed
by the CBDT.
(2) Perquisites exempt from tax in all cases: The following perquisites are
exempt from tax in all cases:
(i) Telephone provided by an employer to an employee at his residence;
(ii) Goods sold by an employer to his employees at concessional rates;
(iii) Transport facility provided by an employer engaged in the business of
carrying of passengers or goods to his employees either free of charge
or at concessional rate;
(iv) Privilege passes and privilege ticket orders granted by Indian
Railways to its employees;
(v) Perquisites allowed outside India by the Government to a citizen of
India for rendering services outside India;
(vi) Sum payable by an employer to a RPF or an approved superannuat-
ion fund or deposit-linked insurance fund established under the Coal
Mines Provident Fund or the Employees’ Provident Fund Act;
(vii) Employer’s contribution to staff group insurance scheme;
(viii) Leave travel concession;
(ix) Payment of annual premium by employer on personal accident policy
effected by him on the life of the employee;

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(x) Refreshment provided to all employees during working hours in office

premises;
(xi) Subsidized lunch or dinner provided to an employee;
(xii) Recreational facilities, including club facilities, extended to employees
in general i.e., not restricted to a few select employees;
(xiii) Amount spent by the employer on training of employees or amount
paid for refresher management course including expenses on boarding
and lodging;
(xiv) Medical facilities subject to certain prescribed limits; [Refer to point
10 of para 4.20]
(xv) Rent-free official residence provided to a Judge of a High Court or
the Supreme Court;
(xvi) Rent-free furnished residence including maintenance provided to an
Officer of Parliament, Union Minister and a Leader of Opposition in
Parliament;
(xvii) Conveyance facility provided to High Court Judges under section 228
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.
(3) Perquisites taxable only in the hands of specified employees
[Section 17(2)(iii)]: The value of any benefit or amenity granted or
provided free of cost or at concessional rate which have not been included
in 1& 2 above will be taxable in the hands of specified employees:
Specified employees are:
(i) Director employee: 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. It also does not matter whether he
is a nominee of the management, workers, financial institutions or the
Government. It is also not material whether or not he is a director
throughout the previous year.
(ii) 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

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company if he is a beneficial owner of equity shares carrying 20% or

more of the voting power in the company.
Beneficial and legal ownership: In order to determine whether a
person has a substantial interest in a company, it is the beneficial
ownership of equity shares carrying 20% or more of the voting power
that is relevant rather than the legal ownership.
Example: A, Karta of a HUF, is a registered shareholder of Bright
Ltd. The amount for purchasing the shares is financed by the HUF.
The dividend is also received by the HUF. Supposing further that A is
the director in Bright Ltd., the question arises whether he is a
specified employee. In this case, he cannot be called a specified
person since he has no beneficial interest in the shares registered in his
name. It is only for the purpose of satisfying the statutory requirements
that the shares are registered in the name of A. All the benefits arising
from the shareholding goes to the HUF. Conversely, it may be noted
that an employee who is not a registered shareholder will be
considered as a specified employee if he has beneficial interest in 20%
or more of the equity shares in the company.
(iii) Employee drawing in excess of 50,000: An employee other than
an employee described in (i) & (ii) above, whose income chargeable
under the head ‘salaries’ exceeds 50,000 is a specified employee.
The above salary is to be considered exclusive of the value of all
benefits or amenities not provided by way of monetary payments. In
other words, for computing the limit of 50,000, the following items
have to be excluded or deducted:
(a) All non-monetary benefits;
(b) Monetary benefits which are exempt under section 10. This is
because the exemptions provided under section 10 are excluded
completely from salaries. For example, HRA or education allowance
or hostel allowance are not to be included in salary to the extent to
which they are exempt under section 10.
(c) Deduction for entertainment allowance [under section 16(ii)) and
deduction towards professional tax [under section 16(iii)] are also to
be excluded.

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If an employee is employed with more than one employer, the

aggregate of the salary received from all employers is to be taken into
account in determining the above ceiling limit of 50,000, i.e. Salary
for this purpose
= Basic Salary + Dearness Allowance + Commission, whether
payable monthly or turnover based + Bonus + Fees + Any other
taxable payment + Any taxable allowances + Any other monetary
benefits - Deductions under section 16]

Check Your Progress - 1

1. Name the various types of allowances.

................................................................................................................
................................................................................................................
................................................................................................................

2. Define perquisites.
................................................................................................................
................................................................................................................
................................................................................................................

6.3 VALUATION OF PERQUISITES

The Income-tax Rules, 1962 contain the provisions for valuation of perquisites. It is
important to note that only those perquisites which the employee actually enjoys
have to be valued and taxed in his hand. For example, suppose a company offers a
housing accommodation rent-free to an employee but the latter declines to accept it,
then the value of such accommodation obviously cannot be evaluated and taxed in
the hands of the employees. For the purpose of computing the income chargeable
under the head “Salaries”, the value of perquisites provided by the employer directly
or indirectly to the employee or to any member of his household by reason of his
employment shall be determined in accordance with new Rule 3.
(1) Valuation of residential accommodation [Sub-rule (1)] - The value of
residential accommodation provided by the employer during the previous
year shall be determined in the following manner -

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Notes:
(1) If an employee is provided with accommodation, on account of his transfer from one
place to another, at the new place of posting while retaining the accommodation at
the other place, the value of perquisite shall be determined with reference to only
one such accommodation which has the lower perquisite value, as calculated above,
for a period not exceeding 90 days and thereafter, the value of perquisite shall be
charged for both such accommodations.
(2) Any accommodation provided to an employee working at a mining site or an on-
shore oil exploration site or a project execution site, or a dam site or a power
generation site or an off-shore site would not be treated as a perquisite, provided it
satisfies either of the following conditions -
(i) the accommodation is of temporary nature, has plinth area not exceeding 800
square feet and is located not less than eight kilometers away from the local
limits of any municipality or a cantonment board; or
(ii) the accommodation is located in a remote area i.e. an area that is located at least
40 kms away from a town having a population not exceeding 20,000 based on
latest published all-India census.
(3) Where the accommodation is provided by the Central Government or any State
Government to an employee who is serving on deputation with any body or
undertaking under the control of such Government:

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(i) the employer of such an employee shall be deemed to be that body or

undertaking where the employee is serving on deputation; and
(ii) the value of perquisite of such an accommodation shall be the amount
calculated in accordance with SI. No.(2)(a) of the above table, as if the
accommodation is owned by the employer.
(4) “Accommodation” includes a house, flat, farm house or part thereof, or
accommodation in a hotel, motel, service apartment, guest house, caravan, mobile
home, ship or other floating structure.
(5) “Hotel” includes licensed accommodation in the nature of motel, service apartment
or guest house.

Illustration 4
Mr. C is a Finance Manager in ABC Ltd. The company has provided him with rent-
free unfurnished accommodation in Mumbai. He gives you the following particulars:
Basic salary 6,000 p.m.
Advance salary for April 2014 5,000
Dearness Allowance 2,000 p.m. (30% for retirement benefits)
Bonus 1,500 p.m.
Even though the company allotted the house to him on 1.4.2013, he occupied the
same only from 1.11.2013. Calculate the taxable value of the perquisite for A. Y.
2014- 15.
Solution
Value of the rent free unfurnished accommodation
= 15% of salary for the relevant period
= 15% of [( 6000 × 5) + ( 2,000 × 30% × 5) + ( 1,500 × 5)] [See Note below]
= 15% of 40,500 = 6,075.
Note: Since, Mr. C occupies the house only from 1.11.2013, we have to include the salary due
to him only in respect of months during which he has occupied the accommodation. Hence
salary for 5 months (i.e. from 1.11.2013 to 31.03.2014) will be considered. Advance salary for
April 2014 drawn during this year is not to be considered because it falls in respect of a period
beyond the relevant previous year.

Illustration 5
Using the data given in the previous illustration 4, compute the value of the
perquisite if Mr. C is required to pay a rent of 1,000 p.m. to the company, for
the use of this accommodation.
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Solution
First of all, we have to see whether there is a concession in the matter of rent. In the
case of accommodation owned by the employer in cities having a population
exceeding 25 lakh, there would be deemed to be a concession in the matter of
rent if 15% of salary exceeds rent recoverable from the employee.
In this case, 15% of salary would be 6,075 (i.e. 15% of 40,500). The rent
paid by the employee is 5,000 (i.e. 1,000 x 5). Since 15% of salary exceeds
the rent recovered from the employee, there is a deemed concession in the matter of
rent. Once there is a deemed concession, the provisions of Rule 3(1) would be
applicable in computing the taxable perquisite.
Value of the rent free unfurnished accommodation 6,075
Less : Rent paid by the employee ( 1,000 × 5) 5,000
Perquisite value of unfurnished accommodation given at
concessional rent 1,075
Illustration 6
Using the data given in illustration 4, compute the value of the perquisite if
ABC Ltd. has taken this accommodation on a lease rent of 1,200 p.m. and
Mr. C is required to pay a rent of 1,000 p.m. to the company, for the use of
this accommodation.
Solution
Here again, we have to see whether there is a concession in the matter of rent. In
the case of accommodation taken on lease by the employer, there would be
deemed to be a concession in the matter of rent if the rent paid by the employer or
15% of salary, whichever is lower, exceeds rent recoverable from the employee.
In this case, 15% of salary is 6,075 (i.e. 15% of 40,500). Rent paid by the
employer is 6,000 (i.e. 1,200 × 5). The lower of the two is 6,000, which
exceeds the rent paid by the employee i.e. 5,000 ( 1,000 × 5). Therefore,
there is a deemed concession in the matter of rent. Once there is a deemed
concession, the provisions of Rule 3(1) would be applicable in computing the
taxable perquisite.

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Value of the rent free unfurnished accommodation [Note1] = 6,000

Less: Rent paid by the employee 1,000 × 5) = 5.000
:. Value of unfurnished accommodation given at concessional rent = 1.000
Note 1: Value of the rent free unfurnished accommodation is lower of
(i) Lease rent paid by the company for relevant period = 1,200 × 5 = 6,000
(ii) 15% of salary for the relevant period (computed earlier) = 6,075

Illustration 7
Using the data given in illustration 4, compute the value of the perquisite if
ABC Ltd. has provided a television (WDV 10,000, Cost 25,000) and two
air conditioners. The rent paid by the company for the air conditioners is
400 p.m. each. The television was provided on 1. 1.2014. However, Mr. C is
required to pay a rent of 1,000 p.m. to the company, for the use of this
furnished accommodation.
Solution
Here again, we have to see whether there is a concession in the matter of rent. In
the case of accommodation owned by the employer in a city having a population
exceeding 25 lakh, there would be deemed to be a concession in the matter of
rent if 15% of salary exceeds rent recoverable from the employee. In case of
furnished accommodation, the excess of hire charges paid or 10% p.a. of the cost
of furniture, as the case may be, over and above the charges paid or payable by the
employee has to be added to the value arrived at above to determine whether there
is a concession in the matter of rent.
In this case, 15% of salary is 6,075 (i.e. 15% of 40,500). The rent paid by
the employee is 5,000 (i.e. 1,000 × 5). The value of furniture (see Note 1
below) to be added to 15% of salary is 4,625. The deemed concession in the
matter of rent is 6,075 + 4,625 – 5,000
= 5,700. Once there is a deemed concession, the provisions of Rule 3(1)
would be applicable in computing the taxable perquisite.
Value of the rent free unfurnished accommodation
(computed earlier) = 6,075
Add: Value of furniture provided by the employer [Note 1] = 4,625

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Value of rent free furnished accommodation = 10,700

Less: Rent paid by the employee ( 1,000 × 5) = 5,000
Value of furnished accommodation given at concessional rent = 5,700
Note 1: Value of the furniture provided = ( 400 p.m. × 2 × 5 months) + ( 25,000 × 10% p.a. for
3 months) = 4,000 + 625 = 4,625

Illustration 8
Using the data given in illustration 7 above, compute the value of the
perquisite if Mr. C is a government employee. The licence fees determined by
the Government for this accommodation was 700p.m.
Solution
In the case of Government employees, the excess of licence fees determined by the
employer as increased by the value of furniture and fixture over and above the rent
recovered/ recoverable from the employee and the charges paid or payable for
furniture by the employee would be deemed to be the concession in the matter of
rent. Therefore, the deemed concession in the matter of rent is 3,125 [i.e. 3,500
(licence fees: 700 × 5) + 4,625 (Value of furniture) – 5,000 ( 1,000 × 5)].
Once there is a deemed concession, the provisions of Rule 3(1) would be
applicable in computing the taxable perquisite.
Value of the rent free unfurnished accommodation ( 700 × 5) = 3,500
Add: Value of furniture provided by the employer (computed earlier) = 4.625
Value of rent free furnished accommodation = 8,125
Less: Rent paid by the employee ( 1,000 x 5) = 5.000
Perquisite value of furnished accommodation given at concessional rent = 3.125
(2) Motor Car [Sub-rule (2) of Rule 3]
The value of perquisite by way of use of motor car to an employee by an employer
shall be determined in the following manner:

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Value of Perquisite Per Calendar Month

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Notes:
(1) Where one or more motor-cars are owned or hired by the employer and the employee
or any member of his household are allowed the use of such motor-car or all of any
of such motor-cars (otherwise than wholly and exclusively in the performance of his
duties), the value of perquisite shall be the amount calculated in respect of one car
as if the employee had been provided one motor-car for use partly in the performance
of his duties and partly for his private or personal purposes and the amount
calculated in respect of the other car or cars as if he had been provided with such car
or cars exclusively for his private or personal purposes.
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(2) Where the employer or the employee claims that the motor-car is used wholly and
exclusively in the performance of official duty or that the actual expenses on the
running and maintenance of the motor-car owned by the employee for official
purposes is more than the amounts deductible in SI. No. 2(ii) or 3(ii) of the above
table, he may claim a higher amount attributable to such official use and the value of
perquisite in such a case shall be the actual amount of charges met or reimbursed by
the employer as reduced by such higher amount attributable to official use of the
vehicle provided that the following conditions are fulfilled:
(a) the employer has maintained complete details of journey undertaken for official
purpose which may include date of journey, destination, mileage, and the
amount of expenditure incurred thereon;
(b) the employer gives a certificate to the effect that the expenditure was incurred
wholly and exclusively for the performance of official duties.
(3) For computing the perquisite value of motor car, the normal wear and tear of a motor-
car shall be taken at 10% per annum of the actual cost of the motor-car or cars.
(3) Valuation of benefit of provision of domestic servants [Sub-rule (3) of Rule 3]
(i) The value of benefit to the employee or any member of his household resulting
from the provision by the employer of the services of a sweeper, a gardener, a
watchman or a person attendant, shall be the actual cost to the employer.
(ii) The actual cost in such a case shall be the total amount of salary paid or
payable by the employer or any other person on his behalf for such services as
reduced by any amount paid by the employee for such services.
(4) Valuation of gas, electricity or water supplied by employer [Sub-rule (4) of Rule 3]
(i) The value of the benefit to the employee resulting from the supply of gas,
electric energy or water for his household consumption shall be determined as
the sum equal to the amount paid on that account by the employer to the
agency supplying the gas, electric energy or water.
(ii) Where such supply is made from resources owned by the employer, without
purchasing them from any other outside agency, the value of perquisite would
be the manufacturing cost per unit incurred by the employer.
(iii) Where the employee is paying any amount in respect of such services, the
amount so paid shall be deducted from the value so arrived at.
(5) Valuation of free or concessional educational facilities [Sub-rule (5) of
Rule 3]
(i) The value of benefit to the employee resulting from the provision of free or
concessional educational facilities for any member of his household shall be
determined as the sum equal to the amount of expenditure incurred by the
employer in that behalf or where the educational institution is itself maintained
and owned by the employer or where free educational facilities for such
member of employees’ household are allowed in any other educational

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institution by reason of his being in employment of that employer, the value of

the perquisite to the employee shall be determined with reference to the cost of
such education in a similar institution in or near the locality.
(ii) Where any amount is paid or recovered from the employee on that account, the
value of benefit shall be reduced by the amount so paid or recovered.
(iii) However, where 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, there would
be no perquisite if the cost of such education or the value of such benefit per
child does not exceed 1,000 p.m.
(6) Free or concessional tickets [Sub-rule (6) of Rule 3] - The value of any benefit or
amenity resulting from the provision by an employer who is engaged in the carriage
of passengers or goods, to any employee or to any member of his household for
personal or private journey free of cost or at concessional fare, in any conveyance
owned, leased or made available by any other arrangement by such employer for the
purpose of transport of passengers or goods shall be taken to be the value at which
such benefit or amenity is offered by such employer to the public as reduced by the
amount. If any, paid by or recovered from the employee for such benefit or amenity.
However, there would be no such perquisite to the employees of an airline or the
railways.
(7) Valuation of other fringe benefits and amenities [Sub-rule (7) of Rule 3] - Section
17(2)(viii) provides that the value of any other fringe benefit or amenity as may be
prescribed would be included in the definition of perquisite. Accordingly, the
following other fringe benefits or amenities are prescribed and the value thereof shall
be determined in the manner provided hereunder :-

(i) Interest-free or concessional loan [Sub-rule 7(i) of Rule 3]

(a) The value of the benefit to the assessee resulting from the provision of
interest-free or concessional loan for any purpose made available to the
employee or any member of his household during the relevant previous year by
the employer or any person on his behalf shall be determined as the sum equal
to the interest computed at the rate charged per annum by the State Bank of
India, as on the 1st day of the relevant previous year in respect of loans for the
same purpose advanced by it on the maximum outstanding monthly balance as
reduced by the interest, if any, actually paid by him or any such member of his
household. ‘Maximum outstanding monthly balance’ means the aggregate
outstanding balance for each loan as on the last day of each month.
(b) However, no value would be charged if such loans are made available for
medical treatment in respect of prescribed diseases (like cancer, tuberculosis,
etc.) or where the amount of loans are petty not exceeding in the aggregate
20,000.

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(c) Further, where the benefit relates to the loans made available for medical
treatment referred to above, the exemption so provided shall not apply to so
much of the loan as has been reimbursed to the employee under any medical
insurance scheme.

(ii) Travelling, touring and accommodation [Sub-rule 7(ii) of Rule 3]

(a) The value of travelling, touring , accommodation and any other expenses
paid for or borne or reimbursed by the employer for any holiday availed of by
the employee or any member of his household, other than leave travel
concession or assistance , shall be determined as the sum equal to the amount
of the expenditure incurred by such employer in that behalf.
(b) Where such facility is maintained by the employer, and is not available
uniformly to all employees, the value of benefit shall be taken to be the value
at which such facilities are offered by other agencies to the public .
(c) Where the employee is on official tour and the expenses are incurred in
respect of any member of his household accompanying him, the amount of
expenditure so incurred shall also be a fringe benefit or amenity.
(d) However, where any official tour is extended as a vacation, the value of
such fringe benefit shall be limited to the expenses incurred in relation to such
extended period of stay or vacation. The amount so determined shall be
reduced by the amount, if any, paid or recovered from the employee for such
benefit or amenity.

(iii) Free or concessional food and non-alcoholic beverages [Sub-rule 7(iii) of

Rule 3]
(a) The value of free food and non-alcoholic beverages provided by the
employer to an employee shall be the amount of expenditure incurred by such
employer. The amount so determined shall be reduced by the amount, if any,
paid or recovered from the employee for such benefit or amenity:
(b) However, the following would not be treated as a perquisite -
(1) free food and non-alcoholic beverages provided by such employer
during working hours at office or business premises or through paid
vouchers which are not transferable and usable only at eating joints, to
the extent the value thereof either case does not exceed fifty rupees per
meal or
(2) tea or snacks provided during working hours or
(3) free food and non-alcoholic beverages during working hours
provided in a remote area or an off-shore installation.
(iv) Value of gift, voucher or token in lieu of such gift [Sub-rule 7(iv) of Rule 3]
(a) The value of any gift, or voucher, or token in lieu of which such gift may
be received by the employee or by member of his household on ceremonial

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occasions or otherwise from the employer shall be determined as the sum equal
to the amount of such gift.
(b) However, if the value of such gift, voucher or token, as the case may be,
is below 5,000 in the aggregate during the previous year, the value of
perquisite shall be taken as ‘Nil’.
(v) Credit card expenses [Sub-rule 7(v) of Rule 3]
(a) The amount of expenses including membership fees and annual fees
incurred by the employee or any member of his household, which is charged to
a credit card (including any add-on-card) provided by the employer, or
otherwise, paid for or reimbursed by such employer shall be taken to be the
value of perquisite chargeable to tax as reduced by the amount, if any paid or
recovered from the employee for such benefit or amenity.
(b) However, such expenses incurred wholly and exclusively for official
purposes would not be treated as a perquisite if the following conditions are
fulfilled.
(1) complete details in respect of such expenditure are maintained by the
employer which may, inter alia, include the date of expenditure and the
nature of expenditure;
(2) the employer gives a certificate for such expenditure to the effect that
the same was incurred wholly and exclusively for the performance of
official duties.
(vi) Club expenditure [Sub-rule 7(vi) of Rule 3)
(a) The value of benefit to the employee resulting from the payment or
reimbursement by the employer of any expenditure incurred (including the
amount of annual or periodical fee) in a club by him or by a member of his
household shall be determined to be the actual amount of expenditure incurred
or reimbursed by such employer on that account. The amount so determined
shall be reduced by the amount. If any, paid or recovered from the employee for
such benefit or amenity.
However, where the employer has obtained corporate membership of the club
and the facility is enjoyed by the employee or any member of his household,
the value of perquisite shall not include the initial fee paid for acquiring such
corporate membership .
(b) Further, if such expenditure is incurred wholly and exclusively for
business purposes, it would not be treated as a perquisite provided the
following conditions are fulfilled:-
(1) complete details in respect of such expenditure are maintained by the
employer which may, inter alia, include the date of expenditure, the nature
of expenditure and its business expediency;

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(2) the employer gives a certificate for such expenditure to the effect that
the same was incurred wholly and exclusively for the performance of
official duties.
(c) There would be no perquisite for use of health club, sports and similar
facilities provided uniformly to all employees by the employer.
(vii) Use of moveable assets [Sub-rule 7(vii) of Rule 3): Value of perquisite is
determined as under:

Note: Where the employee is paying any amount in respect of such asset the amount so paid
shall be deducted from the value of perquisite determined above.

(viii) Transfer of moveable assets [Sub-rule 7(viii) of Rule 3] -Value

of perquisite is determined as under:

Note: Where the employee is paying any amount in respect of such asset the amount so paid
shall be deducted from the value of perquisite determined above.

(ix) Other benefit or amenity [Sub-rule 7(ix) of Rule 3] - The value

of any other benefit or amenity, service, right or privilege provided by
the employer shall be determined on the basis of cost to the employer
under an arms’ length transaction as reduced by the employee’s
contribution, if any. However, there will be no taxable perquisite in
respect of expenses on telephones including mobile phone actually
incurred on behalf of the employee by the employer i.e., if an
employer pays or reimburses telephone bills or mobile phone charges
of employee, there will be no taxable perquisite.

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(8) Valuation of specified security or sweat equity share for the

purpose of section 17(2)(vi) [Sub-rule (8)] - The fair market value of
any specified security or sweat equity share, being an equity share in a
company, on the date on which the option is exercised by the employee,
shall be determined in the following manner -
(1) In a case where, on the date of the exercising of the option, the share
in the company is listed on a recognised stock exchange, the fair
market value shall be the average of the opening price and closing
price of the share on that date on the said stock exchange.
However, where, on the date of exercising of the option, the share is
listed on more than one recognised stock exchanges, the fair market
value shall be the average of opening price and closing price of the
share on the recognised stock exchange which records the highest
volume of trading in the share.
Further, where on the date of exercising of the option, there is no
trading in the share on any recognised stock exchange, the fair market
value shall be-
(a) the closing price of the share on any recognised stock exchange
on a date closest to the date of exercising of the option and
immediately preceding such date; or
(b) the closing price of the share on a recognised stock exchange,
which records the highest volume of trading in such share, if the
closing price, as on the date closest to the date of exercising of the
option and immediately preceding such date, is recorded on more
than one recognised stock exchange.
‘Closing price’ of a share on a recognised stock exchange on a date
shall be the price of the last settlement on such date on such stock
exchange. However, where the stock exchange quotes both ‘buy’ and
‘sell’ prices, the closing price shall be the ‘sell’ price of the last
settlement.
‘Opening price’ of a share on a recognised stock exchange on a date
shall be the price of the first settlement on such date on such stock
exchange. However, where the stock exchange quotes both ‘buy’ and
‘sell’ prices, the opening price shall be the ‘sell’ price of the first
settlement.
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(2) In a case where, on the date of exercising of the option, the share in
the company is not listed on a recognised stock exchange, the fair
market value shall be such value of the share in the company as
determined by a merchant banker on the specified date.
For this purpose, ‘specified date’ means:
(i) the date of exercising of the option; or
(ii) any date earlier than the date of the exercising of the option, not
being a date which is more than 180 days earlier than the date of the
exercising.
Note: Where any amount has been recovered from the employee, the same shall be deducted
to arrive at the value of perquisites.

(9) Valuation of specified security not being an equity share in a

company for the purpose of section 17(2)(vi) [Sub-rule (9)] - The fair
market value of any specified security, not being an equity share in a
company, on the date on which the option is exercised by the employee,
shall be such value as determined by a merchant banker on the specified
date.
For this purpose, ‘specified date’ means,
(i) the date of exercising of the option; or
(ii) any date earlier than the date of the exercising of the option, not being
a date which is more than 180 days earlier than the date of the
exercising.
Definitions for the purpose of perquisite rules - The following
definitions are relevant for applying the perquisite valuation rules -
(i) “member of household” shall include-
(a) spouse(s),
(b) children and their spouses,
(c) parents, and
(d) servants and dependants;
(ii) ‘Salary’ includes the pay, allowances, bonus or commission payable
monthly or otherwise or any monetary payment, by whatever name
called from one or more employers, as the case may be, but does not
include the following, namely:

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(a) dearness allowance or dearness pay unless it enters into the

computation of superannuation or retirement benefits of the employee
concerned;
(b) employer’s contribution to the provident fund account of the
employee;
(c) allowances which are exempted from payment of tax;
(d) the value of perquisites specified in clause (2) of section 17 of
the Income-tax Act;
(e) any payment or expenditure specifically excluded under proviso
to sub-clause (iii) of clause (2) or proviso to clause (2) of section 17;
(f) lump-sum payments received at the time of termination of service
or superannuation or voluntary retirement, like gratuity, severance pay,
leave encashment, voluntary retrenchment benefits, commutation of
pension and similar payments;

Illustration 9
X Ltd. provided the following perquisites to its employee Mr. Y for the P. Y.2013-
14:
(1) Accomodation taken on lease by X Ltd. for 15,000 p.m. 5,000 p.m. is
recovered from the salary of Mr. Y.
(2) Furniture, for which the hire charges paid by X Ltd. is 3,000 p.m. No
amount is recovered from the employee in respect of the same.
(3) A Santro Car which is owned by X Ltd. and given to Mr. Y to be used
both for official and personal purposes. All running and maintenance
expenses are fully met by the employer. He is also provided with a
chauffeur.
(4) A gift voucher of 10,000 on his birthday
Compute the value of perquisites chargeable to tax for the A. Y.2014-15,
assuming his salary for perquisite valuation to be 10 lakh.

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Solution
Computation of the value of perquisites chargeable to tax in the hands of
Mr. Y for the A.Y.2014-15

(10) Medical facilities - The following medical facilities will not amount to a
perquisite:
(i) The value of any medical treatment provided to an employee or any
member of his family in any hospital maintained by the employer;
(ii) 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/
local authority/any other hospital approved by the Government for the
purpose of medical treatment of its employees;
(iii) 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 disease or ailment for which medical treatment
was required and the receipt for the amount paid to the hospital.

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Thus, the two types of facilities covered are as follows:

(a) payment by the employer for treatment in a Government hospital
and
(b) payment by an employer for treatment of prescribed diseases in
any hospital approved by the Chief Commissioner.
(iv) Any premium paid by an employer in relation to an employee to effect
an insurance on the health of such employee. However, any such
scheme should be approved by the Central Government or the
Insurance Regulatory Development Authority (IRDA) for the
purposes of section 36(1)(ib).
(v) Any sum paid by the employer in respect of any premium paid by the
employee to effect an insurance on his family under any scheme
approved by the Central Government for the purposes of section
800.
(vi) 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 to the extent of 15,000 in the previous year.
Note: It is important to note that this expenditure need not be incurred either in
the government hospital or in a hospital approved by the Chief Commissioner.

(vii) Any expenditure incurred by the employer on the following:

(a) medical treatment of the employee or any member of the family
of such employee outside India;
(b) travel and stay abroad of the employee or any member of the
family of such employee for medical treatment;
(c) travel and stay abroad of one attendant who accompanies the
patient in connection with such treatment.

Conditions:
1. The perquisite element in respect of expenditure on medical treatment and
stay abroad will be exempt only to the extent permitted by the RBI.
2. The expenses in respect of travelling of the patient and the attendant will be
exempt if the employee’s gross total income as computed before including
the said expenditure does not exceed 2 lakh.

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Note: For this purpose, family means spouse and children of the individual. Children
may be dependent or independent , married or unmarried. It also includes parents,
brothers and sisters of the individual if they are wholly or mainly dependent upon
him.

Illustration 10
Compute the taxable value of the perquisite in respect of medical facilities received
by Mr. G from his employer during the P. Y.2013- 14:
Medical premium paid for insuring health of Mr. G 7,000
Treatment of Mr. G by his family doctor 5,000
Treatment of Mrs. Gin a Government hospital 25,000
Treatment of Mr. G’s grandfather in a private clinic 12,000
Treatment of Mr. G’s mother (68 years and dependant) by family doctor 8,000
Treatment of Mr. G’s sister (dependant) in a nursing home 3,000
Treatment of Mr. G’s brother (independent) 6,000
Treatment of Mr. G’s father (75 years and dependant) abroad 50,000
Expenses of staying abroad of the patient and 30,000
Limit specified by RBI 75,000
Solution

Computation of taxable value of perquisite in the hands of Mr. G

Note: Grandfather and independent brother are not included within the meaning of family of Mr. G.

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(11) Payment of premium on personal accident insurance policies - If an

employer takes personal accident insurance policies on the lives of
employees and pays the insurance premium, no immediate benefit would
become payable and benefit will accrue at a future date only if certain
events take place.
Moreover, the employers would be taking such policy in their business
interest only, so as to indemnify themselves from payment of any
compensation. Therefore, the premium so paid will not constitute a taxable
perquisite in the employees’ hands [CIT vs. Lala Shri Dhar /1972] 84/
TR 19 (Del.)].

Check Your Progress - 2

1. Which perquisites are to be valued and taxed when in an employee's

hand?
................................................................................................................
................................................................................................................
................................................................................................................

2. What is the extent of exempt for the perquisite element in respect of

expenditure on medical treatment and stay abroad?
................................................................................................................
................................................................................................................
................................................................................................................

6.4 SUMMARY

 Generally, allowances are given to employees to meet some particular

requirements like house rent, expenses on uniform, conveyance etc.
 City compensatory allowance is normally intended to compensate the
employees for the higher cost of living in cities.
 Entertainment allowance is given to employees to meet the expenses
towards hospitality in receiving customers etc.
 The term ‘perquisite’ indicates some extra benefit in addition to the amount
that may be legally due by way of contract for services rendered.

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 Reimbursement of expenses incurred in the official discharge of duties is not

a perquisite.
 Perquisite will become taxable only if it has a legal origin. An unauthorised
advantage taken by an employee without his employer’s sanction cannot be
considered as a perquisite under the Act.
 Perquisites may be divided into three broad categories, namely, perquisites
taxable in the case of all employees, perquisites exempt from tax in the
case of all employees and perquisites taxable only in the hands of specified
employees.
 The Income-tax Rules, 1962 contain the provisions for valuation of
perquisites. It is important to note that only those perquisites which the
employee actually enjoys have to be valued and taxed in his hand.
 For the purpose of computing the income chargeable under the head
‘salaries’, the value of perquisites provided by the employer directly or
indirectly to the employee or to any member of his household by reason of
his employment shall be determined in accordance with new Rule 3.

6.5 KEY WORDS

 Fair market value (FMV): It is an estimate of the market value of a

property, based on what a knowledgeable, willing, and unpressured buyer
would probably pay to a knowledgeable, willing, and unpressured seller in
the market.
 Reimbursement: It is the compensation paid (to someone) for damages
or losses or money already spent.

6.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress- 1

1. The various types of allowances are (a) fully taxable (b) partly taxable and
(c) fully exempt.
2. The term ‘perquisite’ indicates some extra benefit in addition to the amount
that may be legally due by way of contract for services rendered.

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Check Your Progress- 2

1. Only those perquisites which the employee actually enjoys have to be
valued and taxed in his hand.
2. The perquisite element in respect of expenditure on medical treatment and
stay abroad will be exempt to the extent permitted by the RBI.

6.7 SELF-ASSESSMENT QUESTIONS

1. What are allowances? Explain the different types of allowances in detail.

2. How is ‘perquisite’ defined as per section 17(2) of the Income-tax Act,
1961?
3. Write a note explaining the three types of perquisites.
4. What are the provisions for valuation of perquisites?

6.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
http://www.icai.org/ (Accessed on 10 September 2016)

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UNIT–7 SALARIES - III

Objectives
After going through this unit, you will be able to:
 Discuss deductions from salary
 Explain relief under section 89

Structure
7.1 Introduction
7.2 Deductions from Salary
7.3 Relief Under Section 89
7.4 Summary
7.5 Key Words
7.6 Answers to ‘Check Your Progress’
7.7 Self-Assessment Questions
7.8 Further Readings

7.1 INTRODUCTION

The statute enjoins every employer to estimate the liability of tax deductible at source
and to deduct tax at an average rate. For this the employer is required to determine
the salary payable to the employee and accordingly compute the tax liability.
This unit will discuss the entertainment allowance, professional tax and deduction
under Section 80C. The unit will further explain Relief under Section 89.

7.2 DEDUCTIONS FROM SALARY

The income chargeable under the head ‘Salaries’ is computed after making the
following deductions:
(1) Entertainment allowance [Section 16(ii)]
(2) Professional tax [Section 16(iii)]
(1) Entertainment allowance: Entertainment allowance received is fully
taxable and is first to be included in the salary and thereafter the following
deduction is to be made:

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However deduction in respect of entertainment allowance is available in

case of Government employees. The amount of deduction will be lower of:
i. One-fifth of his basic salary or
ii. 5,000 or
iii. Entertainment allowance received.
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)].
Amount actually spent by the employee towards entertainment out of the
entertainment allowance received by him is not a relevant consideration at
all.
(2) Professional tax on employment - Professional tax or taxes on
employment levied by a State under Article 276 of the Constitution is
allowed as deduction only when it is actually paid by the employee during
the previous year.
If professional tax is reimbursed or directly paid by the employer on behalf
of the employee, the amount so paid is first included as salary income and
then allowed as a deduction under section 16.
Illustration 11
Mr. Goyal receives the following emoluments during the previous year ending
31.03.2014.
Basic pay 40,000
Dearness Allowance 15,000
Commission 10,000
Entertainment allowance 4,000
Medical expenses reimbursed 25,000
Professional taxpaid 3,000 ( 2,000 was paid by his employer)
Mr. Goyal contributes 5,000 towards recognized provident fund. He has no other
income. Determine the income from salary for A. Y.2014-15, if Mr. Goyal is a State
Government employee.

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Solution
Computation of salary of Mr. Goyal for the A.Y. 2014-15

Note: Employee’s contribution to RPF is not taxable. It is eligible for deduction under section
80C.

Deduction under Section 80C

Under the provisions of section 80C, an assessee will be entitled to a deduction
from gross total income of the amount invested in LIC policies, provident funds,
payment of tuition fees, repayment of housing loans, investment in infrastructure
bonds etc. subject to a maximum of 1,00,000.
Students may refer to Chapter 11 on ‘Deductions from Gross Total Income’
for a detailed discussion.

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Check Your Progress - 1

1. Which deductions are made before computing the income chargeable

under the head ‘Salaries’?
................................................................................................................
................................................................................................................
................................................................................................................

2. What is the condition for levying professional tax on employment?

................................................................................................................
................................................................................................................
................................................................................................................

7.3 RELIEF UNDER SECTION 89

(1) Where by reason of any portion of an assessee’s salary being paid in

arrears or in advance or by reason of his having received in any one
financial year, salary for more than twelve months or a payment of profit in
lieu of salary under section 17(3), his income is assessed at a rate higher
than that at which it would otherwise have been assessed, the Assessing
Officer shall, on an application made to him in this behalf, grant such relief
as prescribed. The procedure for computing the relief is given in Rule 21A.
(2) Similar tax relief is extended to assessees who receive arrears of family
pension as defined in the Explanation to clause (iia) of section 57. For the
purpose of clause (iia) of section 57, “family pension” means a regular
monthly amount payable by the employer to a person belonging to the
family of an employee in the event of his death.
(3) No relief shall be granted in respect of any amount received or receivable
by an assessee on his voluntary retirement or termination of his service, in
accordance with any scheme or schemes of voluntary retirement or a
scheme of voluntary separation (in the case of a public sector company), if
exemption under section 10(10C) in respect of such compensation
received on voluntary retirement or termination of his service or voluntary
separation has been claimed by the assessee in respect of the same
assessment year or any other assessment year.

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Illustration 12
In the case of Mr. Hari, aged 61 years, you are informed that the salary for the
previous year 2013-14 is 10,20,000 and arrears of salary received is 3,45,000.
Further, you are given the following details relating to the earlier years to which the
arrears of salary received is attributable to:

Compute the relief available under section 89 and the tax payable for the A.Y.
2014-15
Note: Rates of Taxes

Note: Education cess@2% and secondary and higher education cess@1% is attracted on the
income-tax for all the years.

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Salaries - III

Solution:
Computation of tax payable by Mr. Hari for the A.Y. 2014-15

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Illustration 13
Mr. X is employed with AB Ltd. on a monthly salary of ( 25,000 per month and an
entertainment allowance and commission of ( 1,000 p.m. each. The company
provides him with the following benefits:
1. A company owned accommodation is provided to him in Delhi. Furniture
costing 2,40,000 was provided on 7.8.2073.
2. A personal loan of 5,00,000 on 7.7.2013 on which it charges interest @
6.75% p.a. The entire loan is still outstanding. (Assume SBI rate of interest
to be 72.75% p.a.)
3. His son is allowed to use a motor cycle belonging to the company. The
company had purchased this motor cycle for 60,000 on 7.5.2010. The
motor cycle was finally sold to him on 7.8.2073 for 30,000.
4. Professional taxpaid by Mr. X is 2,000.
Compute the income from salary of Mr. X for the A. Y.2014- 15.
Solution
Computation of Income from Salary of Mr. X for the A .Y.2014-15

Note 1: Value of rent free unfurnished accommodation

= 15% of salary for the relevant period
= 15% of ( 3,00,000 + 12,000 + 12,000) = 48,600
Note 2: Value of perquisite for interest on personal loan
= 15,00,000 × (12.75% – 6.75%) for 9 months] = 22,500
Note 3: Depreciated value of the motor cycle
= Original cost – Depreciation @ 10% p.a. for 3 completed years.
= 60,000 – ( 60,000 × 10% p.a. × 3 years) = 42,000.
Perquisite = 42,000 – 30,000 = 12,000.

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Check Your Progress - 2

1. Which rule gives the procedure for computing relief under Section 89?
................................................................................................................
................................................................................................................
................................................................................................................

2. What is ‘family pension’?

................................................................................................................
................................................................................................................
................................................................................................................

7.4 SUMMARY

 The income chargeable under the head ‘Salaries’ is computed after the
following deductions, namely, entertainment allowance [Section 16(ii)] and
professional tax [Section 16(iii)].
 Entertainment allowance received is fully taxable and is first to be included
in the salary and thereafter the deductions are made.
 Deduction is permissible even if the amount received as entertainment
allowance is not proved to have been spent.
 Professional tax or taxes on employment levied by a State under Article
276 of the Constitution is allowed as deduction only when it is actually paid
by the employee during the previous year.
 If professional tax is reimbursed or directly paid by the employer on behalf
of the employee, the amount so paid is first included as salary income and
then allowed as a deduction under section 16.

7.5 KEY WORDS

 Entertainment allowance: It is an amount of money given regularly to an

employee to pay for meals, hotels, drinks etc. for company business clients.

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 Professional tax: It is a tax which is levied by the State on the Income

earned by way of profession, trade, calling or employment.

7.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. The income chargeable under the head ‘Salaries’ is computed after making
the following two deductions:
(a) Entertainment allowance [Section 16(ii)]
(b) Professional tax [Section 16(iii)]
2. Professional tax or taxes on employment levied by a State under Article
276 of the Constitution is allowed as deduction only when it is actually paid
by the employee during the previous year.

Check Your Progress - 2

1. Rule 21A gives the procedure for computing relief.
2. Family pension means a regular monthly amount payable by the employer
to a person belonging to the family of an employee in the event of his death.

7.7 SELF-ASSESSMENT QUESTIONS

1. What are the types of deductions from salary?

2. Write a short note on Relief under section 89.

7.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.

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Salaries - III

Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
http://www.icai.org/ (Accessed on 10 September 2016)

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 Income From
House Property

BLOCK-III
OTHER HEADS OF INCOME

This block provides an in-depth understanding of income as received from various sources
and their treatment. An overview of income from house property, income from capital gain
and income from other sources are discussed in detail in the subsequent units of the block.
The eighth unit focuses on identifying what constitutes income from house property. It
describes ownership of property and examines the different types of deductions that are
made from income from house property. The provision with regard to loss from house
property is also discussed in the unit.
The ninth unit explains the meaning of capital gain. It provides the classification and transfer
of the two types of assets, namely, long term capital asset and short term capital asset. The
transactions that are not regarded as transfer are also discussed in the unit. It also focuses on
the mode of computation of capital gains and helps in identifying the exemptions provided by
ITA.
The tenth unit examines as to what constitutes income from other sources. It lists the
deductions that are allowed to be made under the head 'income from other sources'. The unit
assesses the provisions relating to taxation of casual income. The later section of the unit
discusses interest on securities and the provisions of the Income Tax Act, 1961, regarding
taxation of gifts.

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House Property

UNIT–8 INCOME FROM HOUSE PROPERTY

Objectives
After going through this unit, you will be able to:
 Identify what constitutes income from house property
 Discuss the meaning of ownership of property
 Examine different deductions from income from house property
 Discuss the provision with regard to receipt of arrears of rent
 Discuss the provision with regard to loss from house property
Structure
8.1 Introduction
8.2 House Property Income
8.3 Annual Value and Ownership of Property
8.4 Deductions from Income from House Property
8.5 Summary
8.6 Key Words
8.7 Answers to ‘Check Your Progress’
8.8 Self-Assessment Questions
8.9 Further Readings

8.1 INTRODUCTION

In the previous unit, tax concepts related to salary were discussed. This unit will
discuss income from house property.
Income from house property refers to the inherent capacity of property to yield
income. This unit discusses what constitutes income from house property, and what
does not. It also discusses annual value as well as the deductions available for
computing the taxable amount chargeable to income tax.

8.2 HOUSE PROPERTY INCOME

What constitutes income from house property?

The income tax act (ITA) defines income from house property as the ‘annual value’
of any ‘building or lands appurtenant thereto’ owned by the assessee. The charge is

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House Property

not on the rent received, but on the inherent potential of the property to generate
income. It may be noted that it is only the ‘owner’ of a property who is assessed
under this head. Thus, if a tenant, or lessee, or a licensee lets out the property, any
income received by him will not be taxable under this head, but under the head
‘profits or gains from business’, or as the case may be, ‘income from other sources’.
The term ‘house property’ refers not only to a building but also to a part thereof.
Thus, if an assessee owns only the superstructure built on a leased land the income
from the property is taxable under the head ‘Income from House Property’.

What does not constitute income from house property?

For computing income from house property, the ITA excludes those portions of
property which are used by the assessee for the purposes of his business and whose
profits are chargeable to tax. Also excluded is income received from vacant plots,
which is taxable under the head ‘income from other sources’.
Where an assessee lets out on hire machinery, plant or furniture along with
buildings; and the letting out of the buildings is inseparable from the letting out of
such plant, machinery or furniture, the income is taxable either under the head
‘profits or gains from business or profession’ or ‘income from other sources’
depending on the facts of the case.

Check Your Progress - 1

1. How does the income tax act define income from house property?
................................................................................................................
................................................................................................................
................................................................................................................

2. Who is the individual who is taxed under income from tax property?
................................................................................................................
................................................................................................................
................................................................................................................

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House Property

8.3 ANNUAL VALUE AND OWNERSHIP OF PROPERTY

Annual Value
Income from house property is the annual value of the property. Section 22 of ITA
defines annual value of any property as: (a) the sum for which the property might
reasonably be expected to be let from year to year; or (b) where the property or
any part of the property is let and the actual rent received or receivable by the owner
in respect thereof is in excess of the sum referred to in (a), the amount so received
or receivable; or (c) where the property or any part of the property is let and was
vacant during the whole or any part of the previous year and owing to such vacancy
the actual rent received or receivable by the owner in respect thereof is less than the
sum referred to in (a), the amount so received or receivable.
Annual value is not the annual money benefit derivable by the property; it is
rather the inherent capacity of the property to yield income (Lallamal v. CIT 4 ITR
250 (FB)). It is immaterial whether he actually generates that income or not. Thus, if
a property can be let out for an annual rent of 60,000, then the annual value of the
property is taken as 60,000, even though the owner may not have actually let out
the property.
If the property is actually let out and the rent is more than the notional annual
value, then the annual value is the actual rent received or receivable. For example, if
a property can be let out for an annual rent of 60,000, but is actually let out for an
annual rent of 1,00,000, then the annual value is 1,00,000, and not 60,000.
On the other hand, if the property is actually let out, and the annual rent is less
than the notional annual value, then the actual rent received or receivable is to be
ignored. For example, if a property can be let out for an annual rent of 60,000,
but is actually let out for an annual rent of 50,000, then the annual value is
60000.
Lastly, it is possible that a property is let out, but for whatever reason, remains
vacant during a period of time. As a relief, the ITA provides that if a property is let
out and was vacant during the whole, or part, of the previous year, and the actual
rent received or receivable was lower than the notional annual value, then the actual
rent received or receivable is taken as the annual value.
From the above discussion, we can see that the annual value of a house
property is primarily the income that an owner can generate from the property. But,

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House Property

how do we determine notional annual value, that is, ‘the sum for which the property
might reasonably be expected to let from year to year’?
Valuation done by municipalities or other local authorities may be taken as a
basis. Further, some states in our country have enacted rent control laws, which
prescribe the standard rent that can be charged by a landlord. In such cases, the
standard rent is taken as the basis for determining the annual value of the house
property. These bases have been approved by the Supreme Court in Sheila
Kaushish v. CIT 131 ITR 435.

Ownership of Property
For income being charged to tax under the head ‘income from house property’, the
property must belong to the assessee. The tax under this head is in respect of
ownership and not the occupation or possession of the house.
An owner of the property is one who can exercise the rights of the owner. The
definition of the term owner of house property has been extended beyond mere legal
ownership to also cover the cases of deemed ownership as under:

1. Transfer of Any House Property by an Individual

Where an individual transfers any house property to his or her spouse or a minor
child otherwise than for adequate consideration, he shall be deemed to be the owner
of the house property so transferred. This does not, however, apply to cases where
the transfer is to a married daughter or to a spouse in connection with an agreement
to live apart.

2. Holder of an Impartible Estate

Ordinarily, the property of a Hindu Undivided Family is owned by the HUF and the
holder of the estate merely enjoys its income. However, Section 27(ii) of ITA deems
that the holder of an impartible estate is the owner, and not the HUF.

3. Member of a Cooperative Society

Ordinarily, in a cooperative housing society, it is the society that is the owner of the
apartments and not the members; the members merely occupy the apartment by
virtue of being members. However, Section 27(iii) of ITA deems that where a
cooperative society, company or other association of persons allots or leases a
building or part thereof to a member under any house building scheme the member
is deemed to be the owner of that building or part thereof.

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House Property

4. Person in Possession of a Building

Ordinarily, a person becomes an owner when a deed of conveyance is executed in
his favour. However, Section 27(iv) of ITA deems that a person who is allowed to
take or retain possession of any building or part thereof in part performance of a
contract of the nature referred to in Section 53A of the Transfer of Property Act,
1882, shall be deemed to be the owner of that building or part thereof.

5. Questionable Transfer
A person who acquires any rights in or with respect to any building or part thereof
by virtue of any such transaction as is referred to in Section 269UA(f) of ITA is
deemed to be the owner of that building or part thereof. This does not include any
rights by way of a lease from month to month or for a period not exceeding one year.

Self-Occupied Property
Section 23(2) of ITA provides that the annual value of a house is taken as ‘nil’ if: (i)
it is occupied by the owner for the purpose of his own residence; or (ii) it cannot be
occupied by the owner due to his employment, business or profession carried out at
any other place and he has to stay in that place in a building not belonging to him.
The annual value of one house or any part thereof is to be taken as nil if the
same or its part is in the occupation of the owner for his residence for the whole
year and if no other benefit is derived by the owner from the house property.
Similarly, where the assessee has only one residential house but it cannot be
occupied by the owner by reason of his employment, business or profession carried
out on at any other place, he has to reside at that other place in a building not
belonging to him, the annual value of such house shall be taken to be nil if the house
is not actually let and no other benefit is derived by the owner from such house.
However, if the self-occupied is let out during the previous year, or the owner
derives some other benefit from it, then the annual value of such a house cannot be
taken as ‘nil’. In such a case, the annual value of the property has to be calculated
for the whole year and the proportionate annual value of the period for which the
house was in the occupation of the owner for his own residence is deducted from
the gross annual value.
Where the assessee occupies more than one house for his residence the above
exemption is applicable only to one such house at the option of the assessee. The
annual value of the other house or houses shall be computed as if the house or
houses are let.

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Income From
House Property

Where the house property is self-occupied and its annual value is taken as ‘nil’,
no deductions are allowed, except interest payable on funds borrowed in relation to
the house property.

Check Your Progress - 2

1. How does ITA act define annual value?

................................................................................................................
................................................................................................................
................................................................................................................

2. What does the Section 23(2) of the ITA state?

................................................................................................................
................................................................................................................
................................................................................................................

8.4 DEDUCTIONS FROM INCOME FROM HOUSE

PROPERTY

Income, chargeable under the head income from house property, is computed after
making the following deductions:

1. Flat Deduction
A flat deduction equal to 30 per cent of the annual value is allowed as a deduction
from the annual value.

2. Interest on Borrowed Funds, Generally

Where the property has been acquired, constructed, repaired, renewed or
reconstructed with borrowed capital, the amount of any interest payable on such
capital is allowed as a deduction.

3. Interest on Borrowed Funds in Relation to Self-occupied Property

In the case of a self-occupied property whose annual value is taken as ‘nil’, any
interest is payable on funds borrowed for the purpose of acquiring, constructing,
repairing, renewing or reconstructing a self-occupied house property is allowed as a
deduction.

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 Income From
House Property

The amount of deduction is restricted to 1,50,000 if the funds were borrowed

on, or after, 1 April 1999 (in respect of funds borrowed prior to this date, the
maximum amount of interest allowed as a deduction is restricted to 30,000). This
deductibility of interest is subject to the fulfilment of two conditions:
 The property must be acquired, or constructed, within three years from the
end of the financial year in which the funds were borrowed.
 The assessee furnishes a certificate from the lender in respect of the interest
payable.

Subsequent Receipt of Unrealized Rent

Where the assessee cannot realize rent from a property let to a tenant but
subsequently realizes the amount in respect of such rent, the amount so realized shall
be deemed to be income chargeable under the head ‘Income from house property’
and accordingly charged to income tax as the income of that previous year in which
such rent is realized whether or not the assessee is the owner of that property in that
previous year (Section 25AA of ITA).

Receipt of Arrears of Rent

Where the assessee (a) is the owner of any property consisting of any building or
land appurtenant thereto which has been let to a tenant; and (b) has received any
amount, by way of arrears of rent from such property, not charged to income tax for
any previous year, the amount so received, after deducting a sum equal to 30 per
cent of such amount, shall be deemed to be the income chargeable under the head
‘Income from house property’ and accordingly charged to income tax as the income
of that previous year in which such rent is received, whether the assessee is the
owner of that property in that year or not (Section 25B of ITA).

Property Owned By Co-Owners

Where any house property is owned by two or more persons and their respective
shares are definite and ascertainable, in such a case, the share of each such person
in the income from the property is to be separately included in his total income.

Loss from House Property

Any loss from house property, whether let out or self-occupied, is allowed to be set
off against any other head of income in the same assessment year. Where the loss
under the head ‘income from house property’ cannot be set off against any other
head of income in the same assessment year, it is allowed to be carried forward and
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Income From
House Property

set off against ‘income from house property’ of immediately succeeding eight
assessment years.

Illustration 8.1
(i) Asst. year 2008-09
‘A’ a salaried employee (salary 1,40,000/-) has two properties which are
let out. The loss from one property ‘X’ is 20,000/-. The income from the
other property ‘Y’ is 14,000/-. The loss from property ‘X’ can be set off
against income from property ‘Y’. There will still be loss of 6000/- in
respect of property ‘X’. This can be set off against his salary income.
(ii) Asst. year (as at (i) above)
B’s sources of income/loss are as under:
Rs.
* Interest income 10,000
* Income from other sources 6,000
Net loss from residential House Property (consequent to payment (-) 36,000
of interest on funds borrowed for the construction of House after
31.03.1999)
Net loss 20,000
This loss of 20,000 would be carried forward for being set off in
accordance with the provisions of Section 71B upto 8 years against income
from house properties.

Illustration 8.2
(i) Asst. Year 2008-09
A’s sources of income are:
Rs.
* Salary 1,20,000
* Interest on loan taken for the construction of a house 30,000
for residential purpose
The taxable income for this asstt. year would be 90,000 on which no tax
would be payable.
(ii) If the amount of interest in the above case is say 1,40,000 and funds had
been borrowed for construction of house property for self-residence after
31.03.1999, then 20,000 would be the loss which can be carried
forward for being set off from property income, if any, in future upto 8
years. It would not be available for set off against other incomes.

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 Income From
House Property

Illustration 8.3
In the context of a residential property, the following information relatable to the asst.
year 2008-09 is given for determination of the Gross Annual Value (GAV):
(i) Municipal Valuation 1,20,000 p.a.
(ii) Rent on which property has been let out 20,000 p.m.
2,40,000 p.a.
(iii) Period for which property remained vacant 2 months
The GAV would be 2,00,000.
In respect of this property, the assessee incurs following expenses during
the year 2007-08:
(A) Municipal taxes (including 2000
relating to previous year) 9,000
(B) Repairs 12,000
(C) Interest on money borrowed for construction of the house from
Canara Bank 28,000
(D) Repayment of Loan for house
Construction to Canara Bank 24,000
(E) Chowkidar & Mali’s pay 20,000
The other sources of income of A during the previous year are:
(i) Salary 1,80,000
(ii) Interest from bank 48,000
(iii) Dividends 12,000
A has deposited 24,000 in the Public Provident Fund. Income computation of A
inclusive of property income will be as under:
(a) Salary 1,80,000
(b) Income from property GAV 2,00,000
Less Municipal taxes 9,000
Net ALV 1,91,000
Less standard deduction@30% 57,300
1,33,700
Less interest on loan 28,000 1,05,700

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(c) Income from other sources:

Bank interest 48,000
Dividends 12,000 60,000
Gross Total Income 3,45,700
Less Deduction u/s 80C:
PPF Contribution 24,000
Repayment of loan for
House construction 24,000 48,000
Total Income 2,97,700
Tax there on:
On first 110000 NiL
On next 40,000 @ 10% 4,000
On next 1,00,000 @ 20% 20,000
On balance 47,700 @ 30% 14, 310
Total tax 38,310 38,310
Add: Education Cess on Income Tax @ 2% 766
Secondary and Higher Education Cess
on Income Tax @ 1% 383
Total amount chargeable 39,459
Notes:
(i) No standard deduction from Salaries is available from asst. year 2006-07 onwards.
(ii) No deduction under Section 80L is available from asst. year 2006-07 onwards.
(iii) No rebate under Section 88 is available from asst. year 2006-07 onwards.
(iv) Expenses on repairs and salaries of chowkidar and mali are covered by the standard
deduction of 30% and no separate deduction for these expenses are permissible.

Illustration 8.4
‘A’ who works in a Limited Company in Mumbai has a house property in Kanpur.
He has come with his family on transfer to Mumbai where he stays in a rented
accommodation. He has only one house at Kanpur which remained unoccupied
throughout the year 2007-08 since he could not arrange for a suitable tenant. The
rent of a similar property in Kanpur will be 5000/- p.a. The municipal valuation is
30,000/- and he has paid municipal taxes of 2,500/-. He had taken a loan of
2,00,000 for reconstruction of the property and interest payable thereon is
25,000/-. What will be his income from House Property?

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Assessment year 2008-09

Annual value of the House at Kanpur (since the assessee owns only one house
which he could not use throughout the year because of his employment at Mumbai).
: Nil
Less: Interest on money borrowed : 25,000

Loss from house property : 25,000

Note: Only interest on money borrowed for construction, acquisition, repair and
reconstruction is allowed in respect of such property, subject to a maximum of
30,000/- or 1,50,000/ - as the case may be.

Illustration 8.5
Asst. year 2009-10
Mr. A is owner of two house properties, which are let out. The tentative details for
the financial year 2008-09 are as follows:
Property A Property B
Municipal valuation 60,000 50,000
Fair tent 70,000 60,000
Actual rent received p.m. SOP 10,000
Municipal tax paid by the owner (including Rs. 1000 of 4000 10,000
last year)
Interest on loan taken for the marriage of his daughter 20,000
(Property B is mortgaged)
Interest on loan for Renovation 40,000 -
Interest on loan borrowed for construction (started after 1,60,000
01.04.99 and completed before 1.4.2003)
Property B was lying vacant for two months during the year. The assessee has
appointed a Caretaker for both the properties and he is paid a salary of 1000/-
per month.
The assessee had another house which was given on rent (upto the A.Y 1999-
2000). In 2000-01, it was sold. When it was let out, the assessee could not realize
rent of 25,000 for the A.Ys 1997-98 and 1998-99. However, after a court order,
the tenant has now paid the same.
On account of the said court orders, the assessee has also received 1,00,000/
- as arrears of rent for other previous years also.

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Computation of Income from House Property

Property ‘A’
As the house was used for self-occupation, the Annual value shall be taken as Nil
and no further deduction is allowed, except interest on borrowed capital. However,
as the capital was borrowed for renovating the house, maximum deduction available
is 30,000/-. Computation of income will be:

Annual Value Nil

Less: Interest on borrowed capital
(restrict to 30,000) 30,000
Net loss 30,000

Property ‘B’
Annual value (being the rent received)
(on the basis of actual rent received 10,000 x 10) 1,00,000
Less: Municipal tax actually paid 10,000
Net adjusted annual value 90,000
Less: Deduction under section 24
(i) Deduction u/s 24(a) 27,000
(ii) Interest on capital borrowed 1,60,000
(iii) Total deduction (i) + (ii) 1,87,000
Net loss 97,000
Loss from House Property A 30,000
Loss from House Property B 97,000
Total loss from house properties A and B 1,27,000
Notes:
1. Annual value of let out property: The annual value will be the actual rent
received during the year, as it is higher than the Municipal Valuation and fair
rent.
2. Municipal Taxes: The deduction is on the basis of actual payment.
Therefore, it is immaterial that part of it relates to the earlier years.

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3. Interest on capital borrowed for construction:

a) In the case of self-occupied property - as the loan was for renovation, the
deduction on account of interest is restricted to 30,000/-
b) In the case of let out house, there is no restriction on the interest to be
allowed as deduction. Here, the borrowal may be for repairs, renewals,
construction, acquisition etc.
4. Interest on the loan borrowed for the marriage of the daughter cannot be
allowed as deduction, because the purpose of loan is not for construction,
repairs, etc., of the house property.
5. Payment of salary to caretaker cannot be allowed as deduction as it is
covered in standard deduction @ 30%.
6. Unrealised rent: Such rent will be assessed in the year of receipt even if the
assessee may not own the house any more. No deduction is available for
this income.
7. Arrears: Similarly, arrears are also to be assessed in the year of receipt. The
only deduction to be allowed from this is at flat rate of 30% towards
repairs etc.
Unrealised rent to be treated as income of this year 25,000
Add: Arrears of rent received 1,00,000
Less: Deduction towards
repairs etc. @ 30% 30,000 70,000
95,000

Income under the Head House Property

Net Loss for the year against properties A and B 1,27,000
Less: Income to be assessed in this year as above 95,000
Net Loss to be carried forward to next year for being
set off as per the provisions of Section 71B 32,000

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Check Your Progress - 3

1. What is the rate of flat deduction on the annual value of house property?
................................................................................................................
................................................................................................................
................................................................................................................

2. Which conditions must be fulfilled for the deductibility of interest?

................................................................................................................
................................................................................................................
................................................................................................................

3. What is the provision for loss from house property?

................................................................................................................
................................................................................................................
................................................................................................................

8.5 SUMMARY

 Income from house property refers to the inherent capacity of property to

yield income.
 ITA defines income from house property as the ‘annual value’ of any
‘building or lands appurtenant thereto’ owned by the assessee. The charge
is not on the rent received, but on the inherent potential of the property to
generate income. It may be noted that it is only the ‘owner’ of a property
who is assessed under this head.
 Annual value is not the annual money benefit derivable by the property; it is
rather the inherent capacity of the property to yield income.
 If the property is actually let out, and the annual rent is less than the notional
annual value, then the actual rent received or receivable is to be ignored.
 For income being charged to tax under the head ‘income from house
property’, the property must belong to the assessee. The tax under this
head is in respect of ownership and not the occupation or possession of the
house.

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 Where an individual transfers any house property to his or her spouse or a

minor child otherwise than for adequate consideration, he shall be deemed
to be the owner of the house property so transferred.
 A person who acquires any rights in or with respect to any building or part
thereof by virtue of any such transaction as is referred to in Section
269UA(f) of ITA is deemed to be the owner of that building or part
thereof.
 Section 23(2) of ITA provides that the annual value of a house is taken as
‘nil’ if: (i) it is occupied by the owner for the purpose of his own residence;
or (ii) it cannot be occupied by the owner due to his employment, business
or profession carried out at any other place and he has to stay in that place
in a building not belonging to him.
 Income chargeable under the head income from house property is
computed after making the following deductions:
o Flat deduction
o Interest on borrowed funds
o Interest on borrowed funds in relation to self-occupied property
 Where any house property is owned by two or more persons and their
respective shares are definite and ascertainable, in such a case, the share of
each such person in the income from the property is to be separately
included in his total income.
 Any loss from house property, whether let out or self-occupied, is allowed
to be set off against any other head of income in the same assessment year.

8.6 KEY WORDS

 Annual value of the property: It is the income from house property, i.e.,
it is the inherent capacity of the property to yield income.
 Owner of the property: It refers to the person who can exercise the rights
of the owner.
 Income from house property: It refers to the income from buildings and/
or lands appurtenant thereto.
 Income from other sources: It refers to the income only from vacant plot
or land.
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8.7 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress – 1

1. The income tax act defines income from house property as the ‘annual
value’ of any ‘building or lands appurtenant thereto’ owned by the
assessee.
2. It is only the ‘owner’ of a property who is assessed under income from
house property. Thus, if a tenant, or lessee, or a licensee lets out the
property any income received by him will not be taxable under this head,
but under the head ‘profits or gains from business’, or as the case may be,
‘income from other sources’.

Check Your Progress - 2

1. Section 22 of ITA defines annual value of any property as: (a) the sum for
which the property might reasonably be expected to be let from year to
year; or (b) where the property or any part of the property is let and the
actual rent received or receivable by the owner in respect thereof is in
excess of the sum referred to in ‘a’, the amount so received or receivable;
or (c) where the property or any part of the property is let and was vacant
during the whole or any part of the previous year and owing to such
vacancy the actual rent received or receivable by the owner in respect
thereof is less than the sum referred to in ‘a’, the amount so received or
receivable.
2. Section 23(2) of ITA provides that the annual value of a house is taken as
‘nil’ if: (i) it is occupied by the owner for the purpose of his own residence;
or (ii) it cannot be occupied by the owner due to his employment, business
or profession carried out at any other place and he has to stay in that place
in a building not belonging to him.

Check Your Progress – 3

1. A flat deduction equal to 30 per cent of the annual value is allowed as a
deduction from the annual value.
2. The deductibility of interest is subject to the fulfilment of two conditions:
 The property must be acquired, or constructed, within three years
from the end of the financial year in which the funds were borrowed.

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 The assessee furnishes a certificate from the lender in respect of the

interest payable.
3. Any loss from house property, whether let out or self-occupied, is allowed
to be set off against any other head of income in the same assessment year.
Where the loss under the head ‘income from house property’ cannot be set
off against any other head of income in the same assessment year, it is
allowed to be carried forward and set off against ‘income from house
property’ of immediately succeeding eight assessment years.

8.8 SELF-ASSESSMENT QUESTIONS

1. What incomes are assessable under the head ‘income from house
property’?
2. What incomes are not assessable under the head ‘income from house
property’?
3. Are there any situations where a person, though not legally owning the
property, is subject to tax under the head ‘income from house property’?
4. Enumerate the deductions allowed to be made from ‘income from house
property’.
5. Explain the concept of annual value and explain how it is determined.
6. Write short notes on:
(a) Self-occupied property
(b) Deemed owner of property
7. Find the Gross Annual Value (GAV) of a house property whose municipal
valuation is 1,20,000, fair rent is 80,000 and standard rent is 70,000.
The house is let out to a third party for a monthly rent of 10,000 for 11
months and remains vacant for the remaining part of the year.
8. A took a loan of 3,00,000 @ 20% per annum on June 1, 2003 for the
construction of his house. The construction of the house was completed on
March 31, 2007. Calculate the amount of interest deductible in the year
2005-06.

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8.9 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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UNIT–9 INCOME FROM CAPITAL GAIN

Objectives
After going through this unit, you will be able to:
 Define the term ‘capital’
 Explain and classify capital assets
 Discuss the types and transfer of capital assets
 Identify the transactions not regarded as transfer
 Describe the mode of computation of capital gains
 Examine the cost of acquisition of the asset
 Identify the exemptions provided by ITA

Structure
9.1 Introduction
9.2 Capital Gains
9.3 Cost of Acquisition of the Asset
9.4 Computation of Long Term Capital Gains Tax
9.5 Summary
9.6 Key Words
9.7 Answers to ‘Check Your Progress’
9.8 Self-Assessment Questions
9.9 Further Readings

9.1 INTRODUCTION

Capital gains are gains from the transfer of capital assets. Capital losses are losses or
reductions in value resulting from the sale or exchange of capital assets. Any gain
obtained by an assessee from the transfer of a capital asset is taxable under the
Income Tax Act (ITA). To fully understand the concepts of capital gains or losses,
you need to understand the concepts of ‘capital assets’ and ‘transfer’. Once these
concepts are understood, then you can begin to see how they function within the
broader context of the tax rules for capital gains and losses. This unit discusses what
assets are considered as capital assets, what is meant by transfer of a capital asset,
and how capital gains are computed.

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9.2 CAPITAL GAINS

The term ‘capital’ connotes what a man has invested or sunk into his business out of
his wealth and the term ‘income’ means yield or the produce roped in by him during
a particular period of time from the capital so invested.
Under ITA, income includes gains derived on transfer of a capital asset. When a
person sells (or transfers) a capital asset, the difference between the sale price and
the cost of its acquisition, plus the cost of any improvement and the cost of
effectuating the transfer, is either a capital gain or a capital loss. Thus, capital gain is
the profit or gain arising from the transfer of a capital asset during the previous year.
Since these gains are not routine accruals, they are treated on a different footing for
taxation purposes.

Capital Asset
Almost everything people own and use for personal purposes or investment qualifies
as capital assets. Homes, household furnishings, store equipment, computers, stocks
and bonds are all capital assets. Capital asset means property of every kind held by
an assessee, whether or not, it is held for his business or profession. It includes all
corporeal and tangible properties as well as all kinds of rights in property. The
variety of ‘things’ that the courts have held as capital assets is phenomenal. Among
other things, the courts have held the following to be capital assets: jewellery, foreign
currency, a business undertaking, a partner’s share in the firm, a route permit, a
manufacturing license, leasehold right and the right to subscribe to the shares of a
company.
The question of whether a particular asset is a capital asset is to be determined
with regard to the facts prevailing at the time of transfer of the asset and not the time
when the asset was acquired (Venkatesan v. CIT 144 ITR 886).
However, certain assets are expressly excluded from the definition of capital
asset. These excluded capital assets are enumerated below:
 Stock-in-trade, consumable stores and raw material held for purposes of
the assessee’s business or profession.
 Personal effects, that is, movable property such as wearing apparel,
furniture, motor vehicles, etc. held for personal use of the assessee or any
member of his family dependent on him. However, jewellery is always
treated as a capital asset even though it is meant for personal use.

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 Agricultural land in India, not being land falling within municipal limits or
boundaries of a cantonment board of an area having population of 10,000
or more as per the last census, and not situated within 8 kilometres from
the municipal limits.
 Certain specified gold bonds.
 Special bearer bonds issued by the Central Government.

Types of Capital Assets

There are two types of capital assets, namely, long term capital asset and short term
capital asset. Ordinarily, a capital asset that is held for 36 months or less before its
transfer is called a short term capital asset. Conversely, a capital asset that is held for
a period beyond 36 months is called a long term capital asset.
However, in case of certain assets, such as shares of a company, units of
specified mutual funds or any security traded in a recognised Indian stock exchange,
the holding period for being considered as short term capital asset is twelve months
or less.
The capital gains on the transfer of the long term capital asset are termed long
term capital gains and the capital gains on the transfer of short term capital asset are
termed short term capital gains. Short-term capital gains are included in the total
income of an assessee and charged to tax along with the other incomes at the normal
rates in force.

Transfer of Capital Asset

Capital gain or a capital loss is a gain realised or loss incurred in transferring an
asset. Thus, the primary condition for levy of capital gains tax is the transfer of an
asset (C. A. Natarajan v. CIT (1973) 92 ITR 347 (Mad)). The transfer of a capital
asset must be one as a result of which consideration is received by, or accrues to, the
assessee. Without the element of consideration no transfer will attract capital gains
tax (CIT v. Mohanbhai Pamabhai (1973) 91 ITR 393, 404 (Guj)).
Transfer means ‘putting one person (called the transferee) in place of another
(called the transferor) as owner of an item of property’. Ordinarily, the transfer of
movable property takes place when the item is delivered. In the case of immovable
property, the transfer of property takes place when the conveyance deed is
registered. However, the ITA defines the term ‘transfer’ to include many transactions
which are not ordinarily considered as a transfer. Section 2(47) of the ITA defines
transfer to include the following:
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 The sale, exchange or relinquishment of a capital asset.

 The extinguishment of any rights in a capital asset.
 The compulsory acquisition of a capital asset or rights therein under any
law.
 Conversion of a capital asset by the owner into, or its treatment by him as,
stock-in-trade of his business.
 Where, in respect of an immovable property, the possession of the same is
allowed to be taken or retained in part performance of certain contract
(such as those referred to in Section 53A of the Transfer of Property Act,
1882), the transaction is treated as transfer of the immovable property.
 A transaction that allows or enables an assessee to enjoy any immovable
property in any manner.

Transactions Not Regarded As Transfer

The ITA exempts certain transactions from being covered under the definition of
transfer. These exempted transactions include:
 Distribution of assets of a company to its shareholders upon the company’s
liquidation.
 Any distribution of capital assets on the total or partial partition of a HUF.
 Transfer of a capital asset under a gift or a will or under an irrevocable
trust.
 Transfer of a capital asset to an Indian subsidiary company by a parent
company, or its nominees, who hold the entire share capital of the Indian
subsidiary company. However, a transfer of a capital asset as stock-in-
trade is considered a transfer.
 Any transfer of a capital asset by a wholly-owned subsidiary company to
its Indian holding company. However, a transfer of a capital asset as stock-
in-trade is considered a transfer.
 Any transfer in a scheme of amalgamation, of a capital asset by the
amalgamating company to an Indian amalgamated company.
 In the case where the amalgamating and the amalgamated companies are
both foreign companies, the transfer of shares held in the Indian company
by the foreign amalgamating company to the foreign amalgamated company
is not regarded as a transfer if at least 25 per cent of the shareholders of
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the amalgamating foreign company continue to remain shareholders of the

amalgamated foreign company and such transfer does not attract tax on
capital gains in the country in which the amalgamating company is
incorporated.
 Any transfer by a shareholder, in a scheme of amalgamation, of shares held
by him in the amalgamating company in consideration of the allotment of
any share or shares in the amalgamated Indian company.
 Where a non-resident person transfers any bond or shares of an Indian
company which were issued in accordance with any scheme notified by the
Central Government; or where the non-resident person transfers any bonds
or shares of a public sector company sold by the government and
purchased by the non-resident in foreign currency, such a transfer is not
regarded as a transfer for the purposes of capital gains, provided the
transfer of the capital asset is made outside India by one non-resident
person to another.
 Transfer of any work of art, archaeological or art collection, book,
manuscript, drawing, painting, photograph or print by the assessee to an
university, national museum, national art gallery, national archives,
government or to any other notified institution of national importance.
 Any transfer by way of conversion of a company’s bonds or debentures,
debenture-stock or deposit certificates held in any form into shares and
debentures of that company.
 Transfer of a land belonging to a sick industrial company which is being
managed by its workers’ cooperative, provided that the transfer is made
under a scheme prepared and sanctioned under the Sick Industrial
Companies (Special Provisions) Act, 1985.
 Sale or transfer of any capital or intangible asset of a firm if it is on account
of succession of the firm by a company in the business carried on by it. This
exemption is subject to the fulfilment of specified conditions.
 Where a sole proprietary concern is succeeded by a company in the
business carried on by it and as a result of which the sole proprietor sells or
transfers any capital asset or intangible asset to the company, such transfer
is not regarded as transfer for the purposes of capital gains. This exemption
is subject to the fulfilment of specified conditions.

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Mode of Computation of Capital Gains

The income chargeable under the head ‘capital gains’ is calculated by reducing the
full value of the consideration received (or accruing) as a result of the transfer of the
capital asset by the sum of: (i) the cost of acquisition of the capital asset; (ii) the cost
of improving the asset; and (iii) the expenditure incurred wholly and exclusively in
connection with the transfer. Thus, any capital gains arising out of transfer of a capital
asset is computed using a four-step process.
 Step 1: Determine the expenditure incurred wholly and exclusively in
connection with the transfer (see paragraph 7.8).
 Step 2: Determine the cost of acquisition of the asset (see paragraphs 7.9
and 7.10).
 Step 3: Determine the cost of improvement to the capital asset incurred
before its transfer (see paragraph 7.11).
 Step 4: Subtract the sum of amounts determined in steps 1, 2 and 3 from
the full value of consideration received (or accruing) as a result of transfer
of the capital asset (see paragraph 7.16).
Where a capital gain arises due to the ‘transfer of a long term capital asset’ then
instead of the ‘cost of acquisition’ and ‘cost of improvement’, the indexed cost of
acquisition and the indexed cost of improvement should be subtracted from the full
value of the consideration. In this case, the resultant capital gain is called long term
capital gain.

Expenditure Incurred On Transfer of a Capital Asset

The expenditure incurred wholly and exclusively in connection with the transfer of a
capital asset can be claimed as a deduction from the full value of consideration
received (or accrued) for computing the capital gain. This expenditure must be
reasonable, specific and must be such without which the transfer could not be
effectuated. The test of reasonableness is not the subjective opinion of the Income
Tax Officer but that of a normal, prudent businessman (Mysore Fertilizer Co. v.
CIT (1956) 30 ITR 734).
The courts have held that this expenditure would include not only expenses like
legal fees, stamp duty, etc., but also expenses incurred for preparing a layout and
plotting out the land as house sites and payments made to tenants for vacating a
property which is agreed to be sold with vacate possession.

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Check Your Progress - 1

1. Name any two assets expressly excluded from the definition of capital
asset.
................................................................................................................
................................................................................................................
................................................................................................................

2. Differentiate between long-term and short-term capital assets.

................................................................................................................
................................................................................................................
................................................................................................................

9.3 COST OF ACQUISITION OF THE ASSET

Cost of acquisition refers to the expenditure incurred by the assessee in acquiring the
asset. By its very nature, the cost of acquisition of an asset is capital expenditure. It
is not necessary that the cost of acquisition should be incurred at once; it may be
incurred over an extended period of time. However, it is essential that the
expenditure be of a capital nature (see paragraph 6.14). For example, interest paid
on capital borrowed for the purpose of a capital asset would constitute part of the
cost of acquisition, whereas ground rent paid in relation to the capital asset is not
considered a part of the cost of acquisition. This is because ground rent is incurred
for keeping the capital asset in possession and is in the nature of expense incurred
for maintaining the asset (CIT v. Mithlesh Kumari (1973) 92 ITR 9 (Del)).
Generally, where the assessee became the owner of an asset before 1 April
1981, then the cost of acquisition of such asset is deemed to be cost of acquisition
of the asset or the fair market value of the asset as on 1 April 1981 at the option of
the assessee. Fair market value in relation to a capital asset means the price that the
capital asset would ordinarily fetch on sale in the open market on the target date. The
concept of fair market value brings in the question of a hypothetical seller and a
hypothetical buyer in a hypothetical market (Mahmudabad Properties (P) Limited
v. CIT (1972) 85 ITR 500 (Cal).

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In some cases the expenditure incurred by the assessee in acquiring the asset is
disregarded. Under Section 55(2) of ITA, the cost of acquisition of certain assets is
deemed as under:
 In case of goodwill of a business, or a right to manufacture, produce or
process any article or thing, tenancy right, stage carriage permits, or loom
hours, the cost of acquisition is taken as nil unless the same were
purchased from a previous owner, in which case the cost of acquisition
shall be the purchase price paid.
 In case an assessee becomes entitled to subscribe any additional financial
asset or is allotted any additional financial asset (for example, bonus shares
and rights shares) without any payment by virtue of his holding a share or
shares or any other securities (called original financial asset), the cost of
acquisition of the capital assets is to be calculated as under:
a. In relation to the original financial asset, the amount actually paid for
acquiring the original asset.
b. In relation to any right to renounce the said entitlement to subscribe to
the financial asset and where the right is renounced, the cost of
acquisition of such right shall be taken as nil.
c. In relation to the financial asset to which the assessee has subscribed
on the basis of the said entitlement the cost of acquisition means the
amount actually paid by him for acquiring such asset.
d. In relation to the financial asset allotted to the assessee without any
payment and on the basis of holding of any other financial asset the
cost of acquisition of the new asset allotted shall be taken as nil.
e. Where a person purchases the right to subscribe to such asset by way
of renunciation of rights, then the cost of the asset in the hands of the
buyer shall be the aggregate cost of purchase of the right and the cost
incurred for acquiring the asset in terms of the payment to the
company or institution.
Where a capital asset, being a share or a stock of a company, became the
property of the assessee on account of the consolidation of or the division of all or
any of the share capital of the company into shares of larger amount than its existing
shares; or on account of conversion of any shares of the company into stock; or on
account of the re-conversion of any stock of the company into shares; or on account

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of sub division of any of the shares of the company into shares of smaller amount; or
on account of the conversion of one kind of shares of the company into another
kind, then the cost of acquisition of the asset is calculated with reference to the cost
of acquisition of the stock or shares from which such asset is derived.

Notional Cost of Acquisition of the Asset

In certain circumstances, the cost of acquisition of capital assets in the hands of the
assessee is taken as it was for the previous owner of the asset. The cost of
improvement of the asset incurred or borne by the previous owner or by the
assessee, is also claimable while computing the capital gains. The circumstances
covered are as under:
 Transfer on account of any distribution of the assets on the total or partial
partition of a HUF.
 Transfer under a will or gift.
 Transfer by way of succession, inheritance or devolution.
 Distribution of assets on the liquidation of a company.
 Transfer to a revocable or irrevocable trust.
 Transfer between a holding company and subsidiary company and between
an amalgamating company and an amalgamated company which otherwise
are not regarded as a transfer for the purposes of capital gains.
 Where the HUF becomes the owner of the property on account of the
individual member’s act of throwing his separate property in the common
stock of the HUF or by transferring the property to the HUF for
inadequate consideration as specified in Section 64(2) of ITA.
In the above circumstances, the term ‘previous owner’ means the last owner
who had become the owner of the property in circumstances other than those
enumerated above.

Cost of Improvement
Cost of improvement includes all expenditure of a capital nature incurred after 31
March 1981 by an assessee in making any additions to the capital asset and also
includes expenditure incurred to protect or complete the title to the capital asset and
to cure such title from any defect. The expenditure incurred, therefore, should
increase the value of the capital asset. The cost of improvement, however, does not
include any expenditure which is otherwise deductible in computing the income

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chargeable as income from house property; profit and gains of business or

profession; or income from other sources.
The cost of improvement in relation to goodwill, or a right to manufacture,
produce or process any article or thing is taken as nil.

Cost Inflation Index

For the purpose of computing long-term capital gains, the cost of acquisition is to be
multiplied by the ratio of cost inflation index of the year in which the asset is
transferred and the cost inflation index of the year in which the asset was acquired.
If the asset was acquired before 1 April 1981, instead of cost inflation index of the
year in which the asset was acquired we should use the cost inflation index for the
year beginning on 1 April 1981.
Similarly, the cost of improvement is to be multiplied by the ratio of cost inflation
index of the year in which the asset is transferred and the cost inflation index of the
year in which the asset was acquired.
The method of indexation provides the assessee with protection against inflation
and erosion of the real worth of his investment. It has been provided that the cost of
acquisition or the cost of improvement shall be increased proportionately to the
increase in the general cost inflation index. This index begins from 1 April 1981 and
as on that date its figure is taken at 100 and the figures for successive financial years
are notified by the Central Government from time to time. Table 9.1 shows the cost
inflation index as notified by the Central Government.

Table 9.1 Cost Inflation Index as Notified by the Central Government

Cost Inflation Index
Financial Cost Inflation Financial Cost Inflation Financial Cost Inflation
Year Index Year Index Year Index
1981–82 100 1990–91 182 1998–1999 351
1982–83 109 1991–92 199 1999–2000 389
1983–84 116 1992–93 223 2000–2001 406
1984–85 125 1993–94 244 2001–2002 426
1985–86 133 1994–95 259 2002–2003 447
1986–87 140 1995–96 281 2003–2004 463
1987–88 150 1996–97 305 2004–2005 480
1988–89 161 1997–98 331 2005–2006 497
1989–90 172 1998–99 351 2006–2007 519

Provisions Relating to Depreciable Assets

Where a capital asset forms part of a block of asset in respect of which depreciation
has been allowed under the ITA, the cost of acquisition is calculated as under:

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 Where the full value of consideration received in respect of the capital asset
transferred together with the full value of consideration received in respect
of any other capital asset falling within the same block of asset during the
previous year exceeds the total of the three sums listed below, the
difference is taxable as short term capital gain. The sums are:
a. Written down value of the block of asset at the beginning of the
previous year.
b. Actual cost of any new asset falling within the same block of asset and
which was acquired during the previous year.
c. The expenditure incurred wholly and exclusively in connection with
such transfer or transfers.
 If all the assets in the block of assets are transferred, the cost of acquisition
of the block of assets is taken as the aggregate of the written down value of
the block of assets as at the beginning of the previous year plus the actual
cost of any asset falling in the block of assets acquired during the previous
year.
In case of any asset on which the assessee has claimed depreciation in any
previous year, the cost of acquisition of such asset shall always be the
written down value of the asset. Where any capital asset was subject to
negotiations for transfer and the assessee had received any advance or
other money in respect of such negotiations, the written down value of the
asset shall be reduced by the advance money or sum received and retained
by the assessee.

Capital Gains in Cases of Compulsory Acquisition

Where in respect of a transfer of a capital asset on account of compulsory
acquisition under any law or in respect of a transfer whose consideration is
determined or approved by the Central Government or by the Reserve Bank of
India and in which case the consideration is enhanced or further enhanced by any
court, tribunal or authority, the capital gains is dealt in the manner below:
 With reference to the compensation awarded in the first instance as the
capital gains of the previous year in which such compensation or part
thereof was first received.
 The subsequently enhanced compensation or consideration shall be deemed
to be income chargeable as capital gain of the previous year in which such
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income is received by the assessee and in such cases the cost of acquisition
and the cost of improvement shall be taken as nil.
In case of the death of the transferor or if for any reason the enhanced
compensation or consideration is received by any other person then the
capital gains will be attributed to such other person.

Reference to Valuation Officer

Capital assets can be referred to the valuation cell of the income tax department in
order to ascertain the fair market value in the following cases:
 Where the assessee furnishes a value of an asset in accordance with the
estimate made by a registered valuer and where the assessing officer is of
the opinion that the value declared is less than the fair market value.
 Where the assessing officer is of the opinion that the fair market value of
the asset exceeds the value of the asset by more than 25,000 or 15 per
cent of the value claimed by the assessee, whichever is less.
 Where the assessing officer is of the opinion that having regard to the
nature of the asset and in view of the relevant circumstances, it is necessary
to do so.

Full Value of Consideration Received

The term ‘consideration’ usually refers to the purchase price that is agreed between
the parties under the terms of the contract. Net consideration means the full value of
the consideration received or accruing as a result of the transfer of the capital asset
as reduced by any expenditure incurred wholly or exclusively in connection with such
transfer.
Ordinarily, the value declared in the transfer deed is taken as full value of
consideration received. However, in case of land and building, where the stamp
valuation authority (SVA) fixes a value higher than the transfer price claimed by the
assessee, the value fixed by the SVA is taken as the full value of consideration
(Section 50C (1) of ITA). In order to avoid arbitrariness, the assessee is allowed to
object to the higher valuation by the SVA.

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Check Your Progress - 2

1. Define cost of acquisition of an asset.

................................................................................................................
................................................................................................................
................................................................................................................

2. What is meant by fair market value?

................................................................................................................
................................................................................................................
................................................................................................................

3. Which type of expenditure is included in cost of improvement as per ITA?

................................................................................................................
................................................................................................................
................................................................................................................

9.4 COMPUTATION OF LONG TERM CAPITAL GAINS TAX

In the case of resident individuals, HUFs, domestic companies and other assessees,
the tax on long term capital gains is computed by going through the following steps.
First, the total taxable income of the assessee is reduced by the amount of long term
capital gains included in the total income and the tax is calculated on the balance
income as if it were the total taxable income of the assessee. To this figure the tax on
long term capital gain is added, which is 20 per cent of the capital gains.
However, where the total income, as reduced by long term capital gains, is
below the maximum amount not chargeable to income tax, then tax at the rate of 20
per cent shall be chargeable only on so much of the capital gains which together with
the other income exceeds the maximum amount not chargeable to tax.
A notified Foreign Institutional Investor (FII) is required to pay tax at the rate of
30 per cent on short term capital gains and 10 per cent on long term capital gains
arising out of transfer of securities. The tax is levied on the gross amount of capital
gains. No deductions are allowed from this amount even under the sections relating
to ‘profit and gains from business or profession’ or ‘income from other sources’.
Similarly, indexation of cost of acquisition is also not allowed.
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In the case of non-residents persons, long term capital gains arising on transfer
of a ‘specified asset’ is taxed at the rate of 10 per cent. Specified asset means shares
of an Indian company, debentures of and deposits of an Indian company other than
a private company and government securities or notified assets. All other long term
capital gains are taxed at the rate of 20 per cent. However, no deduction is allowed
and no indexation of cost of acquisition of asset is permitted.

Illustration
Mr Abhay purchased a flat measuring 1,000 square feet in Mumbai in April 1961 at
the rate of 25 per square feet and sold the same in December 2005 at the rate of
8,000 per square feet. The fair market value on 1 April 1981 was 600 per
square feet. Abhay spent 80,000 on brokerage and 20,000 on legal consultation
in connection with the sale of the flat. Compute the capital gain from the above
transaction.

Solution
The above transaction involves long term capital gain as the property was held by
the assessee for more than 36 months before its sale. As the flat was acquired
before 1 April 1981, the cost of acquisition is taken as fair market value (FMV) of
the property on
1 April 1981 as it is advantageous to the assessee. Further, being long term
capital gain we have to apply the cost inflation index (CII). The long term capital gain
is computed as follows:
Full value of consideration 8,000,000
Less: Indexed Cost of Acquisition
(FMV on 1 April 1981) multiplied by (CII of the financial year of sale)
divided by (CII of the financial year of 1981-82), that is
600000 X 497 / 100 = 2,982,000
Less: Expenditure in connection with the sale (80,000 + 20000)100,000
Long Term Capital Gain 4,981,000

Exemptions from Capital Gains Taxation

There are a number of exemptions provided by the ITA where gains on transfer of
a capital asset, though otherwise taxable, are not liable to tax if certain conditions are
satisfied. These exemptions are available in the following circumstances:

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 Transfer of a residential house

 Transfer of agricultural land
 Compulsory acquisition of land and buildings forming part of an industrial
undertaking
 Investment of capital gains in certain bonds
 Transfer of a capital asset other than a residential house
 Shifting of an industrial undertaking from an urban area

Transfer of a Residential House (Section 54 of ITA)

Long term capital gains arising on transfer of a residential house is exempt if the
amount of capital gains is utilized in acquiring another residential house, either by
purchase or by construction. Exemption is also available if the investment is made
partly in the land and partly in construction of a residential house. The benefit is,
however, available only to individuals and HUFs.
If the investment cost of a new residential house exceeds the amount of capital
gains, there is no tax. Where the cost of new house is less than the amount of capital
gain, the gain in excess of the cost of new house is taxed as capital gain. For
example, if the capital gain on transfer of a residential house is 5,00,000 and a new
residential house is purchased for 4,50,000, then the amount by which the cost of
purchase of new residential house is less than the capital gain is taxable, that is
50,000.
Where the acquisition of a new asset is by purchase, the investment in the new
house must be made one year before or two years after the date of transfer of
original asset. The construction of the new house must be completed within three
years of the date of transfer of the original asset.
If the investment in the new asset has not been made by the due date for
furnishing the return of income for the relevant assessment year, the unutilized amount
of capital gains must be deposited before the due date of filing of return in a separate
bank account under the Capital Gains Account (CGA) Scheme, 1988. If the amount
deposited is not utilized wholly or partly for the purpose of purchase or construction
of the new asset within three years, the unutilized portion shall be taxable as capital
gains in the previous year in which the period of three years expires.

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Transfer of Agricultural Land (Section 54B of ITA)

Any capital gain arising on transfer of agricultural land is exempt if the amount of
capital gains is utilized in acquiring another piece of land for use for agricultural
purposes. The benefit is, however, available only to individuals. This exemption is
subject to the following conditions:
 Land transferred must have been used at least for two years immediately
before the transfer by the tax payer or his parents for agricultural purposes.
 The assessee must acquire within two years of the date of transfer another
piece of land for use for agricultural purposes.
 Asset acquired must not again be transferred within 3 years of its purchase.
Where the cost of new agricultural land exceeds the amount of capital gains on
transfer of original land, there is no capital gains tax. If the cost of new asset is less
than the amount of capital gains, the gain in excess of the cost of new asset is alone
liable to tax.
If the new asset is not acquired by the due date for filing the return of income for
the relevant assessment year, the unutilized amount of capital gain must be deposited
in a bank account under the Capital Gains Account Scheme, 1988. Thereafter, the
new agricultural land must be acquired within the time period specified by making
appropriate withdrawals from the scheme. If the whole or part of the amount is not
utilized in acquiring the new asset then the unutilized portion of the deposited amount
shall be taxable as capital gains of the previous year in which the period of two years
expires.
Where the new asset is transferred within three years of its purchase, the
exemption is withdrawn in the sense that the cost of new asset is treated as reduced
by the amount of capital gains treated as exempt at the time of original transfer.

Compulsory Acquisition of Land and Buildings Forming a Part of an

Industrial Undertaking (Section 54D of ITA)
Long term capital gains arising on transfer of land or building which formed part of
an industrial undertaking belonging to an assessee by way of compulsory acquisition
under any law is exempted. This exemption is available to all categories of assessees.
The conditions for exemption of capital gains are as under:
 The asset transferred should be land or building or any right in land or
building which formed part of an industrial undertaking belonging to the
assessee.

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 The asset in question is transferred by way of compulsory acquisition under

any law.
 The asset in question was being used for the purpose of the industrial
undertaking for at least for two years immediately before the date of
compulsory acquisition.
This exemption is available if within three years of the date of compulsory
acquisition, the taxpayer for the purposes of shifting or re-establishing the old
industrial undertaking or setting up a new industrial undertaking: (i) purchases any
other land, building or any other right in any other land or building, or (ii) constructs
any other building for the purpose of the business of the assessee.
If the investment in a new asset or assets exceeds the amount of capital gain,
there is no tax. Where the cost of new asset is less than the amount of capital gain,
the exemption is available only for the amount of investment in the new asset.
If the new asset is not acquired by the due date for filing the return of income for
the relevant assessment year, the unutilized amount of capital gain must be deposited
in a bank account under the Capital Gains Account Scheme 1988. Thereafter, the
new asset must be acquired within the time period specified by making appropriate
withdrawals from the scheme. If the whole or part of the amount is not utilized in
acquiring the new asset then the unutilized portion of the deposited amount shall be
taxable as capital gains of the previous year in which the period of three years
expires.
If the new asset is transferred within three years of its acquisition, the exemption
is withdrawn in the sense that the cost of acquisition of the new asset is treated
reduced by the amount of capital gain treated as exempt at the time of original
transfer.

Investment in Certain Bonds (Section 54EC of ITA)

Any long-term capital gain is exempt if the same is invested, within six months of the
transfer, in specified long term assets. Specified long term assets have been defined
to include any bond redeemable after three years issued by: (i) National Highways
Authority of India (NHAI); and (ii) Rural Electrification Corporation Limited
(RECL) on or after March 31, 2006.
If the investment in new asset or assets exceeds the amount of capital gain, there
is no tax. Where the cost of new asset is less than the amount of capital gain, the
exemption is available only for the amount of investment in the new asset.

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Where the new asset is transferred within three years of its purchase, the
exemption is withdrawn in the sense that the cost of new asset is treated as reduced
by the amount of capital gains treated as exempt at the time of original transfer.

Transfer of any Asset other than a Residential House (Section 54F of ITA)
Long term capital gain arising out of transfer of any capital asset other than a
residential house by an individual or a HUF is exempted if the amount of capital
gains is utilized in acquiring a residential house, either by purchase or by
construction. Exemption is also available if the investment is made partly in the land
and partly in construction of residential house. This exemption is available subject of
the fulfilment to the following conditions:
 The assessee should not hold more than one residential house on the date
of transfer of the original asset.
 No other residential house should be: (i) purchased by the assessee within
two years after the date of transfer of original asset, or (ii) constructed by
the assessee within three years after the date of transfer of original asset.
If the investment in a new asset or assets exceeds the amount of capital gain,
there is no tax. Where the cost of new asset is less than the amount of capital gain,
the exemption is available only for the amount of investment in the new asset.
If the investment in the new asset has not been made by the due date for
furnishing the return of income for the relevant assessment year, the unutilized amount
of capital gains must be deposited before the due date of filing of return in a separate
bank account under the Capital Gains Account (CGA) Scheme, 1988. If the amount
deposited is not utilized wholly or partly for the purpose of purchase or construction
of the new asset within three years the unutilized portion shall be taxable as capital
gains in the previous year in which the period of three years expires.

Shifting of an Industrial Undertaking from an Urban Area (Section 54G of

ITA)
Long term gains arising out of machinery, plant, building, land or any right in building
or land used for the business of an industrial undertaking from an urban area is
exempted. The exemption is available to all categories of tax payers. The conditions
for claiming exemption are as under:
 The transfer is affected in the course of or in consequence of shifting the
undertaking from an urban area to other than an urban area.

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 Asset transferred is machinery, plant, building, land or any right in building

or land used for the business of an industrial undertaking situate in an urban
area.
 The assessee has within one year before or three years after the date of
transfer purchased new machinery or plant for the business of the industrial
undertaking in the area to which the said undertaking is shifted and has
acquired building or land or has constructed building for the purposes of his
business in the said area and has shifted the original asset and transferred
the establishment of such undertaking to such area and has incurred
expenses on such other purpose as may be specified in a scheme framed
by the Central Government for the purposes of this Section.
If the expenses for the aforesaid new asset and activities exceed the amount of
capital gain, there is no tax. If the expenses incurred are less than the amount of
capital gain, only the unutilized amount is taxed as capital gain.
In order to avail this exemption the unutilized amount of capital gain as on the
date on which return of income for the relevant assessment year is due must be
deposited in a bank account under the Capital Gains Accounts Scheme, 1988.
Thereafter the new asset must be acquired and expenses related to the assets must
be expended within the time period specified in the Section by making appropriate
withdrawals from the bank account. If the amount deposited in the said scheme is
not utilized wholly or partly for all or any of the purposes mentioned above within
the period of three years then the amount not so utilized shall be charged as capital
gains of the previous year in which the period of three years from the date of transfer
of the original asset expires.

Check Your Progress - 3

1. Which section of the ITA exempts long-term capital gains arising on

transfer of a residential house?
................................................................................................................
................................................................................................................
................................................................................................................

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2. Which types of bonds are included in specified long-term assets?

................................................................................................................
................................................................................................................
................................................................................................................

9.5 SUMMARY

 Capital gains are gains from the transfer of capital assets. Capital losses are
losses or reductions in value resulting from the sale or exchange of capital
assets.
 Any gain obtained by an assessee from the transfer of a capital asset is
taxable under ITA.
 The term ‘capital’ connotes what a man has invested or sunk into his
business out of his wealth and the term ‘income’ means yield or the
produce roped in by him during a particular period of time from the capital
so invested.
 Under ITA, income includes gains derived on transfer of a capital asset.
 When a person sells (or transfers) a capital asset, the difference between
the sale price and the cost of its acquisition, plus the cost of any
improvement and the cost of effectuating the transfer, is either a capital gain
or a capital loss.
 Almost everything people own and use for personal purposes or investment
qualifies as capital assets.
 Capital asset means property of every kind held by an assessee, whether or
not, it is held for his business or profession. It includes all corporeal and
tangible properties as well as all kinds of rights in property.
 There are two types of capital assets, namely, long term capital asset and
short term capital asset.
 Ordinarily, a capital asset that is held for 36 months or less before its
transfer is called a short term capital asset. Conversely, a capital asset that
is held for a period beyond 36 months is called a long term capital asset.
 The capital gains on the transfer of the long term capital asset are termed
long term capital gains and the capital gains on the transfer of short term
capital asset are termed short term capital gains.
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 Capital gain or a capital loss is a gain realised or loss incurred in

transferring an asset.
 Transfer means ‘putting one person (called the transferee) in place of
another (called the transferor) as owner of an item of property’.
 Ordinarily, the transfer of movable property takes place when the item is
delivered. In the case of immovable property, the transfer of property takes
place when the conveyance deed is registered.
 The income chargeable under the head ‘capital gains’ is calculated by
reducing the full value of the consideration received (or accruing) as a result
of the transfer of the capital asset by the sum of: (i) the cost of acquisition
of the capital asset; (ii) the cost of improving the asset; and (iii) the
expenditure incurred wholly and exclusively in connection with the transfer.
 Where a capital gain arises due to the ‘transfer of a long term capital asset’
then instead of the ‘cost of acquisition’ and ‘cost of improvement’, the
indexed cost of acquisition and the indexed cost of improvement should be
subtracted from the full value of the consideration.
 The expenditure incurred wholly and exclusively in connection with the
transfer of a capital asset can be claimed as a deduction from the full value
of consideration received (or accrued) for computing the capital gain.
 Cost of acquisition refers to the expenditure incurred by the assessee in
acquiring the asset. By its very nature, the cost of acquisition of an asset is
capital expenditure.
 Fair market value in relation to a capital asset means the price that the
capital asset would ordinarily fetch on sale in the open market on the target
date.
 Cost of improvement includes all expenditure of a capital nature incurred
after 31 March 1981 by an assessee in making any additions to the capital
asset and also includes expenditure incurred to protect or complete the title
to the capital asset and to cure such title from any defect.
 The cost of improvement in relation to goodwill, or a right to manufacture,
produce or process any article or thing is taken as nil.
 For the purpose of computing long-term capital gains, the cost of
acquisition is to be multiplied by the ratio of cost inflation index of the year
in which the asset is transferred and the cost inflation index of the year in
which the asset was acquired.
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 Long term capital gains arising on transfer of a residential house is exempt

if the amount of capital gains is utilized in acquiring another residential
house, either by purchase or by construction.
 Any capital gain arising on transfer of agricultural land is exempt if the
amount of capital gains is utilized in acquiring another piece of land for use
for agricultural purposes.

9.6 KEY WORDS

 Capital losses: These are the losses or reductions in value resulting from
the sale or exchange of capital assets.
 Capital assets: It refers to all the things that people own and use for
personal purposes or investment such as homes, household furnishings,
store equipment, computers, stocks and bonds.
 Cost of acquisition: It refers to the expenditure incurred by the assessee
in acquiring the asset.
 Depreciation: It refers to a reduction in the value of an asset over time,
particularly due to wear and tear.

9.7 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. The two assets expressly excluded from the definition of capital asset are as
follows:
a) Stock-in-trade, consumable stores and raw material held for purposes
of the assessee’s business or profession.
b) Personal effects, that is, movable property such as wearing apparel,
furniture, motor vehicles, etc.
2. A short-term capital asset is held for 36 months or less before its transfer
whereas a long-term capital asset is held for a period beyond 36 months.

Check Your Progress - 2

1. Cost of acquisition refers to the expenditure incurred by the assessee in
acquiring the asset.

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2. Fair market value in relation to a capital asset means the price that the
capital asset would ordinarily fetch on sale in the open market on the target
date.
3. Cost of improvement includes all expenditure of a capital nature incurred
after 31 March 1981 by an assessee in making any additions to the capital
asset and also includes the expenditure incurred to protect or complete the
title to the capital asset and to cure such title from any defect as per Income
Tax Act (ITA).

Check Your Progress - 3

1. Section 54 of ITA exempts long-term capital gains arising on transfer of a
residential house.
2. Specified long-term assets include any bond redeemable after three years
issued by the National Highways Authority of India (NHAI) and the Rural
Electrification Corporation Limited (RECL) on or after March 31, 2006.

9.8 SELF-ASSESSMENT QUESTIONS

1. Define the term ‘capital asset’ in the context of the Income Tax Act, 1961.
2. What are the various types of capital assets?
3. How is the cost of acquisition of an asset defined under ITA?
4. What are the conditions for exemption on transfer of agricultural land under
ITA?
5. Describe the various exemptions granted from income under the head
‘capital gains’ under the Income Tax Act, 1961.
6. Write a short note on each of the following:
(i) Cost inflation index
(ii) Notional cost of acquisition
(iii) Cost of improvement
7. What do you understand by the term ‘transfer of capital asset’? Describe
the transactions that are not recognized as transfer by the Income Tax Act,
1961.

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9.9 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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UNIT–10 INCOME FROM OTHER SOURCES

Objectives
After going through this unit, you will be able to:
 Analyse the meaning of the term 'income from other sources' and learn about
its constituents
 Identify the allowable deductions that can be made under the head 'income
from other sources'
 Assess the provisions relating to taxation of casual income
 Evaluate interest on securities and know how to gross up interest
 Discuss the provisions of the Income Tax Act, 1961, regarding taxation of
gifts

Structure
10.1 Introduction
10.2 What Constitutes Income from Other Sources?
10.3 Deductions from Income from Other Sources
10.4 Method of Accounting
10.5 Taxation of Gifts
10.6 Summary
10.7 Key Words
10.8 Answers to ‘Check Your Progress’
10.9 Self-Assessment Questions
10.10 Further Readings

10.1 INTRODUCTION

In the previous unit, you learnt about income from capital gains. Here, we will study
about income from other sources.
‘Income from Other Sources’ is a residuary head of income that includes any
item of income chargeable to tax that does not come under the domain of the other
four specific heads of income. Any income other than income from salary, house
property, business and profession or capital gains is included in income from other
sources. This unit will discuss about various concepts related to income from other
sources in detail.

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Income from
Other Sources

10.2 WHAT CONSTITUTES INCOME FROM OTHER

SOURCES?

Income from other sources deals with income which is not included under any other
head of income. Income from other sources does not come into operation until the
preceding heads are excluded (CIT v. Basant Raj Takht Singh (1933) 1 ITR 197,
201 (PC)).
Certain incomes are always to be taxed under this head of income: Under
Section 56(2) of ITA, any winnings from lotteries, crossword puzzles, races
including horse races, card games and other games of any sort or from gambling or
betting of any form or nature are taxable under the ‘head income from other
sources’.
Certain other incomes are chargeable to tax under this head only if the same are
not otherwise chargeable to tax under the head ‘salaries’ or ‘profits and gains of
business or profession’. These incomes include:
 Any sum received by the assessee from his employees as contribution to
any provident fund or superannuation fund or any other fund set up for the
welfare of the employees
 Income by way of interest on securities
 Income from machinery, plant or furniture belonging to the assessee and let
on hire
 Income from letting on hire machinery, plant or furniture belonging to the
assessee along with buildings if the letting of the building is inseparable from
the letting of the said machinery, plant or furniture
 Any sum received under a Keyman insurance policy including the sum
allocated by way of bonus on such policy
The courts have held the following incomes to be taxable under this residuary
head of income:
 Salaries received by a person who cannot be termed an employee
 Annuities which are not provided by the employers
 Salaries of Members of Parliament and MLAs
 Rental incomes from properties which are not owned by the assessee e.g.
in cases of subletting or in respect of sub lease of properties, etc.

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Other Sources

 Interest on fixed deposits and other deposits before the commencement of

business. Interest income may become ‘profits and gain from business and
profession’ if the investment yielding interest was done in the course of, and
a part of, business. However, where a company, after incorporation, did
not commence business, but merely derived interest income by depositing
money in bank account, was held to be income from other sources (MP
State Industries Corporation Limited v. CIT (1969) 72 ITR 503 (Ker))
 Family pensions
 Income from grant of mining rights
 Income from grant of grazing rights
 Directors’ fees
 Gratuitous payments received by a member of a family from a company in
which the family has substantial interest

Provisions relating to taxation of casual income

The proviso to section 234C contains the provisions for payment of advance tax in
case of capital gains and casual income. Advance tax is payable by an assessee on
total income, which includes capital gains and casual income like income from
lotteries, crossword puzzles. Since it is not possible for the assessee to estimate his
capital gains, or income from lotteries, it has been provided that if any such income
arises after the due date for any instalment, then the entire amount of the tax payable
(after considering tax deducted at source) on such capital gains or casual income
should be paid in the remaining instalments of advance tax, which are due. Where no
such instalment is due, the entire tax should be paid by 31 March of the relevant
financial year. No interest liability on late payment would arise if the entire tax liability
is so paid.

Check Your Progress - 1

1. List any two types of incomes that are chargeable to tax under income
from other sources and not otherwise chargeable to tax under salaries/
profits and business/profession gains.
................................................................................................................
................................................................................................................
................................................................................................................

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Income from
Other Sources

2. Name any four incomes that are taxable under income from other
sources.
................................................................................................................
................................................................................................................
................................................................................................................

10.3 DEDUCTIONS FROM INCOME FROM OTHER SOURCES

Certain deductions are allowed from the income falling under the head ‘income from
other sources’. Generally, an item of expenditure is deductible if it is laid out wholly
and exclusively for the purpose of making or earning the incomes from other
sources; and as long as the expenditure is not of a capital nature (Section 57 (iii) of
ITA).
One of the preconditions of deductibility is that the expenditure must be incurred
wholly and exclusively for the purpose of making or earning the income. The term
‘purpose’ implies the ‘thing intended or the object’ and not the motive behind the
action. The motive of the expenditure is irrelevant as long as it was for the purpose
of making or earning the income (Kevalchand Nemchand Mehta v. CIT (1968)
67 ITR 804, 815-816 (Bom)). There must, therefore, be a nexus between the
character of the expenditure and the earning of income. However, it is not necessary
to show that the expenditure was profitable one, or that profit was actually received
(Moore v. Stewarts and Lloyds (1906) 6 Tax Cas 501).
Besides the general deductions discussed above, certain specific deductions are
also permitted from the income from specific sources as under:
1. Interest on securities: Any reasonable sum paid by way of commission
or remuneration to a banker or any other person for the purpose of
realising such dividend or interest on behalf of the assessee.
2. Employees contributions received by an employer: The amounts paid
by the assessee employer by way of crediting the employees’ account in
the relevant fund on or before by the due date specified under any Act,
rule, order or notification issued thereunder.
3. Income from machinery, plant or furniture let on hire: Amount spent
on current repairs of the premises and on current repairs of machinery,
plant or furniture. Amount of any premium paid in respect of insurance

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Other Sources

against risk of damage or destruction of the premises, machinery, plant or

furniture. Depreciation in respect of the building, machinery, plant and
furniture may also be claimed as a deduction.
4. Joint letting of machinery and building: From the income earned by
letting on hire machinery, plant or furniture belonging to the assessee along
with buildings if the letting of the building is inseparable from the letting of
the said machinery, plant or furniture, the assessee is allowed a deduction of
the amount spent on current repairs of the premises and on current repairs
of machinery, plant or furniture.
Amount of any premium paid in respect of insurance against risk of damage
or destruction of the premises, machinery, plant or furniture and
depreciation in respect of the building, machinery, plant and furniture are
also allowed as a deduction.
5. Family pension: A sum equal to one-third of such income or 15,000,
whichever is less is allowed as a deduction from family pensions.
Where any expense or allowance has been allowed to the assessee in an
earlier previous year from the income from other sources and in any
subsequent previous year the assessee obtains any amount in respect of
such expenditure or allowance in cash or in kind or some benefit on
account of any remission or cessation thereof, such amount or the value of
such benefit shall be chargeable to tax in the year of remission or cessation
as income from other sources. This amount is taxable irrespective of the
fact whether the relevant income from other sources is in existence in the
subsequent previous year or not.

Amounts Not Deductible From Other Sources (Section 58)

There are certain amounts which are not allowed as a deduction from the income
from other sources. Such expenses include:
 Personal expenses of the assessee
 Interest chargeable under the ITA which is payable outside India but on
which no tax was deducted at source
 Any payment which is chargeable under the head ‘salaries’ if it is payable
outside India but on which no tax was deducted at source
 Any sum paid on account of wealth tax

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Income from
Other Sources

The ITA prohibits any deduction in respect of any expenditure or allowance in

connection with winnings from lotteries, crossword puzzles, races, including horse
races, card games, and other games of any sort or from gambling or betting of any
form or nature. A ‘horse race’ means a horse race upon which wagering or betting
may be lawfully made. However this prohibition does not apply to an assessee who
is the owner of horses maintained by him for running in horse races when he earns
income from other sources from the activity of owning and maintaining such horses.

Check Your Progress - 2

1. What does Section 57 (iii) of the ITA state?

................................................................................................................
................................................................................................................
................................................................................................................

2. List some of the amounts that are not allowed as a deduction from the
income from other sources.
................................................................................................................
................................................................................................................
................................................................................................................

10.4 METHOD OF ACCOUNTING

Like in the case of income from the head ‘profits and gains from business and
profession’, income under the head ‘income from other sources’ must be computed
in accordance with the method of accounting regularly employed by the assessee.
The assessee is free to choose the method of accounting (BCGA (Punjab) Ltd. v.
CIT 5 ITR 279, 299 (FB)). Generally, the assessee should choose the method of
accounting at the outset of business. The method of accounting once chosen cannot
be changed casually.

Grossing Up Of Interest
If interest is received after TDS is deducted, then while calculating gross total
income, the net interest is grossed up. It is done as follows:
If net interest received is 990 and TDS is deducted at 10%, then grossing up
of interest will be done as follows:
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Other Sources

Interest × 100
90

Grossing up is when interest is given after deducting TDS and the interest
income is grossed up. It can be calculated as follows:
Amount after TDS × 100
100-rate at which TDS is deducted

Rules of grossing up interest

1. If rate of interest is given, grossing up is done only for tax-free non-
governmental securities.
2. Interest on tax-free non-governmental securities is always net interest and
hence it is to be grossed up irrespective of whether interest rate or amount
is given.
3. Interest on less tax non-governmental securities is grossed up only when
amount is given.

Formula for grossing up

(a) Listed securities @ 10%
(i) Without surcharge if net income = 10,00,000
Income tax @ 10%
+ Surcharge Nil
————
10%
+ Education Cess @ 2% (10 × 2%) 0.2%
————
Total 10.2%
Net amount Net amount
Therefore Gross amount = ————— × 100 = —————— × 100
(100-10.2) 89.8
(ii) With surcharge if net income > 10,00,000
Income tax @ 10%
+ Surcharge @ 10% of income tax
(10 x 10%) 1%
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Other Sources

————
11%
+ Education cess @ 2% of
Income tax + Surcharge (11 × 2%) 0.22%
————
Total 11.22%
Net amount Net amount
Therefore Gross amount = —————— × 100 = ————— × 100
(100-11.22) 88.78
(b) Unlisted securities @ 20%
(i) Without surcharge if net income = 10,00,000
Income tax @ 20%
+ Surcharge NIL
————
20%
+ Education Cess @ 2% (20 x 2%) 0.4%
————
Total 20.4%
Net amount Net amount
Therefore Gross amount = ————— × 100 = ————— × 100
(100-20.4) 79.6
(ii) With surcharge if net > 10,00,000
Income tax @ 20%
+ Surcharge ! 10% of Income tax
(20 × 10%) 2%
————
22%
+ Education Cess @ 2% 0.44%
of income tax + Surcharge (22 x 2%) —————
Total 22.44%
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Other Sources

Net amount Net amount

Therefore Gross amount = —————— × 100 = ————— × 100
(100-22.44) 77.56
(c) Casual Income @ 30%
(i) Without surcharge if net income = 10,00,000
Income tax @ 30%
+ Surcharge NIL
————
30%
+ Education cess @ 2% (30 × 2%) 0.6%
————
Total 30.6%
Net amount Net amount
Therefore Gross amount = ————— × 100 —————— × 100
(100-30.6) 69.4
(ii) With surcharge if net income > 10,00,000
Income tax @ 30%
+ Surcharge @ 10% of income tax
(30 x 10%) 3%
————
33%
+ Education Cess @ 2% of income
tax + surcharge (33 × 2%) 0.66%
————
Total 33.66%
Net amount Net amount
Therefore Gross amount = —————— × 100 = ————— × 100
(100-33.66) 66.34

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Income from
Other Sources

Check Your Progress - 3

1. What is the method of computing income under the head ‘income from
other sources’?
................................................................................................................
................................................................................................................
................................................................................................................

2. What happens if interest on income is received after TDS is deducted?

................................................................................................................
................................................................................................................
................................................................................................................

10.5 TAXATION OF GIFTS

People receive gifts from their friends and relatives, and also from NRls. The
updated provisions of the Income Tax Act, 1961, regarding gifts helps examine how
individuals can attain full exemption from paying income tax in respect of the gifts
received during the financial year. (The sections mentioned below refer to the
Income Tax Act, 1961.)

Gifts are taxable only in the case of individuals and HUFs

Under the provisions of Section 56(2)(vi), certain gifts are liable to income tax as
‘income from other sources’. But, this provision is applicable only for individuals and
Hindu Undivided Families (HUFs). Thus, if gifts are received by any Trust or AOP,
then it is not liable to income tax as ‘income from other sources’. The provision of
taxation of gifts became applicable in respect of gifts received on or after 1.9.2004
and before 1.4.2006 if the gift money exceeded 25,000. From 1.4.2006, this
amount has been increased to 50,000 so that cash gifts and gifts by cheque or
bank draft from non-relatives and from non-exempted categories can be fully
exempt from income tax up to 50,000 in aggregate in one financial year.

Gifts from relatives are exempt from tax

The provisions of the aforesaid Section 56(2)(vi) applicable to the taxation of gifts in
excess of 50,000 in a financial year in the aggregate are applicable for gifts
received from non-relatives. Thus, any gift from relatives of any amount during the
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financial year is completely exempt from tax. Therefore, it is crucial to know the
meaning of the expression ‘relative’ for this purpose. The explanation to Section
56(2)(vi) provides that the expression ‘relative’ means:
(i) Spouse of the individual
(ii) Brother or sister of the individual
(iii) Brother or sister of the spouse of the individual
(iv) Brother or sister of either of the parents of the individual
(v) Any lineal ascendant or descendant of the individual
(vi) Any lineal ascendant or descendant of the spouse of the individual
(vii) Spouse of the person referred to in clauses (ii) to (vi)
Thus, a gift received by an individual from his spouse, or from his brother or sister,
or from the spouse’s brother or sister, parents, or from any lineal ascendant or
descendant of oneself or one’s spouse would normally be fully tax exempt. Similarly,
any gifts of any amount whatsoever received from the spouses of any of these
persons would also be completely exempt from income tax.
For example, if Mr. A receives a gift of 200,000 in cash from his maternal
uncle, that is, his mother’s brother, it would be exempt since the maternal uncle
would be brother of the parent of the individual concerned and would come within
clause (iv) of the aforesaid explanation.
Hence, whenever you receive any gifts from relatives you must carefully apply
the test to ascertain whether the person concerned falls within one of the seven
categories of ‘relatives’ or not. If a person who makes a gift does not fall within any
of the above categories, then he would be considered as a non-relative and gifts
from such people would be exempt only up to the extent of 50,000 in a financial
year. It may be noted that since an HUF cannot have relatives, any gifts received by
it in excess of 50,000 in a year would be liable to full income tax.

Exemption for marriage gifts

Any gift received from any person on the occasion of the marriage of the gift’s
recipient would not be liable to income tax at all. There is no monetary limit attached
to this exemption, which is provided by the proviso to Section 56(2)(vi). However,
it is not made clear by this provision whether the gifts should have been on the exact
date of marriage or a few days before or later. Normally, it should suffice if the gift
is given just on the occasion of the individual’s marriage, which means either on the

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Other Sources

day of the marriage itself or a day or two before or after. Practical common sense
view would prevail in such cases.

Tax-exempt gifts from other persons

The following are the other gifts completely exempt from tax as provided in the
proviso to Section 56(2)(vi) of the IT Act:
1. Gift received under a will or by way of inheritance
2. Gift in contemplation of death of the donor
3. Gift from any local authority
4. Gift from any fund or foundation or university or other educational institution
or hospital or any trust or any institution referred to in Section 10(23C)
5. Gift from any trust or institution, which is registered as a public charitable
trust or institution under Section 12AA
Thus, scholarships, stipends or charities received from a charitable institution would
be completely exempt from income tax in the hands of the recipients without any limit
provided the trust or institution giving the charity is registered under Section 12AA.
Likewise, all gifts under a will, and all amounts received on the death of a person as
a part of the inheritance are fully exempt from income tax.

Gifts in kind are tax exempt

Gifts in kind, such as a gift of shares, land, house, units or mutual funds, jewellery,
would not be liable to any income tax at all. Individuals can receive gifts from the
following sources:
 Relatives or blood relatives
 At the time of marriage
 As inheritance
 In contemplation of death

Gifts exempted from tax

 The gift was given by a blood relative, irrespective of the gift value.
 Immovable properties located outside the country.
Movable properties outside the country, unless the donor –
 Individual is an Indian citizen, who is originally a resident of India
 No individual is resident of India during the year of gift

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Other Sources

 Out of balance gift by NRI in his non-resident account

 Foreign currency gift of convertible foreign exchange, remitted from
overseas by an NRI to a resident relative
 Foreign exchange asset gifted by NRI to his/her relatives
 Special Bearer Bonds, 1991
 Saving certificates issued by the Central Government (notified as
exempted)
 Capital investment bonds up to 10,00,000 per year
 Relief bonds gifts by an original subscriber
 Gifts of certain bonds from the NRI to his/her relatives, which are
subscribed in foreign currency (specified by the Central Government)
 Gift to government or any local authority
 Gifts to any charitable institutions
 Gifts to notified temples, churches, mosques, gurudwaras and other places
of worship
 Gift to children for educational purpose
 Gifts by an employer to its employees in the form of bonus, gratuity or
pension
 Gifts under will
 Gifts in contemplation of death
Illustration 10.1
Mr. Z received the following gifts during the P.Y. 2008–09 from his friend Mr. Y:
(1) Cash gift of 1,00,000 on his birthday, 19 June 2009.
(2) 50 shares of ABC Ltd., the fair market value of which was 1,00,000, on
his birthday, 19th June, 2009.
(3) 100 shares of MNO Ltd., the fair market value of which was 55,000 on
the date of transfer. This gift was received on the occasion of Diwali. Mr. Y
had originally purchased the shares on 1 July 2009 at a cost of 40,000.
Further, on 17 December 2009, Mr. Z purchased land from his sister’s brother-in-
law for 3,50,000. The stamp value of land was 5,00,000. On 1 March 2010, he
sold the 100 shares of XYZ Ltd. for 80,000.
Compute the income of Mr. Z chargeable under the head ‘Income from Other
Sources’ for A.Y. 2009–10.
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Income from
Other Sources

Solution
Computation of Income from Other Sources of Mr. Z for 2009-10
Particulars Rupees
(1) Cash gift received before 1.10.2009 is taxable u/s 56(2)(vi) since 1,00,000
it exceeds Rs.50,000
(2) Value of shares of B Ltd. gifted by Mr.Y on 19th June, 2009 is not —
taxable since only gift of property after 1st October, 2009 is
chargeable to tax u/s 56(2)(vii).
(3) Fair market value of shares of A Ltd. is taxable since the gift was 55,000
made after 1st October, 2009 and the aggregate fair market value
exceeds Rs.50,000.
Purchase of land for inadequate consideration on 17.12.2009 would
attract the provisions of section 56(2)(vii), since the difference
between the stamp value and consideration exceeds Rs.50,000.
Brother’s father-in-law does not fall within the definition of “relative”
u/s 56(2).

Stamp Value 5,00,000

Less: Consideration 3,50,000
1,50,000
_________
Income from other sources 3,05,000

Check Your Progress - 4

1. To whom is the provision of taxation on gifts applicable?

................................................................................................................
................................................................................................................
................................................................................................................

2. What categories of gifts are exempt from income tax?

................................................................................................................
................................................................................................................
................................................................................................................

10.6 SUMMARY

 Income from other sources deals with income which is not included under
any other head of income. Certain deductions are allowed from the income
falling under the head ‘income from other sources’. There are certain
sources of income from which deductions are not allowed.

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 Income from
Other Sources

 Certain incomes are always to be taxed as income from other sources:

winnings from lotteries, crossword puzzles, races including horse races,
card games and other games of any sort or from gambling or betting of any
form or nature.
 Generally, an item of expenditure is deductible if it is laid out wholly and
exclusively for the purpose of making or earning the incomes from other
sources, and as long as the expenditure is not of a capital nature.
 The Income Tax Act prohibits any deduction in respect of any expenditure
or allowance in connection with winnings from lotteries, crossword puzzles,
races, including horse races, card games, and other games of any sort or
from gambling or betting of any form or nature.
 A gift received by an individual from his spouse, or from his brother or
sister, or from the spouse’s brother or sister, parents, or from any lineal
ascendant or descendant of oneself or one’s spouse would normally be
fully tax exempt.
 If a person who makes a gift is considered a non-relative, gifts from such a
person would be exempt only up to the extent of 50,000 in a financial
year. Since an HUF cannot have relatives, any gifts received by it in excess
of 50,000 in a year would be liable to full income tax.
 Gifts in kind, such as a gift of shares, land, house, units or mutual funds,
jewellery, would not be liable to any income tax at all. Individuals can
receive gifts from relatives or blood relatives, at the time of marriage, as
inheritance and in contemplation of death.

10.7 KEY WORDS

 Grossing up of interest: It is done when interest is given after deducting

TDS and the interest income is grossed up.
 Income from other sources: It is the residual head of income that covers
any item of taxable income which does not specifically fall under the other
heads of income: income from profits and gains of business or profession,
capital gains, house property, or salary.
 Interest on securities: It is any reasonable sum paid by way of
commission or remuneration to a banker or any other person for the
purpose of realizing such dividend or interest on behalf of the assessee.
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Income from
Other Sources

 Relative: The term ‘relative’ includes the spouse of the individual, brother
or sister of the individual, brother or sister of the spouse of the individual,
brother or sister of either of the parents of the individual, any lineal
ascendant or descendant of the individual, any lineal ascendant or
descendant of the spouse of the individual.

10.8 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. Certain incomes are chargeable to tax under income from other sources
only if the same are not otherwise chargeable to tax under salaries or
profits and gains of business or profession. These incomes include the
following:
 Any sum received by the assessee from his employees as contribution
to any provident fund or superannuation fund or any other fund set up
for the welfare of the employees
 Income by way of interest on securities
2. Four incomes that are taxable under income from other sources are as
follows:
(i) Salaries received by a person who cannot be termed an employee
(ii) Annuities which are not provided by the employers
(iii) Salaries of Members of Parliament and MLAs
(iv) Family pensions

Check Your Progress - 2

1. According to Section 57 (iii) of the ITA states that an item of expenditure is
deductible if it is laid out wholly and exclusively for the purpose of making
or earning the incomes from other sources; and as long as the expenditure
is not of a capital nature.
2. There are certain amounts which are not allowed as a deduction from the
income from other sources. Such expenses include:
 Personal expenses of the assessee
 Interest chargeable under the ITA which is payable outside India but
on which no tax was deducted at source
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 Income from
Other Sources

Check Your Progress - 3

1. Like in the case of income from the head ‘profits and gains from business
and profession’, income under the head ‘income from other sources’ must
be computed in accordance with the method of accounting regularly
employed by the assessee.
2. If interest is received after TDS is deducted, then while calculating gross
total income, the net interest is grossed up. It is done as follows:
If net interest received is 990 and TDS is deducted at 10%, then
grossing up of interest will be done as follows:
Interest × 100
90

Grossing up is when interest is given after deducting TDS and the interest
income is grossed up. It can be calculated as follows:
Amount after TDS × 100
100-rate at which TDS is deducted

Check Your Progress - 4

1. Under the provisions of Section 56(2)(vi), certain gifts are liable to income
tax as ‘income from other sources’. But, this provision is applicable only
for individuals and Hindu Undivided Families (HUFs).
2. Individuals can receive gifts from the following sources:
 Relatives or blood relatives
 At the time of marriage
 As inheritance
 In contemplation of death

10.9 SELF-ASSESSMENT QUESTIONS

1. What are the various items of income that are chargeable to tax under the
head ‘income from other sources’?
2. List any eight types of incomes that can be included in the head ‘income
from other sources’.
3. State whether these can be included under income from other sources or
not.

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Income from
Other Sources

 Salary of CEO
 Salary of Member of Parliament
 Rent of a house
 Rent of a machine let on hire
 Prize money won on a TV game show
4. Discuss the deductions that are permitted from income from other sources.
5. Describe the deductions that are not permitted from income from other
sources.
6. Mr. Kumar receives 5,000 from a lottery ticket won by him during the
previous year. He spends 100 for the cost of ticket purchased and
collection charges and the purchase of ticket. Calculate the gross winning
and income from other sources.
7. Find the gross amount in the following cases:
 Dividend received: 10,000
 Interest on listed securities received: 2,000
 Wining received from horse race: 10,000

10.10 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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BLOCK-IV
ASSESSMENT OF INDIVIDUAL

In this block you will study about the computation of total income and the deductions made
from gross total income. The block will provide an expansive understanding of Value Added
Tax (VAT) and its various aspects. Filling of return and a discussion on tax authorities also
feature in this block. This block consists of four units.
The eleventh unit lists the various categories of deductions from gross total income. It also
explains the deductions in respect of specified savings and insurance premium. The unit
analyses the contribution to pension funds and will guide you on how to compute interest on
loan taken for higher education, donations for charitable purposes and payment of house
rent. It also provides the definitions of unit linked insurance plan, deferred annuity plans and
equity-linked savings schemes. The entities engaged in infrastructure development,
businesses other than infrastructure development, development of SEZs, certain states and
collecting and processing of bio-degradable waste are also discussed in the unit.
Employment of new workmen and royalty on patents form the final section of the unit.
The twelfth unit elaborates on the process of the computation of total income of an individual
and discusses the steps involved in computation of total income and tax liability of an
individual. It also gives an account of the income earned in different capacities by an
individual.
The thirteenth unit defines the permanent account number and examines the various rules and
regulations related with it. The unit discusses income tax return and the various forms that
can be used to file IT returns. It also analyses the concepts of assessment and advance
payment of taxes.
The fourteenth unit discusses the origin and meaning of value added tax. It explains the need
for value added tax, its features and advantages. The classification of goods, according to
VAT rates, and input tax credit is also discussed in the unit.

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 Deduction from
Gross Total Income

UNIT–11 DEDUCTION FROM GROSS TOTAL INCOME

Objectives
After going through this unit, you will be able to:
 List the categories of deductions
 Explain deductions in respect of specified savings and insurance premium
 Analyse contribution to pension funds
 Compute interest on loan taken for higher education, donations for
charitable purposes and payment of house rent
 Describe the entities engaged in infrastructure development, businesses other
than infrastructure development, development of SEZs, certain states and
collecting and processing of bio-degradable waste
 Enumerate on employment of new workmen and royalty on patents
 Discuss unit linked insurance plan, deferred annuity plans, equity-linked
savings schemes, etc.

Structure
11.1 Introduction
11.2 Categories of Deductions
11.3 Contribution to Pension Funds
11.4 Payment of House Rent
11.5 Summary
11.6 Key Words
11.7 Answers to ‘Check Your Progress’
11.8 Self-Assessment Questions
11.9 Further Readings

11.1 INTRODUCTION

Certain deductions are allowed to be made from income for the purpose of
computing income tax. There are different motives for allowing these deductions.
Some deductions are allowed to encourage thrift, some others to encourage
charitable donations. This unit will discuss deductions form gross total Income.

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Deduction from
Gross Total Income

11.2 CATEGORIES OF DEDUCTIONS

The various deductions that are allowed to be made from gross total income are as
follows:
 Specified savings and life insurance premium
 Contribution to certain pension funds
 Medical insurance premium
 Maintenance (including health expenses) of a disabled dependent
 Interest on loan taken for higher education
 Donations to certain funds and charitable institutions
 Rent paid
 Donations for scientific research or rural development
 Contributions to political parties
 Profits and gains from industrial undertakings or enterprises
 Profits and gains by an undertaking or enterprise engaged in the
development of special economic zone
 Profits and gains from undertakings or enterprises in special category states
 Profits and gains from business of collecting and processing biodegradable
waste

Specified Savings and Life Insurance Premium

Section 80C of the ITA allows deductions in respect of specified savings and
insurance premium paid by an individual or a Hindu Undivided Family (HUF).
However, to avail these deductions, certain requirements need to be met: (i) the
amount must be paid or invested by the assessee from his income of the previous
year and (ii) the overall limit for payments is 1,00,000.
The specified savings and insurance premium are as follows:

1. Insurance and deferred annuity contracts

Any sums paid or deposited in the previous year by the assessee:
 To effect or to keep in force insurance on the life of: (a) in the case of an
individual, the individual, the wife or husband and any child of such
individual and (b) in the case of a HUF any member of HUF.

196
 Deduction from
Gross Total Income

 To effect or to keep in force a contract for a deferred annuity on the life of

the individual, the wife or husband and any child of such individual.
 By way of deduction from the salary payable by or on behalf of the
Government to any individual being a sum deducted in accordance with the
conditions of his service, for the purpose of securing to him a deferred
annuity or making provision for his spouse or children, in so far as the sum
so deducted does not exceed one-fifth of the salary.

2. Provident fund and superannuation fund

Any sums paid or deposited in the previous year by the assessee:
 As a contribution by an individual to any provident fund to which the
Provident Funds Act, 1925, applies.
 As a contribution to any provident fund set up by the Central Government
and notified by it in this behalf in the official gazette, where such
contribution is to an account standing in the name of any specified person.
Specified persons are: (a) in the case of an individual, the individual, the
wife or husband and any child of such individual and (b) in the case of a
Hindu undivided family, any member of HUF.
 As a contribution by an employee to a recognised provident fund.
 As a contribution by an employee to an approved superannuation fund.

3. Specified saving schemes

Any sums paid or deposited in the previous year by the assessee:
 As subscription to any such security of the Central Government or any such
deposit scheme as that Government may specify in this behalf.
 As subscription to any such savings certificate under the Government
Savings Certificates Act, 1959, as the Central Government may specify in
this behalf. The National Savings Certificates (VIII) Issue has been notified.

4. Unit-linked insurance plans

A Unit Linked Insurance Plan (ULIP) is a financial product that offers benefits of life
insurance as well as an investment, like a mutual fund. Part of the premium paid by
the investor goes towards the sum assured (amount he gets in a life insurance policy)
and the balance is invested in securities such as equity shares, bonds and
debentures. Thus, ULIP is a life insurance solution that provides the benefits of
protection and flexibility in investment.
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Deduction from
Gross Total Income

In a ULIP, the policy value at any time varies according to the value of the
underlying assets at the time. The investment component of unit-linked plans works
much like a mutual fund. ULIPs are akin to mutual funds in terms of their structure
and functioning; premium payments made are converted into units and a net asset
value (NAV) is declared for the same. The investor is given a range of fund options
to suit his risk appetite–with an emphasis on equity or debt or a mix of both. Thus,
ULIP provides an opportunity to get market-linked.
One of the major drawbacks of ULIPs is the high administrative charge; which
may be as high as 25 per cent. Thus, out of a payment of 10,000, only 7,500
goes to premium and investments.
Any sums paid or deposited in the previous year by the assessee as a
contribution, in the name of any specified person for participation in:
 The unit-linked insurance plan of the Unit Trust of India.
 In any unit-linked insurance plan of the LIC Mutual Fund notified under
Section 10(23D) of ITA. The Dhanraksha, 1989 plan has been notified.
Specified persons are (a) in the case of an individual, the individual, the wife or
husband and any child of such individual and (b) in the case of a Hindu undivided
family, any member of HUF.

5. Deferred annuity plans

A deferred annuity plan is a type of annuity contract that delays payments of income,
instalments or a lump sum until the investor elects to receive them. This type of
annuity has two main phases, the savings phase in which you invest money into the
account and the income phase in which the plan is converted into an annuity and
payments are received. A deferred annuity can be either variable or fixed.
During the saving and investing phase, the investor’s assets are accumulated for
potential growth. A fixed deferred annuity generally offers guarantee of principal and
a guaranteed interest rate for a set period of time by the issuing insurance company.
Variable deferred annuities offer greater growth potential and investment flexibility
with a full range of funding choices, often with a fixed interest account.
During this phase, the investor has a choice of how to structure his income
payments to complement other retirement income sources. The investor can choose
systematic withdrawals, take income as he needs it, or convert his savings into a
series of steady income payments. The investor can elect to receive these payments

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 Deduction from
Gross Total Income

for a set time period, or can choose a guaranteed income for life, a feature only
available in annuities.
Any sums paid or deposited in the previous year by the assessee to effect or to
keep in force a contract for such annuity plan of the Life Insurance Corporation
(LIC) or any other insurer as the Central Government may specify. The following
plans of LIC have been notified: (i) New Jeevan Dhara; (ii) New Jeevan Dhara-I;
(iii) New Jeevan Akshay; (iv) New Jeevan Akshay-I; and (iv) New Jeevan
Akshay-II.

6. Equity-linked savings schemes

The equity-linked savings scheme (ELSS) is a scheme wherein the amount invested
in the units of the fund is invested in the equity shares of the companies. The
investment will have to be locked in for a period of three years. The unit holder is
free to sell his holdings once this lock-in expires at a price based on the net asset
value (NAV). While, in the case of an open-ended scheme, the units can be sold
any time after the lock in period, in the case of a closed end scheme, the units can
be redeemed only after the specified due date. However on such sale, the capital
gains will be chargeable to tax.
As the fortunes of these instruments are tied to the equity market, they have a
high risk-high return profile. However, as these funds are professionally managed
and as they have a three-year lock-in period, fund managers are able to take a long-
term position on the equity shares that look like winners. Unlike an open-ended
fund, which is bogged down with redemption pressure, ELSS schemes enjoy the
best of both, returns and capital appreciation.
Any sums paid or deposited in the previous year by the assessee as subscription
to any units of any Mutual Fund notified under Section 10(23D) in accordance with
such scheme as the Central Government may specify in this behalf. The Equity
Linked Savings Schemes (ELSS), 2005 has been notified.

7. Pension funds
Any sums paid or deposited in the previous year by the assessee as a contribution
by an individual to any pension fund set up by:
 Any mutual fund notified under Section 10 (23D) of ITA.
 A specified company that is a company whose entire share capital is
subscribed by notified financial institutions or banks.
 The National Housing Bank (NHB).
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Deduction from
Gross Total Income

8. Deposit schemes
Any sums paid or deposited in the previous year by the assessee as subscription to
any deposit schemes of:
 The National Housing Bank;
 A public sector company which is engaged in providing long-term finance
for construction or purchase of houses in India for residential purposes;
 Any authority constituted in India by or under any law enacted either for
the purpose of dealing with and satisfying the need for housing
accommodation or for the purpose of planning, development or
improvement of cities, towns and villages, or for both.

9. Tuition fees
Any sums paid or deposited in the previous year by the assessee as tuition fees
(excluding any payment towards any development fees or donation or payment of
similar nature), whether at the time of admission or thereafter, to any university,
college, school or other educational institution situated within India for the purpose of
full-time education of any of the specified persons.
Specified persons are: (a) in the case of an individual, the individual, the wife or
husband and any child of such individual and (b) in the case of a HUF, any member
of HUF.

10. Purchasing or constructing a residential house

Any sums paid or deposited in the previous year by the assessee for the purposes of
purchase or construction of a residential house property, where such payments are
made towards or by way of:
 Any installment or part payment of the amount due under any self-financing
or other scheme of any development authority, housing board or other
authority engaged in the construction and sale of house property on
ownership basis;
 Any installment or part payment of the amount due to any company or co-
operative society of which the assessee is a shareholder or member
towards the cost of the house property allotted to him;
 Repayment of the amount borrowed by the assessee;
 Stamp duty, registration fee and other expenses for the purpose of transfer
of such house property to the assessee.
200
 Deduction from
Gross Total Income

However, the following payments are not eligible for deduction: (i) any payment
towards or by way of admission fee, cost of share and initial deposit which a
shareholder of a company or a member of a cooperative society has to pay for
becoming such shareholder or member; (ii) any payment towards or by way of the
cost of any addition or alteration to, or renovation or repair of, the house property
which is carried out after the issue of the completion certificate in respect of the
house property by the authority competent to issue such certificate or after the house
property or any part thereof has either been occupied by the assessee or any other
person on his behalf or been let out; and (iii) any payment towards or by way of any
expenditure in respect of which deduction is allowable under the head income from
house property.

11. Subscription to shares and debentures

Any sums paid or deposited in the previous year by the assessee as subscription to
equity shares or debentures forming part of any eligible issue of capital approved by
the CBDT. Eligible issue of capital means an issue made by a public company
formed and registered in India or a public financial institution and the entire proceeds
of the issue are utilized wholly and exclusively for the purposes of any business
relating to developing, operating and maintaining any infrastructure facility.

12. Units of mutual funds

Any sums paid or deposited in the previous year by the assessee as subscription to
units of mutual funds referred to in Section 10(23D) and approved by the CBDT.

Check Your Progress - 1

1. List three types of deductions that are made from gross total income.
................................................................................................................
................................................................................................................
................................................................................................................

2. Define Unit Linked Insurance Plan (ULIP).

................................................................................................................
................................................................................................................
................................................................................................................

201
Deduction from
Gross Total Income

3. Name the two phases of deferred annuity plans.

................................................................................................................
................................................................................................................
................................................................................................................

4. Which section of the ITA allows deductions in respect of specified savings

and insurance premium paid by an individual or a Hindu Undivided Family
(HUF)?
................................................................................................................
................................................................................................................
................................................................................................................

5. Name a type of payment that is not eligible for deduction.

................................................................................................................
................................................................................................................
................................................................................................................

11.3 CONTRIBUTION TO PENSION FUNDS

A pension is a steady income given to a person (usually after retirement). Pensions

are typically payments made in the form of a guaranteed annuity to a retired or
disabled employee. In India, pension plans are offered by mutual funds and
insurance companies. Pension funds invest long-term contractual savings in various
financial instruments.
Mutual fund pension plans are targeted towards retirement corpus. Such funds
are debt-oriented balanced funds that take equity exposure of up to 40 per cent (as
opposed to 65 per cent equities in regular balanced funds), while keeping the
remaining in ‘safer’ debt instruments.
Under Section 80CCC, contribution made by an individual assessee to pension
funds is deductible subject to a maximum of 10,000.

Medical Insurance Premium

In computing the total income of an assessee, a deduction is allowed of the amount
paid by an assessee towards:

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 Deduction from
Gross Total Income

 Where the assessee is an individual, any sum paid to effect or to keep in

force insurance on the health of the assessee or on the health of the wife or
husband, dependent parents or dependent children of the assessee.
 Where the assessee is a Hindu undivided family, any sum paid to effect or
to keep in force an insurance on the health of any member of the family.
It is necessary that the medical insurance schemes are in accordance with a
scheme framed in this behalf by (a) the General Insurance Corporation of India; or
(b) any other insurer and approved by the Insurance Regulatory and Development
Authority. The amount must be paid by cheque in the previous year out of income
chargeable to tax. The maximum deduction allowed is 10,000.

Maintenance and Medical Treatment of a Disabled Dependant Person

Deduction is allowed to an assessee, being an individual or a Hindu undivided family,
who is a resident in India, who has, during the previous year, (a) incurred any
expenditure for the medical treatment (including nursing), training and rehabilitation
of a dependant, being a person with disability; or (b) paid or deposited any amount
under a scheme framed in this behalf by the Life Insurance Corporation or any other
insurer, etc.
The maximum amount of deduction allowed is 50,000. However, where such
dependant is a person with severe disability, the maximum amount of deduction
allowed is 75,000. The deduction is subject to fulfilment of various conditions.

Medical Treatment
Deduction is available to a resident assessee who has, during the previous year,
actually paid any amount for the medical treatment of a specified disease or ailment
(a) for himself or a dependant, in case the assessee is an individual or (b) for any
member of a HUF, in case the assessee is a HUF.
The maximum amount of deduction allowed is the amount actually paid or
40,000, whichever is less. However, if the assessee or his dependant or any
member of a Hindu undivided family of the assessee and who is a senior citizen, then
the maximum amount of deduction allowed is the amount actually paid or 60,000,
whichever is less.
The assessee has to furnish with the return of income, a certificate from a
neurologist, an oncologist, a urologist, a haematologist, an immunologist or such
other specialist, as may be prescribed, working in a Government hospital.

203
Deduction from
Gross Total Income

Dependant means: (a) in the case of an individual, the spouse, children, parents,
brothers and sisters of the individual or any of them; (b) in the case of a Hindu
undivided family, a member of the Hindu undivided family, dependant wholly or
mainly on such individual or Hindu undivided family for his support and maintenance.
A senior citizen means an individual resident in India who is of the age of sixty-
five years or more at any time during the relevant previous year.

Interest on Loan Taken For Higher Education

Deduction is allowed for any amount paid by an assessee in the previous year, out
of his income chargeable to tax, by way of interest on loan taken by him from any
financial institution or any approved charitable institution for the purpose of pursuing
his higher education.
Higher education means full-time studies for any graduate or post-graduate
course in engineering, medicine, management or for post-graduate course in applied
sciences or pure sciences including mathematics and statistics.
The deduction is allowed in computing the total income in respect of the initial
assessment year and seven assessment years immediately succeeding the initial
assessment year or until the interest is paid by the assessee in full, whichever is
earlier.

Donations for Charitable Purposes

Deduction in respect of donations made by the assessee during the previous year to
certain funds, approved educational institutions of national importance, charitable
institutions, etc. is admissible under Section 80G of ITA.
The qualifying amount of aggregate depends upon the institution to which the
donations are made.

Eligibility of 100 per cent Donation

The entire amount of donation is eligible for deduction if made to the following
institutions:
 The National Defence Fund set up by the Central Government
 The Jawaharlal Nehru Memorial Fund
 The Prime Ministers Drought Relief Fund
 The National Children’s Fund
 The Indira Gandhi Memorial Trust

204
 Deduction from
Gross Total Income

 The Rajiv Gandhi Foundation

 The Prime Minister’s National Relief Fund
 The Prime Minister’s Armenia Earthquake Relief Fund
 The Africa (Public Contributions - India) Fund
 The National Foundation for Communal Harmony
 A University or any educational institution of national eminence as may be
approved by the prescribed authority
 The Chief Minister’s Earthquake Relief Fund, Maharashtra
 Any fund set up by the Gujarat Government exclusively for providing relief
to the victims of earthquake in Gujarat
 The National Blood Transfusion Council or to any State Blood Transfusion
Council which has its sole object the control, supervision, regulation or
encouragement in India of the services related to operation and
requirements of blood banks
 Any fund set up by a State Government to provide medical relief to the
poor
 The Army Central Welfare Fund or the Indian Naval Benevolent Fund or
the Air Force Central Welfare Fund established by the armed forces of the
Union for the welfare of the past and present members of such forces or
their dependants
 The Andhra Pradesh Chief Ministers Cyclone Relief Fund, 1996
 The National Illness Assistance Fund
 The Chief Ministers Relief Fund or the Lieutenant Governors Relief Fund in
respect of any State or Union territory, as the case may be
 The National Sports Fund set up by the Central Government
 The National Cultural Fund set up by the Central Government
 The Fund for Technology Development and Application set up by the
Central Government
 The National Trust for Welfare of Persons with Autism, Cerebral Palsy,
Mental Retardation and Multiple Disabilities

205
Deduction from
Gross Total Income

Donations where the Qualifying Amount is Restricted

The qualifying amount of donations to the following funds is restricted to 10 per cent
of the gross total income of the assessee as reduced by deductions under Chapter
VIA:
 Donations by a company to the Indian Olympic Association or to any other
association or institution established in India and notified for the
development of infrastructure for sports and games in India or the
sponsorship of sports and games in India
 Donations to the Government or to any such local authority, institution or
association as may be approved in this behalf by the Central Government,
to be utilized for the purpose of promoting family planning
 Donations to any approved institution or fund established in India for a
charitable purpose
 Donations to an association or institution having as its object the control,
supervision, regulation or encouragement in India of notified games or
sports
 Donations to any corporation referred to in Section 10(26BB) of ITA

Amount of Deduction
The amount of deduction in respect of donations referred in paragraph 9.9.1 (except
to (i) the Jawaharlal Nehru Memorial Fund; (ii) the Prime Ministers Drought Relief
Fund; (iii) the National Children’s Fund; (iv) the Indira Gandhi Memorial Trust; and
(v) the Rajiv Gandhi Foundation) is 100 per cent of the donation.
The amount of deduction in respect of donations to institutions not covered
above is 50 per cent of the qualifying amount.

Check Your Progress - 2

1. Define pension.
................................................................................................................
................................................................................................................
................................................................................................................

206
 Deduction from
Gross Total Income

2. Mutual fund pension plans are targeted towards which group?

................................................................................................................
................................................................................................................
................................................................................................................

11.4 PAYMENT OF HOUSE RENT

Deduction is available under Section 80GG of the ITA with respect to rent paid by
an assessee for accommodation occupied for the purpose of his own residence. The
amount of deduction is 25 per cent of the assessee’s total income or 2,000,
whichever is less. This deduction is subject to the fulfilment of the following
conditions:
 The rent paid is in excess of 10 per cent of the assessee’s total income
before allowing any deductions under chapter VIA of ITA.
 No residential accommodation is owned by the assessee or by the HUF, of
whom the assessee is a member.
The benefit of the above deduction will not be available to an assessee in a case
where he, his spouse or minor child or the HUF of which he is a member, owns any
residential accommodation at a place where the assessee ordinarily resides,
performs the duties of his office or employment or carries on his business or
profession. The deduction will also be denied to an assessee who owns any
residential accommodation at any other place and the concession in respect of self-
occupied property is claimed by him in respect of such accommodation.

Entities Engaged In Infrastructure Development

Deductions in respect of profits and gains of industrial undertakings or enterprises
engaged in infrastructure development, etc. is granted under Section 80IA of ITA.
The term infrastructure facility means: (i) a road including toll road, a bridge or a
rail system; (ii) a highway project including housing or other activities being an
integral part of the highway project; (iii) a water supply project, water treatment
system, irrigation project, sanitation and sewerage system or solid waste
management system; and (iv) a port, airport, inland waterway or inland port.
The deduction allowed is an amount equal to 100 per cent of profits and gains
derived from such business for ten consecutive assessment years. The assessee has

207
Deduction from
Gross Total Income

the option of choosing any ten consecutive assessment years out of fifteen years,
beginning from the year in which the undertaking or the enterprise develops and
begins to operate any infrastructure facility or starts providing telecommunication
service or develops an industrial park or develops or develops and operates or
maintains and operates a special economic zone, or generates power or commences
transmission or distribution of power.
This deduction is available subject to fulfilment of various conditions.

Entities Engaged In Business Other Than Infrastructure Development

Deductions in respect of profits and gains by industrial undertakings or enterprises
engaged in business other than infrastructure development, etc. is granted under
Section 80IB of the ITA. This deduction is available subject to fulfilment of various
conditions.

Entities Engaged In the Development of SEZ

Where the gross total income of an assessee, being a developer, includes profits and
gains derived by an undertaking or an enterprise from any business of developing a
special economic zone (SEZ), a deduction of 100 per cent of such profits is allowed
for ten consecutive assessment years under Section 80IAB of ITA.
The assessee has the option of choosing any ten consecutive assessment years
out of fifteen years beginning from the year in which the SEZ was notified by the
Central Government.

Entities Located In Certain States

Section 80-IC contains special provisions in respect of certain undertakings or
enterprises in certain special category states. A deduction is allowed in computing
the total income of the assessee where the gross total income of an assessee includes
any profits and gains derived by an undertaking or an enterprise from certain
business.
This deduction is available to the following undertaking or enterprise which has
begun or begins to manufacture or produce certain article or thing and undertakes
substantial expansion during certain period in any of the following, in certain states:
 Export Processing Zone (EPZ)
 Integrated Infrastructure Development Centre (IIDC)
 Industrial Growth Centre (IDC)

208
 Deduction from
Gross Total Income

 Industrial Estate
 Industrial Park
 Software Technology Park (STP)
 Industrial Area
 Theme Park
The period of commencement of manufacture and the states in which the
manufacture should commence is as per Table 11.1 given below:

Table 11.1 Period and States of Commencement of Manufacture

Period State(s)

23 December 2002 to 31 March, 2012 Sikkim

7 January 2003 to 31 March 2012 Himachal Pradesh
7 January 2003 to 31 March 2012 Uttaranchal
24 December 1997 to 31 March 2007 Any of the Northeastern states

The quantum of deduction is as follows:

 For investments in the state of Sikkim or any of the North-eastern states
(Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland
and Tripura), the deduction is 100 per cent of such profits and gains for ten
assessment years commencing with the initial assessment year.
 For investments in the states of Himachal Pradesh and Uttaranchal, the
deduction is: (i) 100 per cent of profits and gains for five assessment years
commencing with the initial assessment year and (ii) 25 per cent (or 30 per
cent where the assessee is a company) of the profits and gains.
For availing the above deductions, the undertaking or enterprise should fulfil all the
following conditions, namely: (i) it is not formed by splitting up, or the reconstruction,
of a business already in existence and (ii) it is not formed by the transfer to a new
business of machinery or plant previously used for any purpose.

Entities Engaged In Collecting and Processing Biodegradable Waste

A deduction is allowed under Section 80 JJA of ITA, where the gross total income
of an assessee includes any profits and gains derived from the business of collecting
and processing or treating of biodegradable waste for generating power or
producing bio fertilizers, bio pesticides or other biological agents or for producing
biogas or making pellets or briquettes for fuel or organic manure.

209
Deduction from
Gross Total Income

The amount of deduction allowed is the whole of such profits and gains for a
period of five consecutive assessment years beginning with the assessment year
relevant to the previous year in which such business commenced.

Employment of New Workmen

A deduction is allowed under Section 80JJAA of ITA, where the gross total income
of an assessee, being an Indian company, includes any profits and gains derived from
any industrial undertaking engaged in the manufacture or production of article or
thing.
The amount of deduction allowed is an amount equal to 30 per cent of additional
wages paid to the new regular workmen employed by the assessee in the previous
year for three assessment years including the assessment year relevant to the
previous year in which such employment is provided.
The term additional wages means the wages paid to the new regular workmen in
excess of 100 workmen employed during the previous year. However, in the case of
an existing undertaking, the additional wages shall be nil if the increase in the number
of regular workmen employed during the year is less than 10 per cent of existing
number of workmen employed in such undertaking as on the last day of the
preceding year.
Regular workmen, does not include: (a) a casual workman or (b) a workman
employed through contract labour or (c) any other workman employed for a period
of less than 300 days during the previous year.
The above deduction is not available if the industrial undertaking is formed by
splitting up or reconstruction of an existing undertaking or amalgamation with
another industrial undertaking.

Royalty on Patents
Under Section 80RRB of the ITA, a deduction is allowed in respect of income from
royalty on patents where in the case of an assessee, being an individual, who is (a)
resident in India; (b) a patentee; and (c) is in receipt of any income by way of royalty
in respect of a patent registered on or after 1 April 2003 under the Patents Act,
1970, and his gross total income of the previous year includes royalty.
The amount of deduction admissible is an amount equal to the whole of such
income or 3,00,000, whichever is less:

210
 Deduction from
Gross Total Income

The term patentee means the person, being the true and first inventor of the
invention, whose name is entered on the patent register as the patentee, in
accordance with the Patents Act, 1970, and includes every such person, being the
true and first inventor of the invention, where more than one person is registered as
patentee.
Royalty, in respect of a patent, means a consideration (including any lump sum
consideration but excluding any consideration which would be the income of the
recipient chargeable under the head ‘capital gains’ or consideration for sale of
product manufactured with the use of patented process or of the patented article for
commercial use) for: (i) the transfer of all or any rights (including the granting of a
licence) in respect of a patent; (ii) the imparting of any information concerning the
working of, or the use of, a patent; (iii) the use of any patent; or (iv) the rendering of
any services in connection with the activities referred above.

Check Your Progress - 3

1. Which section of the ITA allows deductions in respect of profits and gains
of industrial undertakings or enterprises engaged in infrastructure
development, etc.?
................................................................................................................
................................................................................................................
................................................................................................................

2. What does infrastructure facility mean?

................................................................................................................
................................................................................................................
................................................................................................................

3. Who is a patentee?
................................................................................................................
................................................................................................................
................................................................................................................

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Deduction from
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11.5 SUMMARY

 The various deductions that are allowed to be made from gross total
income are specified savings and life insurance premium, contribution to
certain pension funds, medical insurance premium, maintenance (including
health expenses) of a disabled dependent, etc.
 Section 80C of the ITA allows deductions in respect of specified savings
and insurance premium paid by an individual or a Hindu Undivided Family
(HUF).
 A Unit Linked Insurance Plan (ULIP) is a financial product that offers
benefits of life insurance as well as an investment, like a mutual fund.
 Part of the premium paid by the investor goes towards the sum assured
(amount he gets in a life insurance policy) and the balance is invested in
securities such as equity shares, bonds and debentures.
 Thus, ULIP is a life insurance solution that provides the benefits of
protection and flexibility in investment.
 In a ULIP, the policy value at any time varies according to the value of the
underlying assets at the time. The investment component of unit-linked
plans works much like a mutual fund.
 A deferred annuity plan is a type of annuity contract that delays payments of
income, instalments or a lump sum until the investor elects to receive them.
 A deferred annuity has two main phases, the savings phase in which you
invest money into the account and the income phase in which the plan is
converted into an annuity and payments are received.
 A deferred annuity can be either variable or fixed.
 The equity-linked savings scheme (ELSS) is a scheme wherein the amount
invested in the units of the fund is invested in the equity shares of the
companies. The investment will have to be locked in for a period of three
years.
 Eligible issue of capital means an issue made by a public company formed
and registered in India or a public financial institution and the entire
proceeds of the issue are utilized wholly and exclusively for the purposes of
any business relating to developing, operating and maintaining any
infrastructure facility.
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 Deduction from
Gross Total Income

 A pension is a steady income given to a person (usually after retirement).

Pensions are typically payments made in the form of a guaranteed annuity
to a retired or disabled employee.
 In India, pension plans are offered by mutual funds and insurance
companies. Pension funds invest long-term contractual savings in various
financial instruments.
 Mutual fund pension plans are targeted towards retirement corpus.
 A senior citizen means an individual resident in India who is of the age of
sixty-five years or more at any time during the relevant previous year.
 Deductions in respect of profits and gains of industrial undertakings or
enterprises engaged in infrastructure development, etc. is granted under
Section 80IA of ITA.
 The term infrastructure facility means: (i) a road including toll road, a bridge
or a rail system; (ii) a highway project including housing or other activities
being an integral part of the highway project; (iii) a water supply project,
water treatment system, irrigation project, sanitation and sewerage system
or solid waste management system; and (iv) a port, airport, inland
waterway or inland port.

11.6 KEY WORDS

 Unit-linked insurance plan (ULIP): It is a financial product that offers

benefits of life insurance as well as an investment like a mutual fund.
 Deferred annuity plan: It is a type of annuity contract that delays
payments of income, instalments or a lump sum until the investor elects to
receive them.
 Equity-linked savings scheme (ELSS): It is a scheme wherein the
amount invested in the units of the fund is invested in the equity shares of
the companies.
 Pension: It is a steady income given to a person (usually after retirement).

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Deduction from
Gross Total Income

11.7 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. The three types of deductions that are allowed to be made from gross total
income are as follows:
a) Specified savings and life insurance premium
b) Contribution to certain pension funds
c) Medical insurance premium
2. A Unit Linked Insurance Plan (ULIP) is a financial product that offers
benefits of life insurance as well as an investment, like a mutual fund.
3. Deferred annuity has two main phases, the savings phase in which you
invest money into the account and the income phase in which the plan is
converted into an annuity and payments are received.
4. Section 80C of the ITA allows deductions in respect of specified savings
and insurance premium paid by an individual or a Hindu Undivided Family
(HUF).
5. Any payment towards admission fee, cost of share and initial deposit,
which a shareholder of a company or a member of a cooperative society
has to pay for becoming such shareholder or member, is not eligible for
deduction.

Check Your Progress - 2

1. A pension is a steady income given to a person (usually after retirement).
Pensions are typically payments made in the form of a guaranteed annuity
to a retired or disabled employee
2. Mutual fund pension plans are targeted towards retirement corpus.

Check Your Progress - 3

1. Deductions in respect of profits and gains of industrial undertakings or
enterprises engaged in infrastructure development, etc. is granted under
Section 80IA of ITA.
2. The term infrastructure facility means: (i) a road including toll road, a bridge
or a rail system; (ii) a highway project including housing or other activities
being an integral part of the highway project; (iii) a water supply project,

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 Deduction from
Gross Total Income

water treatment system, irrigation project, sanitation and sewerage system

or solid waste management system; and (iv) a port, airport, inland
waterway or inland port.
3. The term patentee means the person, being the true and first inventor of the
invention, whose name is entered on the patent register as the patentee, in
accordance with the Patents Act, 1970, and includes every such person,
being the true and first inventor of the invention, where more than one
person is registered as patentee.

11.8 SELF-ASSESSMENT QUESTIONS

1. What deductions are admissible to individuals in respect of payments made

towards life insurance premium? What are the conditions for availing such
deductions?
2. What deductions are admissible to individuals in respect of payments made
towards contribution to provident fund? What are the conditions for
availing such deductions?
3. What deductions are admissible to individuals in respect of payments or
deposits made towards unit-linked insurance plans (ULIP)? What are the
conditions for availing such deductions?
4. What deductions are admissible to individuals in respect of payment of
tuition fees? What are the conditions for availing such deductions?
5. What deductions are admissible to individuals in respect of payments
towards purchase or constructions of a residential house? What are the
conditions for availing such deductions?
6. What deductions are admissible to individuals in respect of payments made
towards medical insurance premium? What are the conditions for availing
such deductions?
7. What deductions are admissible to individuals in respect of payments made
towards medical treatment? What are the conditions for availing such
deductions?
8. What deductions are admissible to individuals in respect of payments made
towards maintenance of a disabled dependent? What are the conditions for
availing such deductions?

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Deduction from
Gross Total Income

9. What deductions are admissible to individuals in respect of payments made

towards donations to charities? What are the conditions for availing such
deductions?
10. What deductions are admissible to individuals in respect of payments made
towards house rent? What are the conditions for availing such deductions?
11. Describe, in brief, the tax benefits available to the following entities:
(a) Entities engaged in the business of infrastructure development
(b) Entities engaged in business other than that of infrastructure
development
(c) Entities engaged in the development of special economic zones (SEZs)
(d) Entities engaged in the collection and processing of biodegradable
waste
12. What deductions are admissible to the assessee in respect of income from
royalty on patents? What are the conditions for availing such deductions?
13. Write short notes on:
(a) Deferred annuity plan
(b) Unit-linked insurance plan (ULIP)
(c) Equity-linked savings scheme (ELSS)
(d) Pension funds

11.9 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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Total Income

UNIT–12 COMPUTATION OF TOTAL INCOME

Objectives
After going through this unit, you will be able to:
 Define total income
 Identify the income earned in different capacities by an individual
 Compute total income of an individual
 Explain the steps involved in computation of total income and tax liability of
an individual

Structure
12.1 Introduction
12.2 Meaning of Total Income
12.3 Computation of Total Income and Tax Liability of Individuals
12.4 Summary
12.5 Key Words
12.6 Answers to ‘Check Your Progress’
12.7 Self-Assessment Questions
12.8 Further Readings

12.1 INTRODUCTION

In the previous units, you learnt about the basic concepts of income tax, tax liability,
salaries etc. The units also shed light on exempted income as well as deductions
from Gross Total Income.

This unit focuses on the income earned income earned in different capacities by
an individual which are to be considered while computing his total income.

12.2 MEANING OF TOTAL INCOME

The Total Income of an individual is arrived at after making deductions, as

mentioned in unit 11, from the Gross Total Income. Gross Total Income is the
aggregate of the net income computed under the five heads of Income as you earlier
studied in unit 2, after giving effect to the provisions for clubbing of income and set-
off and carry forward and set-off of losses.

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Computation of
Total Income

Income to be Considered while Computing Total Income of Individuals

Capacity in which income is Treatment of income earned
earned by an individual in each capacity
(1) In his personal capacity Income from salaries, Income from house
(under the 5 heads of income) property, Profits and gains of business or
profession, Capital gains and Income from
other sources.
(2) As a partner of a firm (i) Salary, bonus etc., received by a partner is
taxable as his business income.
(ii) Interest on capital and loans to the firm is
taxable as business income of the partner.
The income mentioned in (i) and (ii) above
are taxable to the extent they are allowed
as deduction to the firm.
(iii) Share of profit in the firm is exempt in
the hands of the partner.
(3) As a member of HUF (i) Share of income of HUF is exempt in the
hands of the member
(ii) Income from an impartible estate of HUF is
taxable in the hands of the holder of the
estate who is the eldest member of the
HUF
(iii) Income from self-acquired property
converted in joint family property.
(4) Income of other (i) Transferee’s income, where there is a
included in the income transfer of the income without
transfer of assets
(ii) Income arising to transferee from a
revocable transfer of an asset.
In cases (i) and (ii), income is includible in
the hands of the transferor.
(iii) Income of spouse as mentioned in section
64(1)
(iv) Income from assets transferred to son’s
wife or to any person for the benefit of
son’s wife.
(v) Income of minor child as mentioned in
section 64(1A)

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 Computation of
Total Income

Special Provision for Spouses Governed By Portuguese Civil Code

[Section S5A]
This section relates to the computation of total income of husband and wife
governed by the system of community of property as in force in the State of Goa
and in the Union Territories of Dadra and Nagar Haveli and Daman and Diu. Such
income shall not be assessed as that of the community of property.The income under
each head of income (other than under the head ‘Salaries’) should be apportioned
equally between the husband and wife and should be included separately in their
respective total income. However, in the case of salary income, it will be assessed in
the hands of the spouse who has actually earned it.

Check Your Progress - 1

1. How is total income arrived at?

................................................................................................................
................................................................................................................
................................................................................................................

2. How is income treated of an individual who is a partner of a firm?

................................................................................................................
................................................................................................................
................................................................................................................

12.3 COMPUTATION OF TOTAL INCOME AND TAX LIABILITY

OF INDIVIDUALS

Income-tax is levied on an assessee’s total income. Such total income has to be

computed as per the provisions contained in the Income-tax Act, 1961. The
procedure of computation of total income for the purpose of levy of income-tax is
detailed hereunder:
Step 1: Determination of residential status: The residential status of a
person has to be determined to ascertain which income is to be included in
computing the total income. In the case of an individual, the duration for which he is
present in India determines his residential status. Based on the time spent by him, he
may be (a) resident and ordinarily resident, (b) resident but not ordinarily resident, or
(c) non-resident. The residential status of an individual determines the taxability of

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Total Income

income earned by him. For e.g., income earned outside India will not be taxable in
the hands of a non-resident but will be taxable in case of a resident and ordinarily
resident.
Step 2: Classification of income under different heads: The Act prescribes
five heads of income. These heads of income exhaust all possible types of income
that can accrue to or be received by an individual. An individual has to classify the
income earned by him under the relevant head of income.
Step 3: Exclusion of income not chargeable to tax: There are certain
income which are wholly exempt from income-tax e.g. agricultural income. These
income have to be excluded and will not form part of Gross Total Income. Also,
some incomes are partially exempt from income-tax, e.g. House Rent Allowance,
Education Allowance. These incomes are excluded only to the extent of the limits
specified in the Act. The balance income over and above the prescribed limits would
enter computation of total income and have to be classified under the relevant head
of income.
Step 4: Computation of income under each head: Income is to be computed
in accordance with the provisions governing a particular head of income. Under each
head of income, there is a charging section which defines the scope of income
chargeable under that head. There are deductions and allowances prescribed under
each head of income. These deductions and allowances have to be considered
before arriving at the net income chargeable under each head
Step 5: Clubbing of income of spouse, minor child etc.: In case of
individuals, income- tax is levied on a slab system on the total income. The tax
system is progressive, i.e., as the income increases, the applicable rate of tax
increases. Some taxpayers in the higher income bracket have a tendency to divert
some portion of their income to their spouse, minor child etc. to minimize their tax
burden. In order to prevent such tax avoidance, clubbing provisions have been
incorporated in the Income-tax Act, 1961, under which income arising to certain
persons (like spouse, minor child etc.) have to be included in the income of the
person who has diverted his income to such persons for the purpose of computing
tax liability. Effect has to be given to these clubbing provisions.

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 Computation of
Total Income

Step 6: Set-off or carry forward and set-off of losses: An individual may

have different sources of income under the same head of income. He might have
profit from one source and loss from the other. For instance, an individual may have
profit from his let-out house property and loss from his self-occupied property. This
loss can be set-off against the profits of the let-out property to arrive at the net
income chargeable under the head “Income from house property”.
Similarly, an assessee can have loss under one head of income, say, Income
from house property and profits under another head of income, say, Profits and
gains of business or profession. There are provisions in the Income-tax Act, 1961
for allowing inter-head adjustment in certain cases. Further, losses which cannot be
set-off in the current year due to inadequacy of eligible profits can be carried
forward for set-off in the subsequent years as per the provisions contained in the
Income-tax Act, 1961.
Effect has to be given to these provisions for set-off/carry forward and set-off of
losses.
Step 7: Computation of Gross Total Income: The final figures of income or
loss under each head of income, after allowing the deductions, allowances and other
adjustments , are then aggregated, after giving effect to the provisions for clubbing of
income and set-off and carry forward of losses, to arrive at the gross total income.
Step 8: Deductions from Gross Total Income: There are deductions
prescribed from gross total income. The allowable deductionis in case of an
individual are deductions under sections 80C, 80CCC, 80CCD, 80D, 80DD,
80DDB, 80E, 80G, 80GG, 80GGA, 80GGC, 80-IA, 80-IAB, 80IB, 80IC, 80ID,
80IE, 80JJA, 80QQB, 80RRB, 80TTA, and 80U. These deductions are allowable
subject to satisfaction of the conditions prescribed in the relevant sections.
Step 9: Total Income: The total income of an individual is arrived at, after
claiming the above deductions from the gross total income.
Step 10: Application of the rates of tax on the total income: For
individuals, there is a slab rate and basic exemption limit. At present, the basic
exemption limit is 2,50,000. This means that no tax is payable by individuals with
total income of up to 2,50,000. The rates of tax and level of total income are as
under -

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Total Income

Level of total income Rate of tax

(i) where the total income does not Nil;

exceed 2,50,000
(ii) where the total income exceeds 10% of the amount by which the total
2,50,000 but does not exceed 5,00,000 income exceeds 2,50,000
(iii) where the total income exceeds 20% of income exceeding 5,00,000
5,00,000 but does not exceed 10,00,000
(iv) where the total income exceeds 30% of income exceeding 10,00,000.
10,00,000
It is to be noted that for a senior citizen (being a resident individual who is of the age
of 60 years or more at any time during the previous year), the basic exemption limit
is 3,00,000 and for a very senior citizen (being a resident individual who is of the
age of 80 years or more at any time during the previous year), the basic exemption
limit is 5,00,000. Therefore, the tax slabs for these assessees would be as follows:
For senior citizens (being resident individuals of the age of 60 years or more but
less than 80 years):
(i) where the total income does not Nil;
exceed 3,00,000
(ii) where the total income exceeds 10% of the amount total income
3,00,000 but does not exceed exceeds by which the 3,00,000;
5,00,000
(iii) where the total income exceeds 20% of income exceeding 5,00,000;
5,00,000 but does not exceed
10,00,000
(iv) where the total income exceeds 30% of income exceeding 10,00,000;
which 10,00,000
exceeds 10,00,000.
For resident individuals of the age of 80 rears or more at any time during the
previous year
(i) where the total income does not Nil;
exceed 5,00,000
(ii) where the total income exceeds 20% of the amount by which the
5,00,000 but does not exceed total income exceeds 5,00,000;
10,00,000
(iii) where the total income exceeds 30% of the income exceeding
which 10,00,000 10,00,000;
exceeds 10,00,000.

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 Computation of
Total Income

Further, the rates of tax for long-term capital gains, certain short-term capital gains
and winnings from lotteries, crossword puzzles, races etc. are prescribed in sections
112, 111A and 115BB respectively. The rates of tax are 20% (10%, without
indexation benefit or currency fluctuation, in case of long-term capital gains on
transfer iof unlisted securities by non-residents or foreign companies),15% and
30%, respectively,in the above cases.
These tax rates have to be applied on the total income to arrive at the income-
tax liability.
Step 11: Rebate under section 87 (wbere total income  5,00,000)
I Surcharge (where total income  1,00,00,000)
Rebate under section 87A: In order to provide tax relief to the individual tax
payers who are in the 10% tax slab, section 87A has been inserted to provide a
rebate from the tax payable by an assessee, being an individual resident in India,
whose total income does not exceed 5,00,000. The rebate shall be equal to the
amount of income-tax payable on the total income for any assessment year or an
amount of 2,000, whichever is less.
Surcharge: Surcharge is an additional tax payable over and above the income-
tax. Surcharge is levied as a percentage of income-tax. In case where the total
income of an individual exceeds 1 crore, surcharge is payable at the rate of 10%
of income-tax.

Step 12: Education cess and “Secondary and higher education cess”: The
income-tax is to be increased by education cess@2% and secondary and higher
education cess@1% on income-tax. This is payable by all individuals who are liable
to pay income-tax irrespective of their level of total income.
Step 13: Credit for advance tax and TDS: From the total tax due, deduct the
TDS and advance tax paid for the relevant assessment year. The balance is the net
tax payable by an individual which must be paid as self-assessment tax before
submitting the return of income.

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Computation of
Total Income

Check Your Progress - 2

1. Which incomes are partially exempt from income-tax?

................................................................................................................
................................................................................................................
................................................................................................................

2. What is progressive tax system?

................................................................................................................
................................................................................................................
................................................................................................................

12.4 SUMMARY

 The total income of an individual is arrived at after making certain

deductions from the Gross Total Income.
 Gross Total Income is the aggregate of the net income computed under the
five heads of income.
 Income-tax is levied on an assessee’s total income. Such total income has
to be computed as per the provisions contained in the Income-tax Act,
1961.
 The residential status of a person has to be determined to ascertain which
income is to be included in computing the total income.
 In the case of an individual, the duration for which he is present in India
determines his residential status.
 The Act prescribes five heads of income. These heads of income exhaust
all possible types of income that can accrue to or be received by an
individual. An individual has to classify the income earned by him under the
relevant head of income.
 An individual may have different sources of income under the same head of
income.

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 Computation of
Total Income

12.5 KEY WORDS

 Surcharge: It refers to an additional tax payable over and above the

income-tax. It is levied as a percentage of income-tax.

12.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. The total income of an individual is arrived at after making deductions from
the Gross Total Income.
2. The income of an individual who is a partner of a firm is treated in the
following manner:
(a) Salary, bonus etc. received by a partner is taxable as his business
income.
(b) Interest on capital and loans to the firm is taxable as business income
of the partner.

Check Your Progress - 2

1. Incomes partially exempt from income-tax are House Rent Allowance and
Education Allowance.
2. Progressive tax system indicates that as the income increases, the
applicable rate of tax increases.

12.7 SELF-ASSESSMENT QUESTIONS

1. List the incomes that are to be considered while computing total income of
individuals.
2. Explain the procedure of computing total income and tax liability of
individuals.

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Computation of
Total Income

12.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.
http://www.icai.org/ (Accessed on 10 September 2016)

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 Filing of Return
and Tax Authorities

UNIT–13 FILING OF RETURN AND TAX AUTHORITIES

Objectives
After going through this unit, you will be able to:
 Discuss the concept of permanent account number and the various rules and
regulations related to it
 Explain the meaning of income tax return and the various forms used to file
IT returns
 Discuss that income tax must be paid throughout the year
 Analyse the concept of assessment and its various types
 Describe the concept of advance payment of taxes
 Assess the interest payable by/to an assessee

Structure
13.1 Introduction
13.2 Permanent Account Number (PAN)
13.3 Income Tax Return
13.4 Payment of Tax
13.5 Assessment
13.6 Summary
13.7 Key Words
13.8 Answers to ‘Check Your Progress’
13.9 Self-Assessment Questions
13.10 Further Readings

13.1 INTRODUCTION

In the previous unit, you learnt about computation of total income. This unit discusses
the administrative and procedural issues involved in income tax.
We begin by discussing the permanent account number (PAN) that must be
obtained by all assessees. Issues involved in preparing and filing returns is discussed
next and are followed by the different types of assessment of income tax.

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13.2 PERMANENT ACCOUNT NUMBER (PAN)

Permanent Account Number [Section 139A and Rule 114]

(1) Every person who has not been allotted a permanent account number shall,
within such time, as may be prescribed, apply in Form No. 49A to the
Assessing Officer for the allotment of a permanent account number in the
following cases:
(a) if his total income or the total income of any other person in respect of
which he is assessable under this Act during any previous year
exceeded the maximum amount which is not chargeable to income-
tax; or
(b) if he is carrying on any business or profession whose total sales,
turnover or gross receipts are or is likely to exceed 5,00,000 in any
previous year; or
(c) he is required to furnish a return of income under section 139(4A),
i.e., return of trust and charitable institutions; or
(d) if he, being an employer, is required to furnished a return of fringe
benefits under Section 115WD.
(2) The Assessing Officer having regard to the nature of transactions as may be
prescribed may also allot a permanent account number to any other person
(whether any tax is payable by him or not) in the manner and in accordance
with the procedure as may be prescribed.
(3) Any person, not falling under clause (1) or clause (2) above, may apply to
the Assessing Officer for the allotment of a permanent account number and,
thereupon, the Assessing Officer shall allot a permanent account number to
such person forthwith.
(a) The application has to be made to the Assessing Officer who has been
assigned the function of allotment of permanent account number,
where no Assessing Officer has been assigned this function, the
application has to be made to the Assessing Officer having jurisdiction
to assess the applicant.
(b) It has been clarified that any person, who has been allotted a
permanent account number under any clause other than clause 1(d)
above, shall not be required to obtain another permanent account
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 Filing of Return
and Tax Authorities

number and the permanent account number already allotted to him

shall be deemed to be the permanent account number is relation to
fringe benefit tax.

Table 13.1 Time limit for submitting application for allotment of PAN

Situation Time limit for making an application

In case clause (1) (a) above On or before 31st May of the assessment year in which
such income is assessable
In case clause (1) (b) above On or before the end of that accounting year
In case clause (1) (c) above On or before the end of the relevant accounting year
In case clause (1) (d) above No time limit is yet prescribed, but in any case, it shall
be necessary to apply for PAN as the employer has to
deposit fringe benefit tax in advance after the end of
each quarter

Power delegated to the Central Government to notify class or classes of

persons for whom it will be obligatory to apply for permanent account
number (PAN) [Section 139A(1A)]: With a view to progressively making PAN a
common business identification number for other departments such as the Central
Board of Excise and Customs and the Director General of Foreign Trade, the Act
has delegated the power to the Central Government to notify class or classes of
persons for whom it will be obligatory to apply for PAN, provided tax is payable by
them under the Income-tax Act or any tax or duty is payable by them under any
other law in force including importers and exporters whether any tax is payable by
them or not.
The Central Government by Notification No. 11468, dated 29-8-2000 has
notified the following class or classes of persons who shall apply to the Assessing
Officer for allotment of permanent account number:—
(i) Exporters and Importers as defined in section 2(20) and section 2(26) of
the Customs Act, 1962, who are required to obtain an importer-exporter
code under section 7 of the Foreign Trade (Development and Regulations)
Act, 1992.
(ii) Assessees as defined in rule 2(3) of Central Excise Rules, 1944.
(iii) Persons who issue invoices of Cenvat i.e. traders, etc. requiring registration
under Central Excise Rules, 1944.
(iv) Persons who are assessees under service tax.

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The above persons shall apply for allotment of PAN within 15 days of the date
of publication of the notification in the Official Gazette. However, persons who may
fall in the above category, after the date of the above notification, shall apply for
allotment of PAN:—
(a) in case of (i) above, before making an import or export;
(b) in case of (ii) and (iii) above, before making an application for registration
under central excise;
(c) in case of (iv) above, before making an application for registration under
service tax.
The Central Government, by Notification No. 355/2001, dated 11-12-2001 has
further notified the following class or classes of persons:
1. Persons registered under the Central Sales Tax Act, 1956 or the general
sales tax law of the appropriate State or Union Territory, as the case may
be.
2. As on the date of this notification, a person falling within a class or classes
of persons referred to in paragraph I, shall apply for the allotment of
permanent account number within thirty days of the date of publication of
this notification in the Official Gazette.
3. A person who may fall within such class or classes of persons after the date
of this notification, as is referred to in paragraph (I), shall apply for the
allotment of permanent account number (PAN) before making any
application for registration under the Central Sales Tax Act, 1956, or the
general sales tax law of the appropriate State or Union territory, as the case
may be.
Prescribing new class of persons for allotment of PAN and suo-moto
allotment of PAN Section 139A: The Central Government may, for the purpose
of collecting any information which may be useful for or relevant to the purposes of
this Act, by way of notification specify any class or classes of persons, and such
persons shall within the prescribed time apply to the Assessing Officer for allotment
of a permanent account number.
Ten-Digit permanent account number: The CBDT had introduced a new
scheme of allotment of computerized 10 digit permanent account number. Therefore,
everyone was required to apply for a fresh permanent account number even if he
had already been allotted an account number earlier.

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However, the persons to whom permanent account number, under the new
series, had already been allotted, were not required to apply for such number again.
PAN to be quoted in certain cases [Section 139A(5)]: On allotment of
permanent account number, every person shall:
(a) quote such number in all his returns to, or correspondence with, any income
for authority;
(b) quote such number in all challans for the payment of any sum due under this
Act;
(c) quote such number in all documents pertaining to such transactions as may
be prescribed by the Board in the interests of the revenue, and entered into
by him.
Every person shall intimate the Assessing Officer any change in his address or in the
name and nature of his business on the basis of which the permanent account number
was allotted to him.
Transactions where quoting of PAN made compulsory [Section 139A(5)(c)
and Rule 114B]: Quoting of PAN is compulsory in the following transactions:
(a) sale/purchase of any immovable property valued at 5 lakhs or more;
(b) sale/purchase of motor vehicle (other than two wheeled vehicles) which
requires registration under Motor Vehicles Act, 1988;
(e) Time deposit exceeding 50,000 with a bank/banking company/banking
institution;
(d) Deposits exceeding 50,000 in Post Office Savings Bank;
(e) Contract for sale/purchase of securities exceeding 1,00,000;
(f) Opening an account with a bank/banking company/banking institution.
Where the person opening a bank account is a minor and does not have
any income chargeable to income-tax, he shall quote the PAN/GIR number
of his father or mother or guardian as the case may be;
(g) Application for installation of a telephone connection including cellular
connection;
(h) Payment to hotels/restaurants of bills exceeding 25,000 at any time;
(i) payment in cash for purchase of bank draft or pay orders or banker’s
cheques from a banking company to which the Banking Regulation Act,
1949, applies (including any bank or banking institution referred to in
section 51 of that Act) for an amount aggregating 50,000 or more during
any one day;
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(j) deposit in cash aggregating 50,000 or more, with a banking company to

which the Banking Regulation Act, 1949, applies (including any bank or
banking institution referred to in section 51 of that Act) during any one day;
(k) payment in cash in connection with travel to any foreign country of an
amount exceeding 25,000 at any one time. Such payment shall include
payment in cash towards fare, or to a travel agent or a tour operator, or for
the purchase of foreign currency. However, travel to any foreign country
does not include travel to the neighbouring countries or to such places of
pilgrimage as may be specified by the Board under Explanation 3 of section
139(1);
(l) making an application to any banking company to which the Banking
Regulation Act, 1949, applies (including any bank or banking institution
referred to in section 51 of that Act) or to any other company or institution,
for issue of a credit card;
(m) payment of an amount of 50,000 or more to a mutual fund for purchase
of its units;
(n) payment of an amount of 50,000 or more to a company for acquiring
shares issued by it;
(o) payment of an amount of 50,000 or more to a company or an institution
for acquiring debentures or bonds issued by it;
(p) payment of an amount of 50,000 or more to the Reserve Bank of India,
for acquiring bonds issued by it;
1. Any person who has not been allotted a permanent account number
and who enters into any of the above transactions and makes the
payment in cash or otherwise than by way of a crossed cheque drawn
on a bank or through credit card issued by any bank shall make a
declaration in Form No. 60 giving therein the particulars of such
transaction.
2. Where a person, making an application for opening an account
referred to in clause (c) of this rule, is a minor and who does not have
any income chargeable to income-tax, he shall quote the permanent
account number of his father or mother or guardian, as the case may
be, in the document pertaining to the transaction referred to in the said
clause (c).

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3. As per rule 114C, the above provisions shall not apply to:
(a) persons who have ‘agricultural income’ and are not in receipt of any
other income chargeable to income-tax. Such person shall make a
declaration in Form No. 61.
(b) Central Government, State Government and Consular Offices in
transactions where they are the payers.
4. The assessee shall intimate the Assessing Officer any change in his address
or in the name and nature of his business on the basis of which the
permanent account number was allotted to him.
Duty of the person receiving any document relating to the transactions
where quoting of PAN is compulsory [Section 139A(6) and Rule 114C(2)]:
The persons receiving any document relating to a transaction where quoting of PAN
is compulsory shall ensure after verification that the permanent account number
(PAN) has been duly and correctly quoted in the document or declaration in Form
No. 60 or 61 is received by such person. Intimation of PAN in certain cases and
obligation of the person to whom the PAN is intimated:
(i) Obligation of a person receiving any sum/income/amount from which
tax has been deducted at source [Section 139A(5A)]: Such person
(including non-resident) shall intimate his PAN to the person responsible for
deducting tax.
(ii) Obligation of a person who has deducted the tax at source [Section
139A(5B)]: Where any sum or income or amount has been paid after
deducting tax, every such person deducting tax shall quote the PAN of the
person to whom sum/income/amount has been paid by him in:
(a) the statement of perquisites furnished to the employee in accordance
with the newly inserted section 192(2c);
(b) all certificates of TDS furnished under section 203;
(c) in all quarterly statements prepared and delivered or caused to be
delivered in accordance with the provisions of section 200(3).
However, the Central Government may notify different dates from which the
provisions of this sub-section shall apply in respect of any class or classes of
persons.
The above sub-sections (5A) and (5B) shall not apply in case of a person.

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(a) whose total income is not chargeable to tax; or

(b) who is not required to obtain PAN under any provisions of the
Income-tax Act, such person will be required to furnish a declaration
referred to in section 197A in the prescribed form to the effect that the
tax on his estimated total income of the previous year will be nil.
(iii) Obligation of a buyer, licensee, lessee or seller of alcoholic liquor,
timber or any other forest products referred to in section 206C:
(a) Obligation of the buyer or licensee or lessee {Section 139A(5C)}.
Every such buyer, licensee or lessee shall intimate his PAN to the
seller of such goods.
(b) Obligation of the seller of such goods {Section 139A{5D)}. Every
seller, collecting tax under section 206C shall quote the PAN of every
buyer, licensee or lessee:—
(i) in all certificates furnished to the buyer/licensee/lessee under
section 206C;
(ii) in all quarterly statements prepared and delivered or caused to be
delivered in accordance with the provisions of section 206C(3).
Consequence if the person fails to comply with the provisions of Section
139A [Section 272B(1)]
Where any person fails to comply with the provisions of section 139A, the Assessing
Officer may direct that such person shall pay, by way of penalty, a sum of 10,000.
Quoting or intimating PAN which is false [Section 272B(2)] Similarly, if a
person who is required to—
(a) quote the permanent account number in any document referred to in
section 139A(5)(c); or
(b) intimate such number as required under section 139A(5A), or
(c) intimate such number as required under section 139A(5C).
If a person quotes or intimates a number which is false, and which he either
knows or believes to be false or does not believe to be true, the Assessing Officer
may direct that such person shall pay, by way of penalty, a sum of 10,000.
No order under section 272B(1) or (2) shall be passed unless the person on
whom the penalty is proposed to be [imposed is given an opportunity of being heard
in the matter [Section 272B(3)].

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Check Your Progress - 1

1. What form do individuals need to fill in order to apply for a permanent

account number?
................................................................................................................
................................................................................................................
................................................................................................................

2. List two transactions where quoting of the PAN is compulsory.

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13.3 INCOME TAX RETURN

An income tax return is the means by which an assessee declares his income and the
taxes paid on such income. The return has several parts or phases which are
followed for paying tax.
A person is liable to file his income tax return when his total income from all
sources of income exceeds the maximum amount which is not chargeable to income
tax in any previous year ending on 31 March. Any person claiming a refund, or
carrying forward a loss, or who is seeking any specific statutory exemption or
deduction may also file the income tax return. The return of income has to be
compulsorily filed if the income exceeds the basic exemption limit.
An individual who is in receipt of income chargeable under the head ‘salaries’
may, at his option, furnish a return of his income for any previous year to his
employer. The employer, in turn, is required to furnish all returns of income received
by him on or before the due date, in such form (including on a floppy, diskette,
magnetic cartridge tape, CD-ROM or any other computer readable media) and
manner as may be specified.

Form of Income Tax Return

The following forms of income tax return have been notified by the Income Tax
Department for the assessment year 2007–08.

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Form Description
ITR-1 For individuals with an income from salary and interest
ITR-2 For individuals and Hindu undivided families without any income from
business or profession
ITR-3 For individuals and Hindu undivided families who are partners in firms and
not carrying out business or profession under any proprietorship
ITR-4 For individuals and Hindu undivided families with income from a proprietary
business or profession
ITR-5 For firms, associations of persons and bodies of individuals
ITR-6 For companies other than companies claiming exemption under Section
11
ITR-7 For persons, including companies, required to furnish return under Section
139(4A) or Section 139(4B) or Section 139(4C) or Section 139(4D)
ITR-8 Return for fringe benefits
ITR-V Income Tax Return Verification Form (Where the data of the return of
income/fringe benefits in Form ITR-1, ITR-2, ITR-3, ITR-4, ITR-5, ITR-
6 and ITR-8 is transmitted electronically without digital signature)

Due Dates for Filing Income Tax Returns

The due date for filing income tax returns is different for different categories of
assessees. When an assessee fails to file a return within the due date, he will be liable
for payment of interest and penalty.
The due dates for filing income tax return by different categories of assessees are
shown in Table 13.2.

Table 13.2 Due Dates for Filing Income Tax Return

Status Due Date

Company 31 October of the assessment year
Where the accounts of the assesses are 31 October of the assessment year
required to be audited under ITA or any
other law
In any other case 31 July of the assessment year

Types of Income Tax Returns

We have seen earlier that certain persons have to necessarily file a return of income
tax within the due dates. However, sometimes the returns are filed late or the return
may be defective or the return may need to be revised. These circumstances have

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given rise to various phrases in connection with income tax return. These phrases are
discussed as follows:

1. Loss return
If any person has suffered a loss in any previous year under the head ‘profits and
gains from business and profession’, or under the head ‘capital gains’, he can claim
that the loss be carried forward and set off against the income under the same head
in the subsequent years. However, to claim such a facility it is necessary that he files
a return, called ‘loss return’ within the due date for filing the return.
If the person fails to file the loss return within the due date for filing the return,
then he would not be permitted to carry forward the loss set off against the income
under the same head in the subsequent years (Section 80 of the ITA).

2. Belated return
Any person, who has not furnished a return within the time allowed to him, or within
the time allowed under a notice issued, may furnish the return for any previous year
at any time before the expiry of one year from the end of the relevant assessment
year or before the completion of the assessment, whichever is earlier. Such a return
is called a ‘belated return’. An assessee filing a belated return is liable to pay interest
for the period of delay.

3. Revised return
If any person having furnished a return discovers any omission or any wrong
statement therein, he may furnish a revised return at any time before the expiry of
one year from the end of the relevant assessment year or before the completion of
the assessment, whichever is earlier. Such a return is called a revised return.

4 Defective return
Where the Assessing Officer considers that the return of income furnished by the
assessee is defective, he may intimate the defect to the assessee and give him an
opportunity to rectify the defect within a period of 15 days from the date of such
intimation. Assessing Officer may, in his discretion, extend the above period, on an
application made by the assessee.
If the assessee does not rectify the defect within the given period, then, the
return is treated as an invalid return and the provisions of the ITA shall apply as if the
assessee had failed to furnish the return. However, if the assessee rectifies the defect

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after the expiry of the given period, but before the assessment is made, the Assessing
Officer may condone the delay and treat the return as a valid return.

Check Your Progress - 2

1. What is an income tax return?

................................................................................................................
................................................................................................................
................................................................................................................

2. Define revised return.

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13.4 PAYMENT OF TAX

Income tax must be paid throughout the year. People who make certain payments
are required to deduct tax at source from this payment and deposit the tax with the
treasury. Further, persons with a tax liability of 5,000 or more are required to pay
advance tax at regular intervals.

Deduction of Tax at Source

Deduction at source and advance payment [Section 190]

Although regular assessment in respect of any income is to be made in a later
assessment year, but tax on such income is payable in the previous year itself in the
following two manners:
(i) TDS/TCS: In case of certain income, tax is deducted at source by the
payer at the prescribed rate at the time of accrual or payment of such
incomes to the payee. Similarly, in certain cases, tax is collected at source
by the seller from buyer/licencee/lessee at the time of debiting the amount to
account of the buyer/licencee/lessee or the receipt of payment whichever is
earlier.
(ii) Advance tax: The assessee, in certain cases, is under an obligation to pay
tax in advance in certain instalments.

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The taxes deducted/collected or paid as advance tax in the previous year

itself are known as pre-paid taxes. Such pre-paid taxes are deductible
from the total tax due from the assessee.
Further, w.e.f. 1-6-2002 the tax, if paid by the employer under Section
192(1 A) on the non-monetary perquisites provided to the employee, shall
also be one of the mode of collection or recovery of tax under Chapter
XVII of the Income Tax Act.
In addition to above taxes, the assessee has to pay self-assessment tax
under section 140A at the time of filing the return, if any tax is still due on
the basis of returned income after adjusting the TDS/TCS, advance tax and
the tax paid by the employer under section 192(1 A).

Direct payment [Section 191]

In the case of income—
(a) in respect of which provision is not made under Chapter XVII for
deducting income-tax at the time of payment; and
(b) in any case where income-tax has not been deducted in accordance with
the provisions of Chapter XVII (i.e. TDS provisions), income-tax shall be
payable by the assessee directly in the form of advance tax or otherwise.
When is the payer deemed to be in default? [Explanation to section 19']]: W.e.f.
1-6-2003, if any person referred to in section 200 and in the cases referred to in
section 194, the principal officer and the company of which he is the principal officer
does not deduct the whole or any part of the tax and such tax has not been paid by
the assessee direct, then, such person, the principal officer and the company shall,
without prejudice to any other consequences which he or it may incur, be
deemed to be an assessee in default as referred to in sub-section (1) of section 201
in respect of such tax.

Amendment made by the Finance Act, 2008

Explanation to Section 191 substituted [W.r.e.f. 1-6-2003]

The existing explanation to Section 191 provides that if any person, referred to in
Section 200 and the principal officer of the company referred to in section 194,
does not deduct the whole or any part of the tax and such tax has not been paid by
the assessee directly, then, such person, the principal officer of the company shall,
without prejudice to any other consequences which he or it may incur, be deemed to

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be an assessee in default as referred to in sub-section (1) of section 201 in respect

of such tax.
The said explanation thus covers in its ambit persons referred to in section 200.
Section 200 in turn refers to a person deducting any sum in accordance with the
provisions of Chapter XVII-B and who is required to pay within the prescribed time
the sum so deducted to the credit of Central Government. Thus, this provision
leaves room for an interpretation that a person required to deduct tax at source but
not deducting the same will not be deemed an assessee in default under section 201.
Such an interpretation is contrary to legislative intent.
The amendment therefore, seeks to substitute the said explanation to clarify that
where a person is required to deduct tax at source but fails to do so, he shall also be
deemed to be an assessee in default under Section 201. The substituted
Explanation is as under:
‘For the removal of doubts, it is hereby declared that if any person, including the
principal officer of a company,—
(a) who is required to deduct any sum in accordance with the provisions of this
Act; or
(b) referred to in sub-section (1 A) of section 192, being an employer, does
not deduct, or after so deducting fails to pay, or does not pay, the whole or
any part of the tax, as required by or under this Act, and where the
assessee has also failed to pay such tax directly, then, such person shall,
without prejudice to any other consequences which he may incur, be
deemed to be an assessee in default within the meaning of sub-section (1)
of section 201, in respect of such tax.’

Check Your Progress - 3

1. What are pre-paid taxes?

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2. When is the payer deemed to be in default?

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13.5 ASSESSMENT

Assessment is an estimate for an amount assessed while paying income tax. There
are different types of assessments, namely: self-assessment, regular assessment, best
judgement assessment, re-assessment, and precautionary assessment.

Self-Assessment
A person liable to tax is required to file a return of income with the Assessing Officer
having jurisdiction over his case. The assessee, before filing the return, is expected to
compute the tax on his income by way of self-assessment. Any tax paid by the
assessee under self-assessment is deemed to have been paid towards regular
assessment. If the assessee fails to pay the tax as determined by self-assessment, he
would be deemed to be in default and recovery proceedings will be initiated against
him.

Regular Assessment
Regular assessment can take two forms: (i) without calling the assessee; or (ii) after
hearing the assessee.

1. Regular Assessment without Calling the Assessee

After the filing of return by the assessee, it is determined whether any tax or interest
is due. If any tax or interest is due, intimation is sent to the assessee demanding
payment. If any refund is due to the assessee, it will be granted and the assessee
intimated accordingly.

2. Regular Assessment after Hearing the Assessee

Where a return has been furnished by the assessee, the Assessing Officer may
decide to scrutinize. If during scrutiny he has reason to believe that any claim of loss,
exemption, deduction, allowance or relief made in the return is inadmissible, he may
serve on the assessee and require him to produce, or cause to be produced, any
evidence or particulars on which the assessee may rely, in support of such claim.

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On the day specified in the notice, or as soon afterwards as may be, after
hearing such evidence and after taking into account such particulars as the assessee
may produce, the Assessing Officer shall, by an order in writing, allow or reject the
claim or claims specified in such notice and make an assessment determining the total
income or loss accordingly, and determine the sum payable by the assessee on the
basis of such assessment.

Best Judgement Assessment

Best judgement assessment is carried out if the assessee is not able to furnish
sufficient information and evidence in respect of his income. Section 144 of the ITA
mandates that best judgement assessment be carried out by the Assessing Officer in
the following circumstances:
 If any person fails to file the return required or has not filed a return or a
revised return
 If any person fails to comply with all the terms of a notice issued by the
Assessing Officer or fails to comply with a direction issued by him
 If any person having made a return, fails to comply with all the terms of a
notice issued by the Assessing Officer
Best judgement assessment is carried out after taking into account all relevant
material which the Assessing Officer has gathered, and after giving the assessee an
opportunity of being heard. In a best judgement assessment the assessing officer
should really base the assessment on his best judgement, and not vindictively or
capriciously.
There are two types of judgement assessments: compulsory best judgement
assessment and discretionary best judgement assessment.

1. Compulsory Best Judgement Assessment

Compulsory best judgement assessment made by the assessing officer in cases of
non-co-operation on the part of the assessee or when the assessee is in default as
regards supplying information.

2. Discretionary Best Judgement Assessment

Discretionary best judgement assessment is done even in cases where the assessing
officer is not satisfied about the correctness or the completeness of the accounts of
the assessee, or where no method of accounting has been regularly and consistently
employed by the assessee
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Re-Assessment
If the assessing officer has reason to believe that any income chargeable to tax has
escaped assessment for any assessment year, he may assess or reassess such
income and also any other income chargeable to tax which has escaped assessment
and which comes to his notice in course of the proceedings.

Precautionary Assessment
Where it is not clear as to who has received the income, the assessing officer can
commence proceedings against the persons to determine the question as to who is
responsible to pay the tax.

Advance Payment of Tax

Advance payment of tax is another method of collection of tax by the Central
Government in the form of pre-paid taxes. Such advance tax is in addition to
deduction of tax at source or collection of tax at source. Scheme of advance
payment of tax is also known as ‘Pay as you Earn’ scheme i.e., the assessee is
required to pay tax during the course of earning of income in the previous year itself,
though such income is chargeable to tax during the assessment year. Advance tax is
payable on current income in instalments during the previous year.

Liability for payment of Advance Tax [Section 207]

As per the various provisions of advance tax (sections 208 to 219), tax shall be
payable in advance during the financial year in respect of the total income of the
assessee which would be chargeable to tax for the assessment year immediately
following that financial year. Such total income shall be referred to as ‘Current
income’ in this Chapter. We know that income earned during the financial year
2007-08 shall be charged to tax in the assessment year 2008-09. But the assessee
is required to pay tax, in advance, on the taxable income of financial year 2007-08
during the financial year 2007-08 itself.

Conditions of Liability to pay Advance Tax [Section 208]

Advance Tax, as computed in accordance with the provisions of this Chapter, shall
be payable during a financial year, only when the amount of such advance tax
payable by the assessee during that year is 5,000 or more.

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Computation and Payment of Advance Tax where the calculation is made by

the assessee himself [Section 209(l)(a) & (d)]
The amount of advance tax payable by an assessee in the financial year on his own
accord as per section 210(1) or 210(2) or 210(5) or section 210(6) on the
estimated current income shall be computed as follows:
Step I — Estimate the current income of the financial year for
which the advance tax is payable.
Step II — Compute tax on such estimated current income at the
rate(s) of tax given under Part III of the First Schedule
of the relevant Finance Act.
Step III — In case of a company, deduct credit, if allowable, under
section 115JAA (MAT credit) of the tax paid in earlier
years.
Step IV — From tax so computed, deduct the rebate, if any, likely
to be allowed under section 88E.
Step V — On the net tax, if any, computed at Step III, add
surcharge if applicable. Step VI — Add education cess
+ SHEC to the amount computed under step IV. Step
VII — Allow relief, if any, under section 89, 90, 90A
& 91. Step VIII—Deduct the tax deductible or
collectable at source during the financial year from any
income (as computed before allowing deduction
admissible under the Act) which has been taken into
account in computing the current income.
Step IX — The balance amount is the advance tax payable provided
it is 5,000 or more.
However, it will be payable in certain instalments.
Estimated current income means estimate of income likely to be earned during
the current previous year under five heads of income. Thereafter, set off brought
forward losses. From such estimated gross total income deductions likely to be
claimed under sections 80C to 80U will be deducted.

What constitutes Current Income?

Current income will include all items of income. It includes capital gains (both long-
term and short-term), winnings from lotteries, crossword puzzles, etc. For
computation of advance tax on the current non-agricultural income, even agricultural
income will be included for rate purposes, wherever as per provisions of the
Income-tax Act, it is required to be so included.
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Payment of advance tax

(A) By the assessee on his own accord under section 210(1): Every person
who is liable to pay advance tax under section 208 (whether or not he has been
previously assessed by way of regular assessment) shall, of his own accord, pay, on
or before each of the due dates specified in section 211 the appropriate percentage,
specified in that section, of the advance tax on his current income, calculated in the
manner laid down in section 209.
Increase or decrease of subsequent instalments [Section 210(2)]: A person
who pays any instalment or instalments of advance tax under sub-section (1), may
increase or reduce the amount of advance tax payable in the remaining instalment or
instalments to accord with his estimate of his current income and the advance tax
payable thereon, and make payment of the said amount in the remaining instalment
or instalments accordingly.
(B) Payment of advance tax in pursuance of an order/amended order of
Assessing Officer under sections 210(3) & 210(4): Although it is mandatory for
the assessee to calculate and pay advance tax the Assessing Officer may pass an
order under section 210(3) or amended order under section 210(4) and issue a
notice of demand under section 156 requiring the assessee to pay advance tax. Such
order can be passed by Assessing Officer on the assessee, only when the following
conditions are satisfied:
(i) The assessee has already been assessed by way of a regular assessment in
respect of the Total Income of any previous year;
(ii) Such notice can be issued whether the assessee has paid any instalment of
advance tax or not;
(iii) The Assessing Officer is of the opinion that such person is liable to pay
advance tax;
(iv) Such order can be passed at any time during the financial year, but not later
than the last day of February;
(v) Such order must be made in writing;
(vi) The notice of demand should specify the amount of advance tax and the
instalment or instalments in which such advance tax is to be paid.
Computation of tax by Assessing Officer [Section 209(l)(b) read with section
209(2)(a)]: The Assessing Officer, for determining the advance tax payable by the
assessee under section 210(3), shall take the current income of the assessee to be
the higher of the following two:
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(a) The Total Income of the latest previous year in respect of which the
assessee has been assessed by way of regular assessment (it will also
include agricultural income of such previous year which has been taken into
account for rate purposes); or
(b) The Total Income returned by the assessee for any previous year
subsequent to the previous year for which regular assessment has been
made (it will also include agricultural income of such previous year which
has been taken into account for rate purposes).
Tax on above current income at the rate in force during the financial year will be
calculated by the Assessing Officer. From such tax calculated, the amount of
income-tax which would be deductible or collectable at source during the said
financial year shall be reduced and the amount of income-tax as so reduced shall be
the advance tax payable.
Amendment of Order for payment of Advance Tax [Section 210(4)]: If, after
making the above order by the Assessing Officer, but before 1st March, (a) a return
of income is furnished by the assessee under section 139 or in response to a notice
under section 142(1), or (b) a regular assessment of the assessee is made, in respect
of a later previous year, for any higher figure, then the Assessing Officer may
amend his order and issue to such assessee a notice of demand under section 156
on the basis of income declared in such return or income so assessed (such income
shall also include agricultural income which has been taken into account for rate
purposes). On receipt of the revised order, the assessee will have to pay advance
tax accordingly. Such sum shall be payable at the appropriate percentages on or
before the due dates specified in section 211 falling after the date of amended order.
Assessee can submit his own estimate if its current income is likely to be
lower [Section 210(5) and Rule 39]: On receipt of the order/amended order to
pay advance tax from the Assessing Officer, the assessee, if in his estimation, the
advance tax payable on his current income would be less than the amount of the
advance tax specified in such order/amended order, can submit his own estimate of
lower current income and pay advance tax on the basis of his estimation at
appropriate percentages on or before the due dates specified in section 211 falling
after the date of order/amended order. In such a case, the assessee will have to send
an intimation in Form No. 28A to the Assessing Officer on or before the due date of
last instalment specified in section 211.

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Assessee to pay advance tax on his own estimate if its current income is
likely to be higher [Section 210(6)]: If the assessee estimates that current income
is likely to be higher than the amount estimated by the Assessing Officer in the order/
amended order or in the intimation sent by him under section 210(5), the assessee
shall pay whole of such higher tax according to his own estimate on or before the
due date of each instalment specified in section 211. In this case, there is no need to
send an intimation on Form No. 28A to the Assessing Officer.
1. Where the assessee has paid the advance tax as per the order made by the
Assessing Officer under section 210, the assessee shall still be liable to pay
the interest under section 234B & 234C, if the advance tax is not paid as
per the requirements of section 211.
2. If the estimate made by the assessee in Form No. 28A is not correct, then
the assessee shall be deemed to be an assessee in default and shall be
liable to penalty under section 221.

Instalments of advance tax and due dates [Section 211]

In the case of non-company assessees, advance tax has to be paid in three
instalments. However, in the case of a company assessee, advance tax is payable in
four instalments. The relevant due dates of instalments are given as follows:

For Company Assessees

Due date of instalments Amount Payable

1. On or before the 15th June Not less than 15% of advance tax
liability.
2. On or before the 15th September. Not less than 45% of advance tax
liability, as reduced by the amount,
if any, paid in the earlier
instalment.
3. On or before the 15th December Not less than 75% of advance tax
liability, as reduced by the
amount(s)if any, paid in the earlier
instalment(s)
4. On or before the 15th March The whole amount of advance tax
liability as reduced by the
amount(s)if any, paid in the earlier
instalment(s)

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For Non-company Assessees

Due date of instalments Amount Payable

1. On or before the 15th September. Not less than 30% of
advance tax liability;
2. On or before the 15th December. Not less than 60% of
advance tax liability, as
reduced by the amount, if
any, paid in the earlier
instalment.
3. On or before the 15th March The whole amount of
advance tax liability as
reduced by the amount(s)
if any, paid in the earlier
instalments

Note:
1. Although, last date of payment of whole amount of advance tax is 15th March of the
relevant financial year, but any amount paid by way of advance tax on or before the 31st
March shall also be treated as Advance Tax paid for that financial year. The assessee will,
however, be liable to pay interest on the late payment.
2. If the advance tax is payable on the basis of order/amended order passed by the Assessing
Officer which is served after any of the due dates specified above, the appropriate
amount or the whole amount of the advance tax, as the case may be, specified in such
order, shall be payable on or before each of such of those dates as fall after the date of
service of the order.
3. After making the payment of 1st/2nd instalment of advance tax, the assessee can increase/
decrease the amount of remaining instalments of advance tax in accordance with his
revised estimates of Current income. In this case, he will have to pay interest for short-
payment of earlier instalments.
4. If the last day for payment of any instalments of advance tax is a day on which receiving
bank is closed, the assessee can make the payment on the next immediately following
working day, and in such cases, the mandatory interest leviable under sections 234B and
234C would not be charged. [Circular No. 676, dated 14 January, 1994]
Payment of advance tax in case of capital gains/casual income [Proviso to
section 234C]
As already discussed, advance tax is payable on all types of income, including
capital gains and winnings of lotteries, crossword puzzles, etc. However, it is not
normally possible for an assessee to estimate his capital gains or winnings from
lotteries, etc. which are generally unexpected. Therefore, in such cases, it is
provided that if any such income arises after the due date of any instalment, then, the

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entire amount of tax payable (after deduction of tax at source, if any) on such capital
gain or casual income should be paid in remaining instalments of advance tax which
are due or where no such instalment is due, by 31st March of the relevant Financial
Year. If the entire amount of tax payable is so paid, then no interest on late payment
will be leviable.

Assessee Deemed to be in Default [Section 218]

If any assessee does not pay on the date specified in section 211(1), any instalment
of advance tax that he is required to pay by an order of the Assessing Officer under
section 210(3) or (4) and does not, on or before the date on which any such
instalment as is not paid become due, send to the Assessing Officer an intimation
under section 210(5) or does not pay on the basis of his estimate of his current
income the advance tax payable by him under section 210(6), he shall be deemed to
be an assessee in default in respect of such instalment or instalments.

Credit for Advance Tax [Section 219]

Any sum, other than a penalty or interest, paid by or recovered from an assessee as
advance tax, shall be treated as a payment of tax in respect of the income of the
previous year and credit thereof shall be given to the assessee in the regular
assessment.
Consequences if Advance Tax is not paid or paid less or if there is
deferment of payment of Advance Tax
If advance tax is not paid or the amount of advance tax paid is less than 90% of the
assessed tax, the assessee shall be liable to pay simple interest @ 1% per month
from first day of April following the financial year, under section 234B.
Similarly, if the payment of advance tax is deferred beyond the due dates,
interest @1% per month, for a period of 3 months, will be payable for every
deferment, except for the last instalment of 15th March where it will be 1% for one
month, under section 234C.
For detailed discussion on interest payment by the assessee refer to the section
on interest payable by/ to Assessee.

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Interest for default in furnishing return of income u/s 139(1) or (4) or in

response to a notice u/s 142(1) [Section 234A(1)|
When interest is payable: The assessee is liable to pay interest in the following
cases:
(a) where the return of income is furnished after the due date.
(b) where the return of income is not furnished by the assessee.
‘Due date’ means the date specified in section 139(1) as applicable in case
of the assessee.
Rate of interest: Simple interest @ 1%’ per month or part of the
month w.e.f. 8-9-2003.
Period for which The interest will be payable for the period
commencing on the date immediately
interest is payable: following the due date and would end on:
in case of (a) above, the date of furnishing the
return of income; or in case of (b) above, date of
completion of assessment u/s 144 (Best Judgment
Assessment) or u/s 147/153A.
Amount on which Interest is payable on tax determined u/s 143(1) or
on regular assessment under
interest is payable: section 143 (3 )/144/or first assessment u/s 147/
153 A minus the following:
(1) Tax deducted and collected at source,
(2) Advance tax paid by the assessee,
(3) The amount of relief of tax allowed u/s 90 and
90A and deduction from the Indian income-
tax payable, allowed under section 91, and
(4) Tax credit allowed to be set off under section
115JAA from the tax on the total income.
For the purpose of calculating interest under section 234A(1), where in relation to
an assessment year, an assessment is made for the first time under section 147 or
153A (I.e. no determination of income is made under section 143(1) or no
assessment was made under section 143(3) or 144), the assessment so made under

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section 147 or 153A shall be regarded as a regular assessment for the above
purpose. [Explanation 3 to section 234A(1)].
Computation of Though the interest is payable on the balance tax
determined as above, but any
Interest: interest (computed as per the provisions of section
234A) paid under section 140A on account of late filing
of return shall be deductible [Section 234A(2)]. Thus,
interest will be computed as under
Step 1
Tax on total income determined under section 143(1) or on regular assessment
under section 143(3) or 144 or on first assessment under section 147 or section
153A
Less: (i) tax deducted/collected at source —
(ii) advance tax paid —
(iii) the amount of relief of tax allowed
under sections 90 and 90A and
deduction from the Indian income-tax
payable, allowed u/s 91, and —
(iv) tax credit allowed to be set off under
section 115JAA from the tax on
the total income. —
Amount on which interest is payable ______ _______
 Interest payable shall be:

11
Amount on which interest is payable × number of months
100

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Step 2
Deduct the interest (computed as per the provisions of section 234A) already paid
under section 140A on account of late filing of return which must have been
computed as under:
Tax on Total Income declared in the return of income —
Less: (i) tax deducted/collected at source —
(ii)advance tax paid —
(iii)the amount of relief of tax allowed under sections 90 and 90A
and deduction from the Indian income-tax payable,
allowed under section 91, and —
(iv) tax credit allowed to be set off under section 115JAA from the
tax on the total income. —
Amount on which interest is payable —
 Interest paid under section 140A was computed as under:
12
Amount on which interest is payable computed as above × × number of months
100
Interest computed under Step I - Step II shall be the balance interest payable under
section 234A

1. Where the interest is to be calculated for every month or part of a month comprised
in a period, any fraction of a month shall be deemed to be a full month and the
interest shall be so calculated [Rule 119A(B)]
2. For the purpose of computing interest under this section, the income-tax shall
be rounded off to the nearest multiple of 100 and for this purpose any fraction of
100 shall be ignored. For example, if the tax is 1,247 or 1,297, it shall be
rounded off to 1,200 in both the cases. Fraction of 100 will be completely
ignored. [Rule 119A(C)]

Interest for defaults in furnishing the return of income required by a notice

u/s 148 [Section 234A(3)]
Once the income has been determined u/s 143(1) or the assessment has been done
u/s 143(3), 144 or 147 and the Assessing Officer issues a notice:
(i) Under section 148 for filing return of income for the purpose of
reassessment/recomputation u/s 147, or
(ii) under section 153A for assessment in case of search or requisition, the
assessee shall be liable to pay interest in the following cases:

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(a) when the return of income is furnished after the expiry of time allowed in the
notice issued u/s 148 or u/s 153A; or
(b) where no return of income is furnished by the assessee.
Rate of interest. Simple interest @ 1%’ per month or part of the month w.e.f.
8-9-2003.
Period for which interest is payable: The interest will be payable for the
period commencing on the date immediately following the expiry of time limit
given in the notice u/s 148 or u/s 153A and would end on:
In case of (a) above, the date of furnishing of return of income; or
In case of (b) above, date of completion of reassessment or recomputation u/s
147 or reassessment under section 153A.
Amount on which interest is payable. Interest is payable on the amount
calculated as under:
(i) Tax determined u/s 147 or 153A —
(ii) Less: tax on total income determined u/s 143(1) or —
on assessment made u/s 143(3), 144 or 147 earlier —

Amount on which interest is payable —

Increase/decrease in the interest on certain orders [Section 234A(4)|

Where as a result an order, u/s 154 or 155 or 250 or 254 or 260A or 262 or 263
or 264 or 245D(4) the amount of tax on which interest was payable u/s 234A(1) or
u/s 234A(3) has been increased or reduced, as the case may be, the interest shall
also be increased or reduced accordingly, and
(i) in a case where the interest is increased, the Assessing Officer shall serve
on the assessee a notice of demand in the prescribed form specifying the
sum payable, and such notice of demand shall be deemed to be a notice
under section 156 and the provisions of this Act shall apply accordingly;
(ii) in a case where the interest is reduced, the excess interest paid, if any, shall
be refunded.

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Interest payable for defaults in payment of advance tax [Section 234B(1)]

When interest is payable: The assessee is liable to pay interest in the following
cases:
(i) advance tax has not been paid by the assessee; or
(ii) the advance tax paid by the assessee is less than 90% of the ‘assessed tax’.
‘Assessed tax’ means:
Tax determined u/s 143(1) or on regular assessment made u/s
143(3)/144 or on first time assessment u/s 147 or u/s 153A —
Less: (a) TDS/Tax collected at source —
(b) the amount of relief of tax allowed u/ss 90 and 90A and deduction
from the Indian income-tax payable, allowed u/s 91, and —
(c) tax credit allowed to be set off u/s 115JAA from the tax on the total
income. —
Assessed Tax —
Rate of interest: Simple interest @ 1%’ per month or part of the
month.
Period for which interest Interest will be payable from 1st April of the
relevant assessment year to the
is payable: date of determination of income u/s 143(1) and
where a regular assessment is made,
the date of such regular assessment u/s 143(3)/
144/147/ 153A.
Amount on which interest Interest is payable on ‘Assessed tax’ if no
advance tax is paid. However, if is payable:
any advance tax has been paid, interest will be
payable on assessed tax minus advance tax
paid.
Computation of Interest: Interest will be computed as under:
(a) When no tax is paid on self assessment or otherwise: Interest is payable on
assessed tax minus advance tax paid, if any;
(b) Where tax has also been paid on self assessment or otherwise

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(i) interest will be calculated on assessed tax - advance tax paid if any.’ It
will be calculated for a period commencing from 1st April, to the date
on which tax under section 140A or otherwise is so paid, and
thereafter
(ii) interest shall be calculated on the balance amount (i.e. assessed tax -
Advance tax - tax paid) till the date of determination of total income
under section 143(1) or regular assessment under section 143(3)7144
or first assessment under section 147/153A.
Note.—Interest, computed as per clause (b) above, shall be reduced by any interest (computed
as per provisions of section 234B) paid under section 140A.

Interest payable u/s 234B on assessed tax till the date of determination of
total income under section 143(1) or on regular assessment u/s 143(3)/144
or first assessment under section 147/1 S3 A: Interest will be computed under
the following two steps:
Step 1
Assessed tax (for meaning of assessed tax see above) —
Less: Advance tax paid, if any __
Amount on which interest is payable __
Interest will be calculated on this amount from 1st April of the
relevant assessment year till the date of payment of tax on self-
assessment
u/s 140A or otherwise @ 1%’ per month __
Note.—(If in the above case, if some tax was also paid before the tax paid on self assessment
u/s 140 A, interest will be computed in two parts.

Firstly from 1st April to the date of payment of such tax on (assessed tax -
advance tax paid), and Secondly from the date of payment of such tax to the date
of payment of self-assessment tax on (assessed tax - advance tax - tax so paid).
Step 2
Interest will be computed from the date when tax on self-assessment under
section 140A was paid till the date of regular assessment on the following:
Assessed tax (for meaning of assessment tax see above) __
Less: (i) Advance tax paid, if any —
(ii) Tax paid before or on self-assessment u/s 140A — —

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Amount on which interest is payable —

Note: If in the above case any tax is paid for the relevant assessment year after
the tax paid on self assessment u/s 140A, interest will be computed in two parts.
Firstly from the date of self assessment tax u/s 140A to the date of payment of
such tax on the amount computed as above, and
Secondly from the date of payment of such tax to the date of regular
assessment on {the amount computed as above minus the tax so paid).
Amount of interest computed under Step Nos. 1 and 2 shall be aggregated and
from such aggregate interest, interest (computed as per provisions of section 234B)
already paid on self-assessment under section 140A shall be deducted. The balance
shall be the net interest payable.
1. Interest u/s 234B for the purpose of payment u/s 140A must have been
calculated as under:
(A) Where tax has been paid only at the time of self-assessment u/s
140A
Assessed tax on returned income (for meaning see below)
(which for the purpose of interest payable u/s 140A is nothing but Tax
on returned income minus
TDS/TCS/and w.e.f. assessment year 2007-08 relief under section
90, 90A, 91 and MAT
credit allowed under section 115JAA) __
Less: Advance tax paid if any __
Amount of which interest payable __
Interest must have been paid on this amount from the 1st day of April
of the relevant assessment year till the date of payment of self-
assessment tax u/s 140A.
(B)Where some tax has been paid before the date of payment of
self-assessment tax u/s 140A
(1) Assessed tax on returned income __
Less: Advance tax paid, if any __
Such interest must have been calculated on this amount from 1st April
of the relevantassessment year till the date of payment of tax before
self-assessment u/s 140A __
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(2) Assessed tax on returned income —

*Less: (i) Advance tax paid, if any —
(ii) Tax paid before self assessment tax paid u/s 140A
Note.—Interest in this case must have been calculated from the date of payment of
tax to the date of self-assessment tax paid under section 140A for furnishing the
return of income. Aggregate of interest calculated under step 1 and 2 above would
be the interest paid u/s 140A on account of section 234B.
2. Assessee tax on returned income means:
Tax on returned income
Less:
1. Tax deducted or collected at source —
2. The amount of relief of tax allowed under section 90 and 90A
and deduction of tax allowed section 91 —
3. Tax credit allowed to be set off as per section 115JAA —
Tax on returned income
Interest payable for defaults in payment of advance tax |Section 234B(3))
Where, as a result of an order of reassessment/recomputation under section 147 or
section 153A, the amount on which interest was payable u/s 234B(1) is increased,
the assessee shall be liable to pay interest as under.
Rate of interest: 1%’ for every month or part of the month
w.e.f. 8-9-2003.
Period of interest. Period commencing on the day following the
date of determination of total income under
section 143(1) and where regular assessment
is made u/s 143(3)/144/147/153A, the
period following the date of such regular
assessment and ending on the date of the
reassessment or recomputation u/s 147/
153A.
Amount on which Tax on total income determined u/s 147/
153A —

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interest is payable: Less: tax on total income determined u/s

143(1) or on regular
assessment u/s 143(3)/144/147/153A —
Amount on which interest is payable —
Increase/decrease in the interest on certain orders [Section 234B(4)1
Where as a result an order, u/s 154 or 155 or 250 or 254 or 260 or 262 or 263 or
264 or 245D(4) the amount of tax on which interest was payable u/s 234B(1) or (3)
has been increased or reduced, as the case may be, the interest shall also be
increased or reduced accordingly, and
(i) in a case where the interest is increased, the Assessing Officer shall serve
on the assessee a notice of demand in the prescribed form specifying the
sum payable, and such notice of demand shall be deemed to be a notice
under section 156 and the provisions of this Act shall apply accordingly;
(ii) in a case where the interest is reduced, the excess interest paid, if any, shall
be refunded.

Interest for deferment of advance tax |Section 234C|

Advance tax has to be paid in various instalments. If any instalment is not paid or
less paid, interest is chargeable for non-payment or late payment of such instalment.
The interest is computed as under:

In the case of assessees other than companies

Meaning of tax due on returned income: It shall be computed as under:

Tax on returned income
Less: (1) tax deducted and collected at source;
(2) the amount of relief of tax allowed under sections 90 and 90A and
deduction from the Indian income-tax payable, allowed under section 91,
and
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(3) tax credit allowed to be set off under section 115JAA from the tax on
the total income.
Where the Total Income includes capital gains and/or casual income like income
from lotteries, card games etc. then no interest u/s 234C will be charged if the
assessee has paid the entire advance tax payable on such winning etc. in the
remaining instalments due or where no such instalment is due by 31st March.

In the case of companies:

Interest on excess refund granted at the time of summary assessment

[Section 234D]
Section 234D provides as under:
(1) Subject to the other provisions of this Act, where any refund is granted to
the assessee under section 143(1), and—
(a) no refund is due on regular assessment; or
(b) the amount refunded under section 143(1) exceeds the amount
refundable on regular assessment, the assessee shall be liable to pay
simple interest @ 1/2%’ on the whole or the excess amount so
refunded, for every month or part of a month comprised in the period
from the date of grant of refund to the date of such regular assessment.
(2) Where, as a result of an order under section 154 or section 155 or section
250 or section 254 or section 260 or section 262 or section 263 or section
264 or an order of the Settlement Commission under section 245D(4), the
amount of refund granted under section 143(1) is held to be correctly
allowed, either in whole or in part, as the case may be, then, the interest
chargeable, if any, under sub-section (1) shall be reduced accordingly.

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1. The amount refunded to the assessee will also include interest, if any,
paid to him. Hence, besides recovering the tax excess refunded,
including interest on that excess refund, interest shall be chargeable
under section 234D on the total excess amount refunded inclusive of
interest if any.
2. Where, in relation to an assessment year, an assessment is made for
the first time u/s 147 or section 153A, the assessment so made shall
be regarded as a regular assessment for the purposes of this section.
Interest for late payment of demand of tax, interest, penalty, etc. [Section
220(2)]
If the amount specified in any notice of demand under section 156 is not paid within
30 days of the service of notice, the assessee shall be liable to pay simple interest at
1%2 for every month or part of a month comprised in the period commencing from
the day immediately following the end of the period of 30 days and ending with the
day on which the amount is paid.
However, where the Assessing Officer has any reasons to believe that it will be
detrimental to revenue if the full period of 30 days aforesaid is allowed, he may with
the previous approval of Joint Commissioner, direct that the sum specified in the
notice of demand shall be paid within such period being a period less than 30 days
aforesaid as may be specified by him in the notice of demand. If the period allowed
by the Assessing Officer is less than 30 days, then period for payment of interest
shall commence from the day immediately following the said period.
1. It may be mentioned that intimation sent under section 143(1) is a deemed
notice of demand and as such if the demand of tax and interest mentioned
in the intimation is not paid within 30 days of the receipt of intimation, the
assessee shall be liable for interest and penalty under section 220(2).
2. Whereas as a result of an order u/s 154, 155, 250, 254, 260, 262, 264 or
an order of the Settlement Commissioner u/s 245D, the tax etc. on which
interest was payable under this section has been reduced, the interest shall
be reduced accordingly and the excess interest paid, if any, shall be
refunded.

Failure to deduct and pay tax at source [Section 201(1 A)]

If a person, who was required to deduct tax at source, does not deduct the whole
or any part of the tax or after deducting, fails to deposit the tax as required, he or it

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shall be liable to pay simple interest @1% for every month or part of the month
(12% p.a. up assessment year 2007-08) per annum on the amount of such tax from
the date on which such tax was deductible to the date on which such tax is actually
paid. The liability to pay interest will continue to accrue till the tax as well as the
interest till date is paid and such interest shall be paid before furnishing the quarterly
statement for each quarter in accordance with the provisions of sub-section (3) of
section 200.
Where the assessee failed to deduct tax under section 194C, but it was found
that the contractor had paid the advance tax and self-assessment tax over and above
the tax payable, thereby not causing any loss to the revenue. In such cases if the
revenue is permitted to levy interest under section 201(1 A) even in a case where
the person liable to tax has paid tax on due date, the revenue would derive undue
benefit by getting interest on the amount of tax which had already been paid on the
due date. Such a position cannot be permitted. [CIT’ v Rishikesh Apartments Co-
op. Housing Society Ltd. (2001) 119 Taxman 239 (Guj)].
Interest under section 201(lA) is mandatory: Where the tax deducted at
source is not deposited, the levy of interest would be mandatory under section
201(1 A). [Kanol Industries Ltd. v ACIT (2003) 261 ITR 488 (Cal)].
Levy of interest under section 201(1 A) is neither treated as a penalty nor has
said provision been included in section 273B to make ‘reasonableness of cause’ for
failure to deduct a relevant consideration. Hence tribunal was in error when it held
that assessee had a bonafide belief that payment made by it were exempt from
deduction at source. Interest under section 201(1 A) is mandatory. [CITv Majestic
Hotel Ltd. (2006) 155 Taxman 447 (Del)].
Where interest is to be calculated on annual basis, the period for which such
interest is to be calculated shall be rounded off to a whole month or months and for
this propose any fraction of a month shall be ignored, and the period so rounded off
shall be deemed to be the period in respect of which the interest is to be calculated.
[Rule 119A(A)]

Waiver of interest
The interest payable under sections 234A, 234B and 234C was mandatory and
automatic and there was no provision for reduction or waiver of the penal interest.
As a result several tax payers faced an unintended hardship in certain circumstances.

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The Central Board of Direct Taxes in exercise of the powers specified in section
119(2)(a) has decided to authorise the Chief Commissioners and Directors-
General (Investigation) to reduce or waive penal interest charged under the
aforesaid sections in the following circumstances, namely:
(i) Where, in the course of search and seizure operations, books of account
have been taken over by the Department and were not available to the
taxpayer to prepare his return of income.
(ii) Where, in the course of search and seizure operations, cash had been
seized which was not permitted to be adjusted against arrears of tax or
payment of advance tax instalments falling due after the date of the search.
(iii) Any income other than ‘capital gains’ which was received or accrued after
the date of the first or subsequent instalment of advance tax, which was
neither anticipated nor contemplated by the taxpayer and on which
advance tax was paid by the taxpayer after the receipt of such income.
(iv) Where, as a result of any retrospective amendment of law or the decision
of the Supreme Court, certain receipts which were hitherto treated as
exempt, become taxable. Since no advance tax would normally be paid in
respect of such receipts during the relevant financial year, penal interest is
levied for the default in payment of advance tax.
(v) Where the return of income is filed voluntarily without detection by the
Income-tax Department and due to circumstances beyond the control of
the taxpayer such return of income was not filed within the stipulated time
limit or advance tax was not paid at the relevant time [Notification No. F.
No. 400/234/95-IT(B), dated 23-5-1996].

Interest payable to assessee [Section 244A]

A. Interest on refund of income tax: Where refund of any amount
becomes due to the assessee under the Income-tax Act, he shall be entitled
to receive, in addition to the said amount, simple interest on the refund
calculated in the following manner:
(a) Where the refund is out of any tax deducted at source/tax collected at
source or advance tax paid during the financial year, interest will be
paid at the rate of 1/2%’, or part of a month from the period starting
from 1st day of April of the assessment year to the date on which the

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refund is granted. However, no interest shall be payable if the amount

of refund is less than 10% of the tax determined u/s 143(1).
(b) In other cases, interest shall be paid @ 1/2% per month for every
month or part of a month for the period commencing from the date of
payment of tax or penalty to the date on which refund is granted.
1. For the purpose of this clause (b) above, ‘date of payment of tax
or penalty’ means the date on and from which the amount of tax or
penalty specified in the notice of demand issued under section 156 is
paid in excess of such demand.
2. If the proceedings resulting in the refund are delayed for reasons
attributable to the assessee, whether wholly or in part, the period of
the delay so attributable to him shall be excluded from the period for
which interest is payable, and where any question arises as to the
period to be excluded, it shall be decided by the Chief Commissioner
or Commissioner whose decision thereon shall be final.
3. If as a result of an order passed u/s 147, 154, 155, 250, 254,
260, 262, 263, 264 or 245D, the amount on which the interest was
payable has been increased/reduced, the interest shall accordingly be
increased/reduced.
4. Where the interest is to be calculated for every month or part of
a month comprised in a period, any fraction of a month shall be
deemed to be a full month and the interest shall be so calculated [Rule
119A(B)]
5. For the purpose of computing interest under this section, the
income-tax shall be rounded off to the nearest multiple of 100 and
for this purpose any fraction of 100 shall be ignored. [Rule
119A(C)]
B. Interest on refund of fringe benefit tax: Section 244A has been
amended to provide that interest @ 1/2% for every month or part of the
month shall be payable where refund of any amount out of fringe benefit tax
paid by way of advance tax becomes due.
However, no interest shall be payable if the amount of refund is less than
10% as determined under section 115WE(1).

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Similarly, interest @ 1/2% for every month or part of the month shall be
payable in any other case for the period or periods from the date or dates
of payment of tax or penalty to the date on which the refund is granted.

Authority for Imposing Tax

The Constitution of India empowers the legislature to enact and enforce tax laws.
The taxes so collected are required to be divided between the Central Government
and the State Governments. The Central Government levies direct taxes such as
income tax and wealth tax, and also indirect taxes like customs duties, central excise
duties and central sales tax. The states in turn are empowered to levy state sales tax,
entertainment tax, etc., apart from various other local taxes like entry tax, Octroi,
etc. Thus, the authority to levy taxes is shared by the central government, state
governments and local authorities.
The Central Government is empowered to levy the following taxes:
 Income tax (except tax on agricultural income)
 Customs duties
 Central excise
 Central Sales tax (tax on inter-state sale of goods)
 Service tax
The State Governments are empowered to levy the following taxes:
 Sales tax (tax on intra-state sale of goods)
 Stamp duty (duty on transfer of property)
 State excise (duty on manufacture of alcohol)
 Land revenue
 Duty on entertainment
 Tax on professions and callings
Local bodies are empowered to levy tax on:
 Properties (buildings, etc.)
 Octroi (tax on entry of goods for use or consumption within areas of the
local bodies)
 Tax on markets
 Tax or user charges for utilities like water supply, drainage, etc.

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Check Your Progress - 4

1. List the different types of assessment.

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................................................................................................................

2. When is best judgement assessment carried out?

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13.6 SUMMARY

 Every person who has not been allotted a permanent account number shall,
within such time, as may be prescribed, apply in Form No. 49A to the
Assessing Officer for the allotment of a permanent account number.
 An income tax return is the means by which an assessee declares his
income and the taxes paid on such income. The return has several parts or
phases which we follow for paying tax.
 A person is liable to file his income tax return when his total income from all
sources of income exceeds the maximum amount which is not chargeable
to income tax in any previous year ending on 31 March.
 An individual who is in receipt of income chargeable under the head
‘salaries’ may, at his option, furnish a return of his income for any previous
year to his employer.
 The due date for filing income tax returns is different for different categories
of assessees. When an assessee fails to file a return within the due date, he
will be liable for payment of interest and penalty.
 Income tax must be paid throughout the year. People who make certain
payments are required to deduct tax at source from this payment and
deposit the tax with the treasury. Further, persons with a tax liability of
5,000 or more are required to pay advance tax at regular intervals.

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 Assessment is an estimate for an amount assessed while paying income tax.

There are different types of assessments, namely: self-assessment, regular
assessment, best judgement assessment, re-assessment, and precautionary
assessment.
 The assessee is liable to pay interest in the following cases:
(a) where the return of income is furnished after the due date
(b) where the return of income is not furnished by the assessee

13.7 KEY WORDS

 Permanent Account Number: A PAN is a ten-digit, alphanumeric

number, issued in the form of a laminated card, by the Income Tax
Department, to any person who applies for it or to whom the department
allots the number without an application.
 Best Judgement Assessment: Best Judgement Assessment is carried out
if the assessee is not able to furnish sufficient information and evidence in
respect of his income.
 Income Tax Return: An income tax return is a document one files with
the Central Government reporting one’s income, profits and losses of one’s
business and other deductions as well as details about the tax refund or tax
liability.
 Loss Return: If any person has suffered a loss in any previous year under
the head ‘profits and gains from business and profession’, or under the
head ‘capital gains’, he can claim that the loss be carried forward and set
off against the income under the same head in the subsequent years.

13.8 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress -1

1. Every person who has not been allotted a permanent account number shall,
within such time, as may be prescribed, apply in Form No. 49A to the
Assessing Officer for the allotment of a permanent account number.

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2. Quoting of PAN is compulsory in the following transactions:

(a) sale/purchase of any immovable property valued at 5 lakhs or more
(b) sale/purchase of motor vehicle (other than two wheeled vehicles)
which requires registration under Motor Vehicles Act, 1988

Check Your Progress - 2

1. An income tax return is the means by which an assessee declares his
income and the taxes paid on such income.
2. If any person having furnished a return discovers any omission or any
wrong statement therein, he may furnish a revised return at any time before
the expiry of one year from the end of the relevant assessment year or
before the completion of the assessment, whichever is earlier. Such a return
is called a revised return.

Check Your Progress - 3

1. The taxes deducted/collected or paid as advance tax in the previous year
itself are known as pre-paid taxes. Such pre-paid taxes are deductible
from the total tax due from the assessee.
2. If any person referred to in section 200 and in the cases referred to in
section 194, the principal officer and the company of which he is the
principal officer does not deduct the whole or any part of the tax and such
tax has not been paid by the assessee direct, then, such person, the
principal officer and the company shall, without prejudice to any other
consequences which he or it may incur, be deemed to be an assessee in
default as referred to in sub-section (1) of section 201 in respect of such
tax.

Check Your Progress - 4

1. There are different types of assessments, namely: self-assessment, regular
assessment, best judgement assessment, re-assessment, and precautionary
assessment.
2. When is best judgement assessment carried out?

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13.9 SELF-ASSESSMENT QUESTIONS

1. Describe the concept of advance payment of taxes

2. What is a permanent account number? Under what situations are
permanent account numbers prescribed?
3. Under what situation is the assessee liable to pay interest? How is the
interest computed?
4. What are the different types of income tax return?
5. Under what situations can the Chief Commissioners and Directors-
General (Investigation) reduce or waive penal interest charged?
6. Discuss the amendment made by the Finance Act, 2008.

13.10 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.
Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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 Value Added Tax

UNIT–14 VALUE ADDED TAX

Objectives
After going through this unit, you will be able to:
 Explain the origin and meaning of value added tax
 Explain the need for value added tax, its features and advantages
 Discuss classification of goods according to VAT rates
 Define input tax credit

Structure
14.1 Introduction
14.2 Origin of VAT
14.3 VAT Rates and Classification of Goods
14.4 Summary
14.5 Key Words
14.6 Answers to ‘Check Your Progress’
14.7 Self-Assessment Questions
14.8 Further Readings

14.1 INTRODUCTION

Value Added Tax (VAT) is a multi-point taxation system which is a sales tax and is
payable at each stage. It is collected in stages on transactions involving sales of
goods within a particular state. Tax paid on purchases (input tax) is rebated against
tax payable on sales (output tax). It is a simple and transparent system of taxation
that is fair to both business and consumer. VAT is levied on sales of all taxable
goods. The unit will discuss all aspects related to tax.

14.2 ORIGIN OF VAT

In India’s prevalent sales tax structure, there have been problems of double taxation
of commodities and multiplicity of taxes, resulting in a cascading tax burden. For
instance, in this structure, before a commodity is produced, inputs are first taxed,
and then after the commodity is produced with input tax load, output is taxed again.
This causes an unfair double taxation with cascading effects. VAT was developed to
avoid this cascading effect of taxes. The basic principle is that at every stage, tax

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should be paid only on value added at that stage and not on entire sale price. Value
added is the difference between sale price and cost of material and other inputs on
which tax has been paid.
When VAT is introduced in place of central excise duty, a set-off is given, i.e., a
deduction is made from the overall tax burden for input tax. In the case of VAT, in
place of sales tax system, a set-off is given from tax burden not only for input tax
paid but also for tax paid on previous purchases. With VAT, the problem of ‘tax on
tax’ and related burden of cascading effect is thus removed. Furthermore, since the
benefit of set-off can be obtained only if tax is duly paid on inputs (in the case of
central VAT), and on both inputs and on previous purchases (in the case of state
VAT), there is a built-in check in the VAT structure on tax compliance in the centre
as well as in the states, with expected results in terms of improvement in
transparency and reduction in tax evasion. For these beneficial effects, VAT has now
been introduced in more than 150 countries, including several federal countries. In
Asia, it has now been introduced in almost all the countries.
Full-fledged VAT was initiated first in Brazil in the mid-1960s, then in European
countries in 1970s and subsequently introduced in about 130 countries, including
several federal countries. In Asia, it has been introduced by a large number of
countries from China to Sri Lanka. Even in India, there has been a VAT system
introduced by the Govt. of India for about last eighteen years in respect of Central
Excise duties. At the state-level, the VAT system, as decided by the state
governments, has been introduced in 20 states w.e.f. April, 2005.
In India, VAT was introduced at the central level for a selected number of
commodities in terms of MODVAT with effect from 1 March 1986, and in a five
step-by-step manner for all commodities in terms of CENVAT in 2002–03.
Subsequently, after Constitutional Amendment empowering the centre to levy taxes
on services, these service taxes were also added to CENVAT in 2004–05. Although
the growth of tax revenue from the central excise has not always been especially
high, the revenue growth of combined CENVAT and service taxes has been
significant.
Introduction of VAT in the states has been a challenging exercise in a federal
country like India, where each state, in terms of constitutional provision, is sovereign
in levying and collecting state taxes. Before introduction of VAT, in the sales tax
regime, there was no harmony in the rates of sales tax on different commodities
among the states. Not only were the rates of sales tax numerous (often more than ten

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in several states), and different from one another for the same commodity in different
states, there was also an unhealthy competition among the states in terms of sales tax
rates — so called ‘rate war’ — often resulting in, revenue-wise, a counter-
productive situation.
It is in this background that attempts were made by the states to introduce a
harmonious VAT, at the same time keeping in mind the state’s sovereign tax
structure. The first preliminary discussion on state-level VAT took place in a meeting
of chief ministers convened by the then Union Finance Minister, Manmohan Singh, in
1995. In this meeting, the basic issues on VAT were discussed in general terms and
this was followed up by periodic interactions of state finance ministers. Thereafter, in
a significant meeting of all the chief ministers, convened on 16 November 1999 by
Yashwant Sinha, the then Union finance minister, two important decisions, among
others, were taken. First, before the introduction of state-level VAT, the unhealthy
sales tax ‘rate war’ among the states would have to end, and sales tax rates would
need to be harmonized by implementing uniform floor rates of sales tax for different
categories of commodities with effect from 1 January 2000. Secondly, on the basis
of achievement of the first objective, steps would be taken by the states for
introduction of state-level VAT after adequate preparation. For implementing these
decisions, a Standing Committee of State Finance Ministers was formed which was
then made an Empowered Committee of State Finance Ministers.
Thereafter, the empowered committee met regularly. All the decisions were
taken on the basis of consensus. On the strength of these repeated discussions and
collective efforts, involving the ministers and the concerned officials, it was possible
within a period of about a year-and-a-half to achieve nearly 98 per cent success in
the first objective, namely, harmonization of sales tax structure through
implementation of uniform floor rates of sales tax.
After reaching this stage, steps were initiated for systematic preparation for
introduction of state-level VAT. Again, to avoid any unhealthy competition among
the states, which may lead to distortions in manufacturing and trade, attempts were
made from the beginning to harmonize the VAT structure, keeping also in view the
distinctive features of each state and the need for federal flexibility. This has been
done by the states collectively agreeing, through discussions in the empowered
committee, to certain common points of convergence regarding VAT, and allowing at
the same time certain flexibility to accommodate the local characteristics of the
states. In the course of these discussions, references to the Tenth Five Year Plan

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report of the advisory group on tax policies and tax administration (2001) and the
Kelkar Task Force report were helpful.
Along with these measures, steps were taken for necessary training,
computerisation and interaction with trade and industry. While these preparatory
steps were taken, the empowered committee got significant support from P.
Chidambaram, the then Union finance minister, when he responded positively in
providing central financial support to the states in the event of loss of revenue in
transitional years of implementation of VAT.
As a consequence of all these steps, the states started implementing VAT,
beginning 1 April 2005. After overcoming the initial difficulties, all the states and
Union Territories have now implemented VAT. The empowered committee has been
monitoring closely the process of implementation of state-level VAT, and deviations
from the agreed VAT rates have been contained to less than 3 per cent of the total
list of commodities. Responses of industry and also of trade have been indeed
encouraging. The rate of growth of tax revenue has nearly doubled from the average
annual rate of growth in the pre-VAT five year period after the introduction of VAT.

Meaning
Value added tax or VAT, as we have discussed, is basically a state subject, derived
from Entry 54 of the State List, for which the states are sovereign in taking decisions.
The state governments, through the taxation departments, carry out the responsibility
of levying and collecting VAT in the respective states. While, the central government
plays the role of a facilitator for the successful implementation of VAT. The Ministry
of Finance is the main agency for levying and implementing VAT, both at the Centre
and the state-level. The Department of Revenue, under the Ministry of Finance,
exercises control in respect of matters relating to all the direct and indirect taxes,
through two statutory boards, namely, the Central Board of Direct Taxes (CBDT)
and the Central Board of Excise and Customs (CBEC). The sales tax division, of
Department of Revenue, deals with enactment and amendment of the Central Sales
Tax Act; levy of tax on sales in the course of inter-state trade or commerce; levy of
VAT; etc. The Central Board of Excise and Customs (CBEC) deals with the tasks
of formulation of policy concerning levy and collection of customs and central excise
duties, and allowing of Central Value Added Tax (CENVAT) credit. While the
decision to implement state-level VAT was taken at the meeting of the Empowered
Committee (EC) of state finance ministers held on June 18, 2004, where a broad
consensus was arrived at to introduce VAT in all States/ Union Territories (UTs).

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Features
 Broad based: This means that the VAT is charged on a wide range of
goods and services in SVG.
 Multi-stage: VAT is charged and collected at all levels in the economy
(i.e. from production to the final consumer).
 Transaction tax: VAT is charged on every supply of goods and services
including:
1. Business to business,
2. Business to consumers and
3. Transactions with the government.
 Consumption tax: VAT is expected to be passed on the consumers in the
price of goods and services they consume.
 Domestic consumption: VAT is charged on the value of imports, but VAT
is not charged on value of exports.

Advantages
The main motive of VAT has been the rationalisation of overall tax burden and
reduction in general price level. Thus, it seeks to help common people, traders,
industrialists as well as the government. It is indeed a move towards more efficiency,
equal competition and fairness in the taxation system. The main benefits of
implementation of VAT are as follows:
 Minimizes tax evasion as VAT is imposed on the basis of invoice/ bill at
each stage, so that tax evaded at first stage gets caught at the next stage
 A set-off is given for input tax as well as tax paid on previous purchases
 Other taxes, such as turnover tax, surcharge, and additional surcharge will
be abolished
 Overall tax burden will be rationalised
 Abolishes multiplicity of taxes, that is, taxes such as turnover tax, surcharge
on sales tax, and additional surcharge are being abolished
 Replaces the existing system of inspection by a system of built-in self-
assessment of VAT liability by the dealers and manufacturers (in terms of
submission of returns upon setting off the tax credit)
 Tax structure becomes simpler and more transparent

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 Improves tax compliance

 Generates higher revenue growth
 Promotes competitiveness of exports
 There will be self-assessment by dealers
 Transparency will increase
 There will be higher revenue growth
VAT is more scientific in approach than existing sales tax, because VAT is:
 More equitable — shares tax burden among all involved dealers
 More transparent—deals with only two basic rates
 More simple — ensures simple computation and easy compliance
 More consistent — avoids distortions in trade and economy through
uniform tax rates
 More authentic—prevents cascading effects of tax through input rebate
 More convenient — assist self-assessment
At the central level, there is Central Value Added Tax (CENVAT), which
pertains to the rationalisation of central excise duty structure in India. At present,
there is a uniform rate of CENVAT of 16 per cent on most of the inputs and final
products. The CENVAT has been introduced to end all the disputes that were taking
place due to classification of various types of inputs as rates were different on
different varieties. Accordingly, the CENVAT Credit Rules have been notified and
amended, from time-to-time.
Under these, a manufacturer or producer of final products and a provider of
output service is allowed to take credit (known as CENVAT credit) of the duty of
excise, as mentioned in the rules, paid on specified inputs and capital goods used in
or in relation to the manufacture of specified final products. The CENVAT credit so
allowed can be utilized for payment of: (i) any duty of excise on any final product; or
(ii) an amount equal to CENVAT credit taken on inputs, if such inputs are removed
as such or after being partially processed; or (iii) an amount equal to the CENVAT
credit taken on capital goods, if such capital goods are removed as such; or (iv)
service tax on any output service, as per the conditions laid down in the rules.

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Check Your Progress - 1

1. Why was value added tax introduced in India?

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2. When was VAT introduced first?

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3. What is the role of the Empowered Committee of State Finance

Ministers?
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4. Which is the main agency for levying and implementing VAT?

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5. What is the function of CBEC?

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6. Mention, at least, two advantages of VAT.

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14.3 VAT RATES AND CLASSIFICATION OF GOODS

At present, there are two basic rates of VAT, namely, 4 per cent and 12.5 per cent,
besides an exempt category and a special rate of 1 per cent for a few selected items.
The items of basic necessities and goods of local importance (up to 10 items) have
been put in the zero rate bracket or the exempted schedule. Gold, silver and
precious stones have been put in the 1 per cent schedule.
Under exempted category, there will be about 46 commodities comprising
natural and unprocessed products in unorganised sector, items which are legally
barred from taxation and items which have social implications. Included in this
exempted category is a set of maximum of 10 commodities flexibly chosen by
individual states from a list of goods (finalised by the empowered committee) which
are of local social importance for the individual states without having any inter-state
implication. The rest of the commodities in the list will be common for all the states.
Under 4 per cent VAT rate category, there will be the largest number of goods
(about 270), common for all the states, comprising items of basic necessities such as
medicines and drugs, all agricultural and industrial inputs, capital goods and declared
goods. The schedule of commodities will be attached to the VAT Bill of every state.
The remaining commodities, common for all the states, will fall under the general
VAT rate of 12.5 per cent.
There is also a category with 20 per cent floor rate of tax, but the commodities
listed in this schedule are not eligible for input tax rebate/set off. This category covers
items like motor spirit (petrol, diesel and aviation turbine fuel), and liquor. Some of
the other features of VAT in the state (as finalized by the empowered committee) are:
 As per provision for eliminating the multiplicity of taxes, all the state taxes
on purchase or sale of goods (excluding entry tax in lieu of octroi) are
required to be subsumed in VAT or made VATable.
 A provision has been made for allowing Input Tax Credit (ITC), which is
the basic feature of VAT. However, since the VAT being implemented is
intra-state VAT and does not cover inter-state sale transactions, ITC is not
to be available on inter-state purchases.
 Exports to be zero-rated, with credit given for all taxes on inputs/purchases
related to such exports.

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 There are provisions to make the system more business-friendly. For

instance, provision for self-assessment by the dealers; provision of a
threshold limit for registration of dealers in terms of annual turnover of 5
lakh; and provision for composition of tax liability up to annual turnover
limit of 50 lakh.
Regarding the industrial incentives, the states have been allowed to continue with
the existing incentives, without breaking the VAT chain. Further, no fresh sales tax/
VAT-based incentives are permitted.
Haryana became the first state in the country to introduce VAT. Till 2007, VAT
has been introduced by more than 30 states/UTs, including Tamil Nadu
(implemented VAT from January 1, 2007) and the UT of Puducherry (implemented
VAT from April 1, 2007). From January 01, 2008, the government of Uttar Pradesh
made VAT effective in the state. Some of the other states/ UTs which have
implemented VAT are (a) Andhra Pradesh (b) Chhattisgarh (c) Delhi (d) Goa (e)
Gujarat (f) Jammu and Kashmir (g) Jharkhand (h) Karnataka (i) Kerala (j)
Maharashtra (k) Meghalaya (l) Odisha (m) Rajasthan (n) West Bengal.
Over the years, the experience of implementing VAT in India has been very
encouraging, with the empowered committee constantly reviewing the progress of
implementation. The revenue performance of VAT-implementing states/UTs has also
been very significant. During 2006-07, the tax revenue of the thirty-one VAT states/
UTs had collectively registered a growth rate of about 21 per cent over the tax
revenue of 2005-06. During 2007-08, the tax revenue of thirty-two VAT states/UTs
showed a further growth of 14.6 per cent during the first six months of 2007-08
(April-September) as compared to the corresponding period of last year.
Besides, the central government had announced a compensation package under
which the states are compensated for any revenue loss on account of VAT
introduction at the rate of 100 per cent of revenue loss during 2005-06, 75 per cent
during 2006-07 and 50 per cent during 2007-08. Further, technical and financial
support is being provided to the states/ UTs for VAT computerisation, publicity and
awareness and other related aspects.
But certain points in this regard are to be analysed:
1. VAT rates: As per recommendations of the VAT advisory committee, the
rates of VAT depend on the nature of goods and services. They classified
goods into various schedules and the rate of VAT, as applicable on net

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turnover of sales under Section 16(2) of the Act, is based on schedules

which are shown in the Table.

Description of goods Rates of VAT

Schedule A goods Nil (exempted goods)
Schedule AA goods 0% (zero-rated sale)
Schedule B goods 1%
Schedule C goods 4%
Schedule CA goods 12.5%
Schedule D goods As may be notified by
the state government,
not exceeding 30%

2. Parties responsible or payment of VAT: Under VAT, a taxable person

may be an individual, a partnership firm, a company or anything else which
supplies taxable goods and services and who belong to any of the following
categories: all dealers registered under VAT, all dealers with an annual
turnover of more than 5 lakh, and all dealers having annual turnover
between 5 lakh and 25 lakh may opt for a simple composition tax at a
nominal rate in place of VAT. One thing is to be mentioned here clearly that
only for the last category of dealers no input tax credit shall be available in
respect of any VAT paid on purchases.
Every registered VAT trader is given a number, called TIN (Tax Payer’s
Identification Number), and has to show the amount of VAT charged to
customers on invoices. In this way, the customer, if he is a registered
dealer, knows how much he can deduct in turn and the customer knows
how much tax he has paid on the final product. With the help of this
mechanism the correct amount of VAT is to be paid in different stages and
for this reason it is to be recognised as self-policing.
3. VAT calculation procedure: VAT levy will be administered by the Value
Added Tax Act and this Act directs three methods for the purpose of
computation of VAT and these are as follows:
 Subtraction method: Tax rate is to be applied on the difference of
value of output and cost of input.

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 Addition method: Value added is to be computed by adding all the

payments which are payable to the factors of production.
 Tax credit method: This method entails set-off of the tax paid on inputs
from collected tax on sales.
In terms of decision of the empowered committee, VAT on AED items relating
to sugar, textile and tobacco, because of initial organisational difficulties, will not be
imposed for one year after the introduction of VAT, and till then the existing
arrangement will continue. The position will be reviewed after one year.

How VAT is computed

While computing VAT tax liability, let us assume that tax on a product is 10% of
selling price. Manufacture ‘A’ supplies his output to ‘B’ at 100. Thus ‘B’ gets the
material at 110, inclusive of tax @ 10%. He carries out further processing and sells
his output to ‘C’ at 150. While calculating his cost ‘B’ has considered his pure
purchase cost of materials as 110 and added 40 as his conversion charges.
While selling product to ‘C’, ‘B’ will charge tax again @ 10%. Thus ‘C’ will get the
item at 165 ( 150 + 10% tax). As stages of production and/or sales continue,
each subsequent purchases has to pay tax again and again on the material which has
already suffered tax.
In the example we saw, ‘B’ will purchase goods from ‘A’ @ 110, which is
inclusive of duty of 10. Since ‘B’ is going to get credit of duty of 10, he will not
consider this amount for his costing. He will charge conversion charges of 40 and
sell his goods at 140. He will charge 10% tax and raise invoice of 154 to ‘C’ (
140 plus tax @ 10%). In the invoice prepared by ‘B’, the duty shown will be 14.
However, ‘B’ will get credit of 10 paid on the raw material purchased by him from
‘A’. Thus, effective duty paid by ‘B’ will be only 4. ‘C’ will get the goods at 154
and not at 165 which he would have got in absence of CENVAT. Thus, in effect,
‘B’ has to pay duty only on 40, which is the value added by him.
The following example will illustrate the tax credit method of CENVAT.
Transaction without VAT Transaction with VAT
Details A B A B
Purchases – 110 – 100
Value Added 100 40 100 40
Sub-Total 100 150 100 140
Add Tax 10% 10 15 10 14
Total 110 165 110 154

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Note: ‘B’ is purchasing goods from ‘A’. In second case, his purchase price is 100 as he is
entitled to CENVAT credit of 10 i.e. tax paid on purchases. His invoice shows tax paid as 14.
However, since he has got credit of 10, effectively he is paying only 4 as tax, which is 10%
of 40, i.e., 10% of ‘value-added’ by him. Simply put, ‘value-added’ is the difference between
selling price and the purchase price.

Coverage of goods under VAT

In general, all the goods, including declared goods will be covered under VAT and
will get the benefit of input tax credit. The only few goods which will be outside VAT
will be liquor, lottery tickets, petrol, diesel, aviation turbine fuel and other motor spirit
since their prices are not fully market determined. These will continue to be taxed
under the Sales Tax Act or any other State Act or even by making special provisions
in the VAT Act itself, and with uniform floor rates decided by the Empowered
Committee.

Input Tax Credit

Input tax credit is the amount of tax paid by the dealer on purchases for which the
dealer is entitled to claim a credit. The input tax credit has to be claimed in the tax
period in which a dealer records tax invoice and can be adjusted against tax liability
of the dealer on all the sales effected during the said tax period. There is no one-to-
one correlation between input tax credit and output tax of an item. Input tax credit
on all items purchased in a tax period can be adjusted against total tax payable
during the tax period. Input tax credit will be available for the taxable goods
purchased for the purpose of:
 Sale or resale within the state
 Sale in the course of inter-state trade or commerce
 Sale in the course of exports
 Use as raw materials, processing materials or processing materials in the
manufacture of taxable goods
 Use as packing of goods
 Sale to SEZ/EOU
 Transfer outside the state

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Input tax credit will not be available for crude oil, Lignite, Petrol and High Speed
Diesel besides purchases unrelated to goods under sale. Input tax credit would be
available in case of branch transfer after deducting 4 per cent as under:
 In the case of reseller: 4 per cent of the value of the goods so transferred;
 In the case of manufacturer: 4 per cent of the value of the goods used in the
manufacture of goods so transferred.
Input tax credit will be available in case of works contracts (except capital
goods) but it would not be available for transfer of rights to use goods. Input tax
credit will be admissible for capital goods used in the manufacture of taxable goods.
Capital goods must be used continuously for a full period of five years within the
State. However, no input tax credit would be admissible for capital goods purchased
for the use in:
 Manufacture of tax-free goods
 Generation of electricity including captive power
 Works contract
Input tax credit will not be available on inter-state purchases or imports. Only
purchases within the state are qualified for input tax credit.
Apportionment of input tax credit:
1. The extent of input tax credit available to a registered dealer, for a tax
period, shall be equal to the amount of tax paid on purchases as evident
from the original tax invoice, and where such invoice has been lost, on the
basis of duplicate copy thereof issued to him in accordance with these
rules, subject to the other provisions of the Act, and the following
conditions:
(a) That such dealer has maintained a true and correct separate account of
input tax relating to his purchases against tax invoice.
(b) That such dealer has maintained a true and correct separate account of
output tax relating to his sales against tax invoice.

Taxpayer Identification Numbers (TIN)

A Taxpayer Identification Number (TIN) is used for identification/ registration of
dealers under VAT. TIN consists of eleven digit numerals throughout the country. Its
first two characters represent the state code and the set-up of the next nine
characters can vary in different states.

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Check Your Progress - 2

1. What are the basic VAT rates?

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2. What are the factors which determine the rate of VAT?

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3. Which was the first state to implement tax?

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4. How is VAT calculated?

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5. Give a few examples of goods which are outside the VAT brackets.
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6. What is input tax credit?

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14.4 SUMMARY

 VAT is a multi-point destination based system of taxation, with tax being

levied on value addition at each stage of transaction in the production/
distribution chain. The term ‘value addition’ implies the increase in value of
goods and services at each stage of production or transfer of goods and
services.
 In India’s prevalent sales tax structure, there have been problems of double
taxation of commodities and multiplicity of taxes, resulting in a cascading
tax burden.
 VAT was developed to avoid this cascading effect of taxes. The basic
principle is that at every stage, tax should be paid only on value added at
that stage and not on entire sale price.
 When VAT is introduced in place of Central excise duty, a set-off is given,
i.e., a deduction is made from the overall tax burden for input tax.
 With VAT, the problem of ‘tax on tax’ and related burden of cascading
effect is thus removed.
 In India, VAT was introduced at the central level for a selected number of
commodities in terms of MODVAT with effect from 1 March 1986, and in
a five step-by-step manner for all commodities in terms of CENVAT in
2002–03.
 Introduction of VAT in the states has been a challenging exercise in a
federal country like India, where each state, in terms of constitutional
provision, is sovereign in levying and collecting state taxes.
 The first preliminary discussion on state-level VAT took place in a meeting
of chief ministers convened by the then Union Finance Minister Manmohan
Singh in 1995.
 For implementing the decisions, a Standing Committee of State Finance
Ministers was formed which was then made an Empowered Committee of
State Finance Ministers.
 The empowered committee met regularly. All the decisions were taken on
the basis of consensus.
 Steps were initiated for systematic preparation for introduction of state-
level VAT.
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 Along with these measures, steps were taken for necessary training,
computerisation and interaction with trade and industry.
 As a consequence of the steps, the states started implementing VAT,
beginning 1 April 2005.
 After overcoming the initial difficulties, all the states and Union Territories
have now implemented VAT.
 Value added tax or VAT, as we have discussed, is basically a state subject,
derived from Entry 54 of the State List, for which the states are sovereign
in taking decisions.
 The Ministry of Finance is the main agency for levying and implementing
VAT, both at the Centre and the state-level.
 The Central Board of Excise and Customs (CBEC) deals with the tasks of
formulation of policy concerning levy and collection of customs and central
excise duties, and allowing of Central Value Added Tax (CENVAT) credit.
 The main motive of VAT has been the rationalisation of overall tax burden
and reduction in general price level.
 At the central level, there is Central Value Added Tax (CENVAT), which
pertains to the rationalisation of central excise duty structure in India.
 At present, there is a uniform rate of CENVAT of 16 per cent on most of
the inputs and final products.
 At present, there are two basic rates of VAT, namely, 4 per cent and 12.5
per cent, besides an exempt category and a special rate of 1 per cent for a
few selected items.
 Under exempted category, there will be about 46 commodities comprising
natural and unprocessed products in unorganised sector, items which are
legally barred from taxation and items which have social implications.
 Under 4 per cent VAT rate category, there will be the largest number of
goods (about 270), common for all the states, comprising items of basic
necessities such as medicines and drugs, all agricultural and industrial
inputs, capital goods and declared goods.
 There is also a category with 20 per cent floor rate of tax, but the
commodities listed in this schedule are not eligible for input tax rebate/set
off.

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 Regarding the industrial incentives, the states have been allowed to continue
with the existing incentives, without breaking the VAT chain. Further, no
fresh sales tax/VAT-based incentives are permitted.
 Haryana became the first state in the country to introduce VAT.
 During 2006-07, the tax revenue of the thirty-one VAT states/UTs had
collectively registered a growth rate of about 21 per cent over the tax
revenue of 2005-06.
 As per recommendations of the VAT advisory committee, the rates of VAT
depend on the nature of goods and services.
 Under VAT, a taxable person may be an individual, a partnership firm, a
company or anything else which supplies taxable goods and services.
 Every registered VAT trader is given a number, called TIN (Tax Payer’s
Identification Number), and has to show the amount of VAT charged to
customers on invoices.
 In terms of decision of the empowered committee, VAT on AED items
relating to sugar, textile and tobacco, because of initial organisational
difficulties, will not be imposed for one year after the introduction of VAT,
and till then the existing arrangement will continue.
 Input tax credit is the amount of tax paid by the dealer on purchases for
which the dealer is entitled to claim a credit.

14.5 KEY WORDS

 Value added: It is the difference between sale price and cost of material
and other inputs on which tax has been paid.
 Rate war: It refers to frequent changing of rates due to stiff competition.
 TIN: A taxpayer identification number (TIN) is used for identification/
registration of dealers under VAT.
 Central Value Added Tax (CENVAT): It is the value added tax wherein
the centre plays the role of a facilitator in implementing the tax.
 Transaction tax: VAT charged on every supply of goods and services.

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14.6 ANSWERS TO ‘CHECK YOUR PROGRESS’

Check Your Progress - 1

1. In India’s prevalent sales tax structure, there have been problems of double
taxation of commodities and multiplicity of taxes, resulting in a cascading
tax burden. VAT was developed to avoid this cascading effect of taxes. The
basic principle is that at every stage, tax should be paid only on value
added at that stage and not on entire sale price.
2. VAT was first introduced at the central level for a selected number of
commodities in terms of MODVAT with effect from 1 March 1986, and in
a five step-by-step manner for all commodities in terms of CENVAT in
2002–03.
3. The Empowered Committee of State Finance Ministers was set up to
monitor the implementation of value added tax at the state-level and
recommend changes according to changing economic needs.
4. The Ministry of Finance is the main agency for levying and implementing
VAT, both at the Centre and the state-level.
5. The Central Board of Excise and Customs (CBEC) deals with the tasks of
formulation of policy concerning levy and collection of customs and central
excise duties, and allowing of Central Value Added Tax (CENVAT) credit.
6. Two advantages of VAT are:
(i) Overall tax burden will be rationalised
(ii) Tax structure becomes simpler and more transparent

Check Your Progress - 2

1. At present, there are two basic rates of VAT, namely, 4 per cent and 12.5
per cent, besides an exempt category and a special rate of 1 per cent for a
few selected items. The items of basic necessities and goods of local
importance (up to 10 items) have been put in the zero rate bracket or the
exempted schedule. Gold, silver and precious stones have been put in the
1 per cent schedule.

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2. The rates of VAT depend on the nature of goods and services based on the
classification in various schedules.
3. Haryana was the first state in the country to introduce VAT.
4. VAT is calculated through:
a) Subtraction method: Tax rate is to be applied on the difference of
value of output and cost of input.
b) Addition method: Value added is to be computed by adding all the
payments which are payable to the factors of production.
c) Tax credit method: This method entails set-off of the tax paid on inputs
from collected tax on sales.
5. Only few goods which are outside VAT are liquor, lottery tickets, petrol,
diesel, aviation turbine fuel and other motor spirit since their prices are not
fully market determined.
6. Input tax credit is the amount of tax paid by the dealer on purchases for
which the dealer is entitled to claim a credit.

14.7 SELF-ASSESSMENT QUESTIONS

1. Introduction of VAT in the states has been a challenging exercise in a

federal country like India. Discuss.
2. Briefly discuss how VAT rates are determined according to goods.
3. Write a brief note on input tax credit.
4. Why was VAT introduced, replacing the Goods and Services Tax?
5. Discuss the advantages of VAT over sales tax.

14.8 FURTHER READINGS

Hariharan, N. Income Tax Law and Practice Assessment Year 2009-10. New
Delhi: Tata McGraw-Hill Publishing Company Limited.
Lal, B. B. Income Tax. New Delhi: Dorling Kindersley (India) Pvt. Ltd.
Puttaswamaiah, K. (eds). 1994. Economic Policy and Tax Reform in India.
New Delhi: Indus Publishing Company.

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Value Added Tax

Jain, R. T., Trehan, M., Uppal R., and Trehan R. 2011. Indian Economy. New
Delhi: V. K. Global Publications Pvt. Ltd.
Krishnan, V. S. 2006. Indirect Tax Reforms: Challenge & Response. New Delhi:
Abhinav Publications.

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