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Materials in this block have been partially adopted from IGNOU

and for Latest Financial Act,


icia.org, incometaxmanagement.com and taxguru.com have been
referred.
Bachelor of Commerce
(BCOM)

BCO-06
Income Tax Law & Practice

Block-3
Heads of Income - II
Unit-7 Profits and Gains of Business & Profession
Unit-8 Capital Gains
Unit-9 Income from Other Sources
UNIT-7 PROFITS AND GAINS FROM BUSINESS &
PROFFESSION

Structure
7.0 Objectives
7.1 Introduction
7.2 Computation of Profits & Gains of Business & Profession
7.3 Method of Accounting
7.4 General Principles for allowing business deductions
7.5 Expenses allowed as deduction
7.6 General Allowable deductions
7.7 Business Losses Deductable
7.8 Expenses not deductable under Business & Profession
7.9 Deemed Profit chargeable to tax
7.10 Deduction for expenditure incurred on setting up a specified business
7.11 Let us Sum Up
7.12 Key Words
7.13 Further Readings
7.14 Terminal Questions

7.0 OBJECTIVES

After studying this chapter, you would be able to know :


 The meaning of “business” and “profession” and the scope of income
chargeable to tax under this head;
 The meaning of speculative transaction and the tax treatment of loss incurred
in speculative business;
 The expenditures/ payments which are admissible as deduction,
 The deductions available while computing business income applying the
relevant provisions;
 The expenditures / payments which are not admissible as deduction;

7.1 INTRODUCTION

Third important head of the income is ‘Profit and gains of business or profession.
Major part of the revenue is collected by income tax department from the tax payers
engaged in business activities.

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Meaning of Business- Sec. 2 (13) Business includes any trade, commerce or
manufacture or any adventure or concern in the nature of trade, commerce or
manufacture.

“Profession” includes ‘Vocation’ Sec. 2 (36)Profession- The expression Profession


involves the idea of an occupation requiring Purely intellectual skill or manual Skill
controlled by the operator as distinguished from an occupation or business which is
substantially the production/ sale/ arrangements for the production or sale of
commodities.

Vocation: In the act, It implies natural ability of person for some particular work. In
the other words by the way in which a man passes his life.

Profits and Gains of business/ Profession include -


Profit from trading activities, Compensation, Receipts from Profession, Profit from
speculation business, Brokerage, Commission, Import-export Incentives, Income of
trade Associations, Royalty etc.

7.2 COMPUTATION OF PROFITS AND GAINS OF BUSINESS OR


PROFESSION’ (SECTION 28)

1. Business Incomes Taxable under the head of ‘Profit and Gains of Business or
Profession’ (Section 28).

Under section 28, the following income is chargeable to tax under the head “Profits
and gains of business or profession”:

i. profits and gains of any business or profession;


ii. any compensation or other payments due to or received by any person
specified in section 28(ii);
iii. income derived by a trade, professional or similar association from specific
services performed for its members;
iv. the value of any benefit or perquisite, whether convertible into money or not,
arising from business or the exercise of a profession;
v. any profit on transfer of the Duty Entitlement Pass Book Scheme;
vi. any profit on the transfer of the duty free replenishment certificate;
vii. export incentive available to exporters;
viii. any interest, salary, bonus, commission or remuneration received by a partner
from firm
ix. any sum received for not carrying out any activity in relation to any business
or
x. profession or not to share any know-how, patent, copyright, trademark, etc.;
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xi. fair market value of inventory as on the date on which it is converted into, or
treated as, a capital asset determined in the prescribed manner;
xii. any sum received under a Keyman insurance policy including bonus;
xiii. any sum received (or receivable) in cash or kind, on account of any capital
asset (other than land or goodwill or financial instrument) being demolished,
destroyed, discarded or transferred, if the whole of the expenditure on such
capital asset has been allowed as a deduction under section 35AD; and income
from speculative transaction.

2. Business Income Not Taxable under the head ‘Profit and Gains of Business
or Profession’

In the following cases, income from trading or business is not taxable under section
28, under the head “Profits and gains of business or profession”:

 Rental income in the case of Dealer in Property


 Dividend on Shares in the case of a Dealer-in-Shares
 Winnings from Lotteries, etc.
 Interest received on Compensation or Enhanced Compensation

3. Basic Principles for Computing income Taxable under the head ‘Profit and
Gains of Business or Profession’

 Business or profession carried on by the assessee


 Business or profession should be carried on during the previous year
 Income of previous year is taxable during the following assessment year
 Tax incidence arises in respect of all businesses or professions
 Illegal business

7.3 METHOD OF ACCOUNTING FOR COMPUTING BUSINESS INCOME


(SECTION 145)

(1) Income to be computed either on the basis of cash or mercantile system of


accounting [Section 145(1)]
Income chargeable under the head "Profits and gains of business or profession" or
"Income from other sources" shall, subject to the provisions of section 145(2), be
computed in accordance with either cash or mercantile system of accounting regularly
employed by the assessee.

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(2) Central Government empowered to notify income computation and
disclosure standards [Section 145(2)]
The Central Government may notify, in the Official Gazette from time to time,
income computation and disclosure standards to be followed by any class of assessees
or in respect of any class of income. The Central Government vide Notification No.
87/2016, dated 29.9.2016 has notified certain Income Computation and Disclosure
Standards to be followed by all assessees.

(3) Assessing Officer empowered to make assessment in the manner provided


under section 144 in certain cases [Section 145(3)]
i) Where the Assessing Officer is not satisfied about the correctness or
completeness of the accounts of the assessee, or
ii) Where the method of accounting provided in section 145(1) has not been
regularly followed by the assessee, or
iii) Where income has not been computed in accordance with the standards
notified under section 145(2), the Assessing Officer may make an assessment
in the manner provided in section 144.

(4) Income Computation and Disclosure Standards (ICDS)


The Central Government has notified the following Income Computation and
Disclosure Standards (ICDS) to be followed by all assesses (other than an individual
or a Hindu undivided family who is not required to get his accounts of the previous
year audited in accordance with the provisions of section 44AB), following mercantile
system of accounting for the purposes of computation of income chargeable to tax
under the head “profit and gains of business or profession” or “income from other
sources”

7.4 GENERAL PRINCIPLES FOR ALLOWING BUSINESS DEDUCTIONS


FROM PROFITS AND GAINS OF BUSINESS OR PROFESSION.

Section 28 defines various income which are chargeable to tax under the head “Profits
and gains of business or profession”. Section 29 permits deductions and allowances
laid down by sections 30 to 43D while computing profits or gains of a business or
profession. Loss of revenue nature, which is incidental to business, is allowable as
deduction while computing taxable business income, even though it is not codified
specifically under any of these sections. Sections 40, 40A and 43B give a list of
expenses which are not deductible.

Before studying the nature and amount of permissible and non-permissible deductions
under sections 30 to 43D, it will be useful if one keeps in view the following
principles governing admissibility of these deductions:
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 It is the responsibility of the assessee to prove that a particular deduction is
admissible in his case
 Allowances are cumulative
 Expenditure should relate to the previous year
 Business should be carried on during the previous year
 Expenditure should have been incurred in connection with assessee’s business
 Benefit of expenditure may extend to somebody else
 Benefit of expenditure may extend beyond the relevant previous year
 No allowance in respect of exhaustion of wasting assets
 No allowance in respect of expenditure incurred before the setting up of a
business
 No allowance in respect of non-assessable business
 Expenditure relating to illegal business
 No allowance in respect of anticipated losses
 No deduction in respect of depreciation of investment
 Relevance of distinction between capital and revenue expenditure

7.5 EXPENSES ALLOWED AS DEDUCTIONS AGAINST PROFITS AND


GAINS OF BUSINESS OR PROFESSION [SECTION-30-37]

1. Rent, Rates, Taxes, Repairs and Insurance for Building [Section 30]
In respect of rent, rates, taxes, repairs and insurance for premises, used for the
purposes of the business or profession, profession, the following deductions shall be
allowed:
a. Where the premises are occupied by the assessee:
i) As a tenant — the rent paid for such premises; and further if he has
undertaken to bear the cost of repairs to the premises, the amount paid on
account of such repairs;
ii) Otherwise than as a tenant — the amount paid by him on account of
current repairs to the premises;
b. Any sum paid (whether as owner or tenant) on account of land revenue, local
rates or municipal taxes;
c. Any insurance premium paid (whether as owner or tenant) in respect of
insurance against risk of damage or destruction of the premises.

2. Repairs and insurance of machinery, plant and furniture [Section 31]


In respect of machinery, plant or furniture used for the purpose of business, the
following deductions are allowable:
1. Amount paid on account of current repairs,

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2. Any insurance premium paid in respect of insurance against risk of damage or
destruction of the plant and machinery or furniture.

3. Depreciation [Section 32] :


 In order to claim depreciation, an assessee has to fulfill the following
conditions:
 The asset should be owned by the assessee. Where, however, an assessee
carries on business or profession in a building not owned by him but taken on
lease, he is entitled to depreciation in respect of the capital expenditure
incurred by him after March 31, 1970 on the construction of any structure or
any work in relation to the building by way of improvement, renovation or
extension.
 The asset, in respect of which depreciation is claimed, must have been used for
the purpose of business. Where, however, the asset is partly used for business
or profession and partly used for private and personal purposes, a reasonable
proportion of the depreciation attributable to the business user of the asset is
allowed [Section 38].
 Under the Income-tax Act, one can claim depreciation in respect of the
following assets—
 Tangible Assets – Building, Machinery, Plant and Furniture
 Intangible Assets acquired after March 31, 1998. - Know-how, patents,
copyrights, trademarks, licenses, franchises or any other business or
commercial rights of similar nature.

4. Section 32AD - Investment if new plant or machinery in notified


backward areas in certain states
Additional investment allowance is available from the assessment year 2016-17
under section 32AD. Accordingly, if an undertaking is set up in the notified
backward areas in Andhra Pradesh, Bihar, Telangana and West Bengal by a
company, it shall be eligible to claim deduction under section 32AD if it fulfills the
conditions specified under section 32AD.

Conditions for Claiming Deduction Under Section 32AD

The following conditions should be satisfied in order to avail tax incentive of


additional investment allowance under section 32AD –
 The assessee may be a company or any other person.
 He/it sets up an undertaking/enterprise for manufacture or production of any
article or thing on or after April 1, 2015.
 Such undertaking must be set up in any backward area (notified by the Central
Government) in Andhra Pradesh, Bihar, Telangana and West Bengal.

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 He/it acquires and installs (for the purposes said undertaking) a “new asset”.
“New asset” for this purpose is a new plant or machinery. But it does not
include second hand machinery, machinery installed in office/ residential
accommodation/guest house, vehicle, ship or aircraft or any plant and
machinery, the whole of the actual cost of which is allowed as deduction
(whether by way of depreciation or otherwise) in computing business income
of any previous year.

 The new asset should be acquired and installed after March 31, 2015 but before
April 1, 2020. Both ‘acquisition’ and ‘installation’ of the new asset (i.e., new
plant and machinery) are required to be made after March 31, 2015 but before
April 1, 2020.

5. Expenditure on Scientific Research [Section 35]


The term “scientific research” means “any activity for the extension of knowledge in
the fields of natural or applied sciences including agriculture, animal husbandry or
fisheries”. The term ‘scientific research’ has a wide scope. It does not necessarily
mean only invention or successful scientific research. With a view to accelerating
scientific research, section 35 provides tax incentives

Under this section amount deductible in respect of scientific research may be


classified as under:

Expenditure on Research carried on Contribution to Outsiders


by the Assessee
1. Revenue Expenditure under Section 1. Contribution to an Approved
35(1))(i) Research Association under Section
35(1)(ii)/(iii)
2. Capital Expenditure under Section 2. Payment to National Laboratory
35(2) under Section 35(2AA)
3. Expenditure on an Approved in-House 3. Contribution to an Indian Scientific
Research under Section 35(2AB) Research Company.

1. Revenue Expenditure Incurred by an Assessee who Himself Carries On


Scientific Research [Section 35(1)(i)]
Where the assessee himself carries on scientific research and incurs revenue
expenditure, deduction is allowed for such expenditure only if such research relates to
his business.

2. Contribution to Outside Institutions for Scientific Research [Section


35(1)(ii)/(iii)]

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Where the assessee does not himself carry on research but makes contributions to the
following institutions for this purpose, a deduction is allowed as follows

To whom Contribution can be given Deduction( as a percentage of Actual


Expenditure)
For AY 2018-19 For AY 2021-
to 2020-21 22 onwards
An approved’ scientific association which has, 150% 100%
as its object, undertaking of scientific research
related or unrelated to the business of assessee
[sec. 35(1)(ii)]
An approved’ university, college or other 150% 100%
institution for the use of scientific research
related or unrelated to the business of assessee
[sec. 35(1)(ii)]
An approved’ university, college or other 100% 100%
institution for the use of research in social
sciences or statistical research related or
unrelated to the business of the assessee
[sec. 35(1)(iii)]

3. Amount Paid to an Approved Scientific Research Company [Section 35(1)(iia)]


Section 35(1) (iia) is applicable if the following conditions are satisfied—
 The taxpayer is any person (maybe an individual, HUF, firm, company or any
other person).
 The taxpayer has paid any sum to an Indian company (hereinafter referred as
“payee-company”) to be used by the payee for scientific research.
 The scientific research may or may not be related to the business of the
taxpayer.
 The payee-company has as its main object the scientific research and
development.
 The payee-company is for the time being approved by the prescribed
authority (i.e., the Chief Commissioner of Income-tax having jurisdiction over
the applicant). An application shall be submitted online for this purpose in
Form No. 3CF-III.
 The payee-company fulfils such other conditions as may be prescribed. These
conditions are given in rule 5F.

Amount of Deduction –
If the above conditions are satisfied, the taxpayer can claim a deduction under
section 35(1) (iia). The amount of deduction is –

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- for the assessment years 2009-10 to 2017-18 : 125% of the amount paid;
- from the assessment year 2018-19 onwards : 100% of the amount paid.

Payee-company cannot claim Deduction under Section 35(2AB) –


With a view to avoid multiple claims for deduction, it has been provided that the
payee-company approved under the provisions of section 35(2)(iia) is not entitled to
claim deduction under section 35(2AB). However, deduction to the extent of 100% of
the sum spent as revenue expenditure or capital expenditure on scientific research
which is available under section 35(1) will continue to be allowed.

4. Capital Expenditure Incurred by an Assesses who himself Carries On Scientific


Research [Section 35(2)]
Where the assessee incurs any expenditure of a capital nature on scientific research
related to his business, the whole of such expenditure incurred in any previous year is
allowable as deduction for that previous year.

5. Contribution to National Laboratory for Scientific Research[Section 35(2AA)]


The provisions of section 35(2AA) are given below
CONDITIONS - The following conditions should be satisfied
1. The payment is made to—
a. National Laboratory; or
b. University; or
c. Indian Institute of Technology; or
d. Specified person as approved by the prescribed authority.

The above payment is made under a specific direction that it should be used by the
aforesaid person for undertaking scientific research program approved by the
prescribed authority.

AMOUNT OF DEDUCTION –
If the aforesaid conditions are satisfied, the taxpayer is eligible for deduction as
follows—
 For the assessment years 2018-19 to 2020-21 : 150% of actual payment
 From the assessment year 2021-22 onwards : 100% of actual payment
Such contribution which is eligible for deduction under the aforesaid provisions is not
eligible for any other deduction under the Act.

6. Expenses on In-House Research and Development Expenses [Section 35(2AB)]


From the assessment year 1998-99, sub-section (2AB) has been inserted in section 35.
It provides for a deduction in respect of expenditure on in-house research and
development expenses.

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Amount of Deduction -
If all the above conditions are satisfied, the quantum of deduction is as follows

For the assessment years 2018-19 to 2020-21 150% of actual payment


From the assessment year 2021-22 onwards 100% of actual payment

A company approved under the provisions of section 35(1)(iia) is not eligible to claim
weighted deduction under section 35(2AB). However, deduction under section
35(1)(i)/(2) can be claimed to the extent of 100% of the sum spent as revenue
expenditure or capital expenditure on scientific research.

7. Deduction in respect Of Expenditure On Specified Business [Section 35AD]


Deduction under section 35AD shall be allowed to the assessee who is carrying on
specified business:

Nature and Amount of Deduction:


100% Deduction shall be allowed an account of any expenditure of capital nature
incurred wholly and exclusively for the purpose of the above specified business
carried on by such assessee during the previous year in which such expenditure in
incurred by him.

8. Payment to Associations and Institutions for carrying out Rural Development


Programs [Section 35CCA]
Under Section 35CCA, any assessee who is carrying on a business/profession shall be
allowed a deduction of the amount of the expenditure incurred by way of payment of
any sum to the following :
 any association or institution to be used for carrying out any programe of rural
development approved before March 1, 1983;
 an association or institution which has its object the training of persons for
implementation of a rural development programme approved before March 1,
1983;
 the National Fund for Rural Development; and notified National Urban
Poverty Eradication Fund.

9. Expenditure on Agricultural Extension Project [Section 35CCC]


Deduction shall be allowed on account of any expenditure incurred by the assessee on
agricultural extension project notified by the Board in this behalf in accordance with
the guidelines as may be prescribed

Amount of Deduction :
150% of such expenditure incurred during the previous year for the assessment years
2013-14 to 2020-21
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[from the assessment year 2021-22, an assessee can claim 100 % of expenditure as
deduction (but not weighted deduction)].

10. Expenditure on Skill Development Project [Section 35CCD]


Deduction shall be allowed on account of any expenditure (not being expenditure in
the nature of cost of any land or building) incurred by the company on skill
development project notified by the Board in this behalf in accordance with the
guidelines as may be prescribed

Quantum of Deduction:
150% of such expenditure incurred during the previous year for the assessment years
2013-14 to 2020-21 [from the assessment year 2021-22, an assessee can claim 100 %
of expenditure as deduction (but not weighted deduction)].

11. Amortisation of Preliminary Expenses [Section 35D]


An Indian company or a resident non-corporate assessee can claim deduction under
section 35D in respect of preliminary expenses. Such expenditure may be incurred
before commencement of the business or after commencement of the business in
connection with extension of an undertaking or in connection with setting up a new
unit.

Assessees who can claim deduction under this section are:


1. Indian Company, or
2. a person other than a company who is resident in India.

Expenditure in respect of which deduction is available


a. expenditure incurred before the commencement of business; or
b. expenditure incurred after the commencement of business in connection with the
extension of existing undertaking or in connection with setting up a new unit.
Expenses qualifying for deduction:

The following expenses qualify for deduction:


 Expenditure incurred in connection with:
a. preparation of a feasibility report;
b. preparation of a project report;
c. conducting market survey or any other survey necessary for the business of
the assessee;
d. engineering services relating to the business of the assessee;
 legal charges for drafting any agreement between the assessee and any other
person relating to the setting up or conduct of the business of the assessee;
 where the assessee is company, also, expenditure—

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a. by way of legal charges for drafting the Memorandum and Articles of
Association of the company;
b. on printing of the Memorandum and Articles of Association;
i) by way of fees for registering the company under the provisions of the
Companies Act, 1956;
ii) in connection with the issue, for public subscription, of shares in or
debentures of the company, being underwriting commission, brokerage
and charges for drafting, typing, printing and advertisement of the
prospectus;
 such other items of expenditure (not being expenditure eligible for any allowance
or deduction under any other provisions of this Act) as may be prescribed.

Amount Qualifying for Deduction:


The aggregate of the expenditure referred to in clauses (1) to (4) above shall not
exceed 5% of the cost of the project in case of all assessees other than companies.
In the case of a company, it cannot exceed 5% of—
 the Cost Of the Project, or
 the Capital Employed in the Business of the Company,
 whichever is beneficial to the company.

Amount of Deduction:
1/5th of the Qualifying Expenditure is Allowable as Deduction in each of the 5 (five)
successive years beginning with the year in which the business commences, or as the
case may be, the previous year in which extension of the undertaking is completed or
the new unit commences production or operation.

12. Amortisation of Expenditure in case of Amalgamation / Demerger [Section


35DD]
Where an assessee, being an Indian company, incurs any expenditure, wholly and
exclusively for the purpose of amalgamation or demerger of an undertaking, the
assessee shall be allowed a deduction of an amount equal to 1/5th of such expenditure
for each of 5 (five) successive previous years beginning with the previous year in
which the amalgamation or demerger takes place.

No deduction shall be allowed in respect of the expenditure mentioned above under


any other provision of the Act.

13. Amortisation of Expenditure under Voluntary Retirement Scheme [Section


35DDA]
Where an assessee incurs any expenditure in any previous year by way of payment of
any sum to an employee in connection with his voluntary retirement, in accordance
with any scheme or schemes of voluntary retirement, 1/5th of the amount so paid shall
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be deducted in computing the profits and gains of the business for that previous year,
and the balance shall be deducted in equal installments for each of the four
immediately succeeding previous years. No deduction shall be allowed in respect of
such expenditure under any other provision of the Income-tax Act.

14. Insurance Premium [Section 36(1)(i)]


Insurance premium is deductible in the following cases –
i) Any premium paid in respect of insurance against risk of damage or destruction of
stocks or stores, used for the purposes of business or profession.
ii) Insurance premium paid by a federal milk co-operative society on the lives of
cattle, owned by the members of a primary milk co-operative society affiliated to
it.
iii) Health insurance premium of employees paid by employer by any mode other
than cash.

15. Bonus or Commission to Employees [Section 36(1)(ii)]


Bonus or commission paid to an employee is allowable as deduction subject to certain
conditions:
 Admissible only if not payable as profit or dividend -
One of the conditions is that the amount payable to employees as bonus or
commission should not otherwise have been payable to them as profit or dividend.
This is provided to check an employer from avoiding tax by distributing his/its profits
by way of bonus among the member employees of his/its concern, instead of
distributing the sum as dividend or profits.

 Deductible on payment basis -


Bonus or commission is allowed as deduction only where payment is made during the
previous year or on or before the due date of furnishing return of income under section
139

16. Interest on Borrowed Capital [Section 36(1)(iii)]


Interest on capital borrowed is allowed as deduction if the following conditions are
satisfied —
i) The assessee must have borrowed money.
ii) The money so borrowed must have been used for the purpose of business.
iii) Interest is paid or payable on such borrowing.

 Assessee must have Borrowed Capital -


Interest in respect of capital borrowed for the purpose of business/ profession is a
permissible deduction. Interest on own capital is not deductible. In other words,
interest shall be paid to another person. Interest paid by one unit of the assessee to
another unit is not deductible.
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 Capital must be used for the Purpose of Business -
Capital should have been borrowed for the purpose of business or profession.

 Interest on capital borrowed for acquiring a capital asset -


Interest liability pertaining to the period beginning from the date on which capital is
borrowed by an existing concern for the acquisition of an asset till the date, when such
asset is first put to use, should be capitalised and it cannot be claimed as deduction
under section 36. Only interest on capital borrowed to purchase a capital asset for
business purposes pertaining to the period after the asset is put to use, is deductible on
year to year basis under section 36.

17. Discount on issue of Zero Coupon Bonds [Section 36(1)(iiia)]


Any discount on issue of zero coupon shall be allowed on a pro rata basis having
regard to the period of life of such bond calculated in a manner as may be prescribed.

 What are Zero Coupon Bonds -


According to section 2(48), zero coupon bond is a notified bond issued by any
infrastructure capital company (or infrastructure capital fund or public sector company
or scheduled bank) on or after June 1, 2005. In respect of such bond, no
payment/benefit is received (or receivable) by a bondholder before
maturity/redemption.

18. Employer’s Contribution to Recognised Provident Fund and Approved


Superannuation Fund [Section 36(1)(iv)]
Any sum paid by the assessee as an employer by way of contribution towards a
recognised provident fund or approved superannuation fund or any other approved
welfare scheme of employee is allowed as a deduction subject to such limits as may
be prescribed for the purpose of recognizing the provident fund or approving the
superannuation fund, etc. as the case may be.

19. Employer’s Contribution to National Pension Scheme (NPS) [Section


36(1)(iva)]
Any sum paid by the assessee as an employer by way of contribution towards a
pension scheme, as referred to in section 80CCD on account of an employee to the
extent it does not exceed 10% of the salary of the employee in the previous year shall
be allowed as deduction.

20. Contribution towards Approved Gratuity Fund [Section 36(1)(v)]


Any sum paid by the assessee as an employer by way of contribution towards
approved gratuity fund, created by him for the exclusive benefit of his employees

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under an irrevocable trust, shall be allowed as a deduction subject to the provisions of
section 43B.

21. Employees’ Contribution to Staff Welfare Schemes [Section 36(1)(va)]


Certain employers were deducting amounts from the salaries of the employees
towards certain welfare schemes like PF, ESI, etc. but were not crediting it to the
employees' accounts even after long periods. This Section was introduced to check
such malpractices. Sum deducted from the salary of the employee as his contribution
to any provident fund or superannuation fund or ESI or any other fund for the welfare
of such employee is now treated as an income of the employer as per section 2(24)(x).
However, if such contribution is actually paid on or before the due date mentioned
below the deduction will be allowed for the same under this clause.

22. Bad debts [Section 36(1)(vii)]


The amount of any bad debt or part thereof, which has been written off as
irrecoverable in the accounts of the assessee for the previous year, shall be allowed as
a deduction subject to the provisions of section 36(2) which are as under:—
 Such debt or part thereof must have been taken into account in computing the
income of the assessee of the previous year or of an earlier previous year, or
 It represents money lent in the ordinary course of the business of banking or
money-lending which is carried on by the assessee.

23. Provision for Bad and Doubtful Debts relating to Rural Branches of
Commercial Banks [Section 36(1)(viia)]
In respect of any provision for bad and doubtful debts made by,—

i) A scheduled bank (not being a foreign bank) or a co-operative bank (other than a
primary agricultural credit society or a primary co-operative agricultural and rural
development bank) or a non-scheduled bank, a deduction shall be allowed
 of an amount not exceeding 8.5% of the total income (computed before
making any deduction under this clause and Chapter VIA i.e. deductions u/s
80C to 80U) and
 of an amount not exceeding 10% of the aggregate average advances made
by the rural branches of such bank computed in the prescribed manner.
ii) A bank incorporated by or under any foreign laws or a public financial institution
or a State Financial Corporation or a State Industrial Investment Corporation, a
deduction shall be allowed of an amount not exceeding 5% of the total income
(computed before making any deduction under this clause and Chapter VIA).
iii) A non-banking financial company, a deduction shall be allowed of an amount
not exceeding 5% of total income (computed before making any deduction
under this clause Chapter VIA).

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24. Transfer to Special Reserve [Section 36(1)(viii)]
A financial corporation, banking company, co-operative bank and a housing finance
company can claim deduction under section 36(1)(viii) as follows, if a few conditions
are satisfied —
 the amount transferred during the previous year to the special reserve account
created for the purpose of section 36(1)(viii); or
 20 % of the profits derived from the business of providing long-term finance
before claiming deduction under section 36(1)(viii); or
 200 % of (paid-up share capital and general reserve as on the last day of the
previous year) minus the balance of the special reserve account on the first day of
the previous year, whichever is lower.

25. Family Planning Expenditure [Section 36(1)(ix)]


This deduction is allowed only to company assessees. Any expenditure bona fide
incurred by a company for the purpose of promoting family planning amongst its
employees is allowable as deduction in the year in which it is incurred. Where such
expenditure or part thereof is of a capital nature, 1/5th of such expenditure shall be
deducted for the previous year, in which it was incurred and the balance shall be
deducted in four equal installments during the subsequent four years.

26. Securities Transaction Tax [Section 36(1)(xv)]


An amount equal to the securities transaction tax paid by the assessee in respect of the
taxable securities transactions entered into in the course of his business during the
previous year, if the income arising from such taxable securities transactions is
included in the income computed under the head "Profits and Gains of Business or
Profession".

27. Commodities Transaction Tax [Section 36(1)(xvi)]


An amount equal to the commodities transaction tax paid by the assessee in respect of
the taxable commodities transactions entered into in the course of his business during
the previous year shall be allowable as deduction, if the income arising from such
taxable commodities transactions is included in the income computed under the head
"Profits and gains of business or profession".

28. Expenditure by Co-Operative Society for purchase of Sugarcane [Section


36(1)(xvii),
The amount of expenditure incurred by a cooperative society engaged in the business
of manufacture of sugar for purchase of sugarcane at a price which is equal to or less
than the price fixed or approved by the Government shall be allowed as a deduction.

16
29. General Deductions [Section 37]
Any expenditure (not being expenditure of the nature described in Sections 30 to 36)
and not being in the nature of capital expenditure or personal expenditure of the
assessee, laid out or expended wholly and exclusively for the purposes of the business
or profession, shall be allowed as deduction in computing the income chargeable
under the Head "Profits and Gains of Business or Profession".
The twin requirements, therefore, are that the expenditure should be—
i) Wholly and exclusively.
ii) For the purpose of business.

Examples of Expenditure Allowable as a Deduction u/s 37(1)


 Remuneration to Employees:
 Payment of Penalty / Damages:
 Legal Expenses:
 Expenditure on Raising Loans:
 Expenditure on Advertisement:

7.6 [SECTION 37(1)]: ALLOWABLE DEDUCTIONS UNDER BUSINESS OR


PROFESSIONS

Section 37(1) says that any expenditure (not being expenditure of the nature described
in sections 30 to 36 and not being in the nature of capital expenditure or personal
expenses of the assessee), laid out or expended wholly and exclusively for the
purposes of the business or profession shall be allowed in computing the income
chargeable under the head, “Profits and Gains of Business or Profession”.

(A) Conditions for Allowance of General Deduction from Business Income Under
Section 37(1)
In order to claim Deduction under this Section, the following conditions should be
satisfied :

1. Expenditures should not be covered by Section 30 to 36 -


For claiming deduction of an expenditure under section 37(1), it should be ensured
that the expenditure is not in the nature described by sections 30 to 36. The rule is that
if an item of expenditure is covered under any of the aforesaid sections, the same
cannot be claimed under the residuary section.

2. Expenditure should not be of Capital Nature. -


Capital Expenditures are Not Deductible under Section 37(1).

17
As the Act does not define the terms “Capital Expenditure” and “Revenue
Expenditure”, one has to depend upon its natural meaning as well as decided cases as
described below :
 Acquisition of Fixed Assets v. Routine expenditure
 Several Previous Years v. One Previous Year
 Improvement v. Maintenance
 Non-Recurring v. Recurring
 Lump sum Payment v. Periodic Payment

3. The expenditure should not be of a Personal Nature-


Section 37(1) expressly prohibits deduction on account of personal expenses. Personal
expenses mean expenses satisfying personal needs such as food, cloth, shelter, etc.,
which are not related to the business. In other words, money expended for domestic or
private purpose, as distinct from the purpose of the trade or profession, are not
deductible.

4. The expenditure should have been incurred during the previous year -
- In order to claim deduction, the amount should have been laid out or expended in the
previous year.

5. The expenditure should have been incurred wholly or exclusively for the
purpose of the Business or Profession -
The main requirement of provision of section 37(1) is that expenditure should have
been laid out wholly and exclusively for the purpose of the business.

6. Expenses should be in respect the Business carried on by the Assessee -


- For the purpose of claiming deduction under section 37(1), expenditure should be
incurred for the purpose of the business which is carried on by the assessee in the
previous year and profits of which are to be computed and assessed and expenditure
should be incurred after the business is set up.

7. Illegal Expenditure -
Any expenditure incurred by an assessee for any purpose which is an offence or which
is prohibited by any law shall not be deemed to have been incurred for the purpose of
the business or profession and no allowance or deduction shall be made in respect of
such expenditure. Unlawful expenditure is not allowable as deduction. These
provisions apply only to ‘business expenditure’ and not to ‘business loss’ and, hence,
loss arising as a result of seizure and confiscation of illegal stock-in-trade is allowable
as a business loss against income from illegal business.

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(B) List of Expenditure Allowable as a Deduction Under Section 37(1) from
Business Income :
To have better understanding of section 37(1), a few instances are given where
expenditures are allowable under section 37(1):
 Litigation expenses in protecting the trade or business.
 Expenditure incurred for the preservation or protection of the asset or for
saving such asset from destruction, dissipation or wastage in the interest of and
for the benefit of assessee’s business.
 Litigation expenses incurred in order to defend or maintain an existing title to
the business asset.
 Expenses on litigation (whether civil or criminal) if incurred wholly and
exclusively for the purpose of the business.
 Legal charges for obtaining a loan from a financial institution.
 Royalty paid by an assessee to a company for using its logo.
 Consultancy charges paid for maintenance of software.
 Environment monitoring expenses and community development expenses.
 Litigation expenses for making agreements, various deeds, etc.
 Legal expenses incurred in altering the articles of association so as to bring it
in conformity with the changes brought about in the Companies Act.
 Damages for breach of contract for export of goods before declaration of
export policy of the Government.
 Damages paid to a worker in order to dismiss him in the interest of business.
 Damages for failure to fulfil a contract in time.
 Brokerage paid for raising loan to finance business.
 Stamp and registration charges for the purpose of entering into agreement for
obtaining overdraft facilities.
 Amount spent towards stamps, registration fees, lawyer’s fees, etc., for
obtaining loan or raising money by issue of debentures (not shares).
 Guarantee commission paid to brokers and shareholders for giving personal
guarantee to obtain credit facility.
 Commission paid at a percentage of profits to general manager.
 Commission paid to selling agents.
 Contribution to a trade syndicate with a view to preventing uneconomic
competition.
 Contribution to a union formed for opposing nationalisation of assessee’s
business.
 Salary and perquisite to employees.
 Salary, bonus and travelling expenses paid by a partner-assessee to his staff to
look after his interest and to earn income for partnership.
 Expenditure incurred in obtaining use of trademark, technical information,
training of apprentices and technicians.
19
 Recurring expenses incurred on imparting of the basic training to apprentices
under the Apprentices Act, 1961.
 Expenses incurred on the occasion of Diwali and mahurat subject to the
Assessing Officer being satisfied that the expenses are admissible as a
deduction under the law and are not expenses of a personal, social or religious
nature.
 Initial expenditure on the first installation of fluorescent lights is treated as
capital expenditure and all subsequent expenditure for replacement of tubes is
treated as revenue expenditure and are allowed in toto.
 Expenditure in respect of commitment charges paid by the borrower with
regard to the amount of loan not drawn by him but kept in readiness by the
lender for disbursement.
 Premia paid on loss of profit policies.
 Professional tax paid by a person carrying on business or trade.
 All expenditure on maintenance of a tea garden including expenditure on the
maintenance of an area that has not reached maturity.
 Deposit made under “own your telephone” scheme [is allowable as deduction
in the year of payment and in case the telephone is not installed and money is
returned, it is chargeable to tax under section 41(1)].
 Forfeiture of security deposit for breach of contract.
 Expenses on registration of trademarks.
 Penalty levied for supply of foodgrains not conforming to the contract quality.
 Expenditure incurred by a surgeon to keep himself up-to-date about the latest
technique in surgery.
 Substantial repair charges on plant and machinery being necessary owing to
long neglect of assets.
 Entertainment expenses incurred on opening of new branches at different
places.
 Expenditure incurred to protect capital asset income of which is assessable to
tax.
 Cash shortage found in business at the end of day.
 Periodical payment for the use of goodwill.
 Expenditure incurred on renovation of the living room, bathroom, back
verandah, study, etc., of branch office.
 Municipal property tax chargeable under local tax law of Japan.
 Expenditure incurred to secure overdraft facilities for the business purposes.
 Annual listing fees paid to stock exchanges.
 Expenditure on management of temple in factory premises for recreation of
employees.

20
 Contribution given under a development scheme for construction of roads
around factory building for facilitating the transport of sugarcane to the factory
and the flow of manufactured sugar out of the factory.
 Expenditure incurred for purchase of loom hours.
 Royalty payable on goods manufactured as a consideration to acquire
monopoly rights to manufacture the product.
 Expenditure on licence fees for the import of capital goods and registration
fees of trade mark.
 Expenditure on valuation of shares.
 Amount paid in compromising a bona fide dispute and as part of an
arrangement for enabling the assessee to continue business.
 Expenditure incurred by the assessee on replacement of damaged moulds.
 Expenditure in regard to contribution made by the assessee-company to State
Electricity Board towards laying of additional circuit line in order to meet
increased demand of company.
 Expenditure on re-routing of pipeline in order to obtain saline free water for
factory.
 Donation/contribution made by an assessee to any relief fund, such as Chief
Minister’s Drought Relief Fund or a District Welfare Fund established by
District Collector for benefit of public with a view to securing benefit to
assessee’s business .
 Amount paid by the assessee-company for Flag Day Fund on Government’s
appeal.
 Contribution made by the assessee, running a refinery, to railway department
for construction of railway track and siding which are necessary for the
purpose of smooth running of business in a profitable and advantageous
manner (only expenditure incurred in relevant year of assessment alone is to be
allowed).
 Contribution made by the assessee-company to State Housing Board for
construction of tenements for its workers, ownership of which tenements
remained with Housing Board.
 Expenditure incurred by the assessee-company on foreign visit of director and
his wife in connection with medical treatment of the director.
 Expenditure incurred by the assessee on plantations in factory premises and
residential quarters of company, with a view to making atmosphere pollution
free.
 Royalty paid by the assessee for user of trademark of another company.
 The expenditure incurred solely for repairs and modernizing the hotel and
replacing the existing components of the building, furniture and fittings, with a
view to create a conductive and beautiful atmosphere for the purpose of
running of the business of a hotel.
21
 Penalty which is compensatory in nature and which is paid for breach of a
contract or statute is deductible.
 Software programme once developed by the assessee cannot be said to be of
enduring benefit and expenses incurred in developing such software
programme are allowable as revenue expenditure.
 Expenditure on issue of bonus shares.
 Harvesting and transportation expenses incurred by the Co-operative Sugar
Mills for procuring sugarcane from farmers, who are members of such Co-
operative Sugar Mills and who are bound under an agreement to supply the
sugarcane exclusively to the concerned sugar mill.
 Expenditure for improving the performance of existing products is deductible.
 Expenditure incurred for purpose of sub-division of shares for easy trading of
shares in market, is revenue in nature and deductible.
 Expenses incurred by an assessee for preliminary work for a project (which
has been abandoned for some unavoidable reasons) is deductible.
 Advertisement expenditure incurred by an assessee for building up its brand is
deductible.
 Expenses on replacement of mother board/UPS and expenditure incurred on
ERP software/customizing software, are deductible.
 Expenditure incurred on garden to control pollution is deductible.

(C). List of Expenditures NOT Allowable as Deduction Under Section 37(1) from
Business Income :
 Damages and penalty paid for transgressing the terms of agreement with the
State.
 Penalty and damages paid in connection with infringement of law.
 Litigation expenditure incurred for curing any defect in title of assets or
completing that title.
 Litigation expenses for registration of shares.
 Fees paid for increase of authorised capital.
 Expenditure on raising equity share capital and preference share capital (may
be redeemable). However, expenditure on issue of bonus shares is deductible.
 Amount paid for acquiring technical know-how which is to be utilised for the
purpose of manufacturing any new article and such know-how is to become
the property of the assessee at the end of the stipulated period.
 Amount expended for acquiring a business or a right of a permanent character
or an asset which generates income or for avoiding compensation in business.
 Payments made for acquisition of goodwill.
 Expenditure incurred for acquiring right over or in land to win minerals
(where, however, minerals are already on surface, expenditure incurred for
obtaining right to acquire raw material is deductible).
22
 Fees paid to obtain license to investigate and search minerals.
 Payment made in consideration of acquiring a monopoly right to manufacture
a product (royalty payable on the basis of goods produced under the same
arrangement is, however, deductible).
 Tax paid by the assessee (who is defaulter by not deducting tax at source under
section 195) on behalf of nonresident.
 Compensation paid to contracting party with the object of avoiding an
unnecessary investment in capital asset.
 Expenditure on shifting of registered office.
 Insurance premia paid by a firm on life insurance policies of its partners.

Amount paid by liquor contractor to police staff and other officer to enable it to make
unauthorized purchases and sales of liquor.

7.7 BUSINESS LOSSES DEDUCTIBLE UNDER THE HEAD 'PROFITS


AND GAINS OF BUSINESS OR PROFESSION'

1. Following Losses are Deductible from Business Income


 Loss of stock-in-trade as a result of enemy action, or arising under similar
circumstances.
 Loss of stock-in-trade due to destruction by an act of God.
 Loss arising on account of failure on the part of the assessee to accept delivery
of goods.
 Depreciation in funds kept in foreign country for purchase of stock-in-trade.
 Loss due to exchange rate fluctuations of foreign currency held on revenue
account.
 Loss arising from sale of securities held in the regular course of business.
 Loss of cash and securities in a banking company on account of dacoity
(maybe after banking hours.) 8. Loss incurred on realisation of amount
advanced in connection with business.
 Loss of security deposited for the purposes of acquisition of stock-in-trade.
 Loss due to forfeiture of a deposit made by the assessee for properly carrying
out of contract for supply of commodities.
 Loss on account of embezzlement by an employee.
 Loss incurred due to theft or burglary in factory premises during or after
working hours.
 Loss of precious stones or watches of a dealer while bringing them from
business premises to his house.
 Loss arising from negligence or dishonesty of employees.
 Loss incurred on account of insolvency of banker with which current account
is maintained by the assessee.
23
 Loss incurred due to freezing of the stock-in-trade by enemy action.
 Loss incurred by a sugar manufacturing company by foregoing advance made
to sugarcane growers who used to sell sugarcane crop exclusively to the
company.
 Loss on account of non-recovery of advances given by the assessee-company
(engaged in the business of financing its subsidiaries) to its 100 per cent
subsidiary company.
 Loss incurred by a holding company which has guaranteed a loan taken by its
subsidiary company.
 Loss arising as a result of seizure and confiscation of illegal stock-in-trade is
allowable as a business loss against income from illegal business—
 Loss arising as a result of rejection of goods by the importer (as goods are
unfit for human consumption).

2. Following Losses are Not Deductible from Business Income


 Loss which is not incidental to trade or profession, carried on by the assessee.
 Loss incurred due to damage, destruction, etc., of capital assets.
 Loss incurred due to sale of shares held as investment.
 Loss of advances made for setting up of a new business which ultimately could
not be started.
 Depreciation of funds kept in foreign currency for capital purposes.
 Loss arising from non-recovery of tax paid by an agent on behalf of the non-
resident.
 Anticipated future losses.
 Provision made by assessee in respect of non-performing assets.
 Loss relating to any business or profession discontinued before the
commencement of previous year.

7.8 EXPENSES NOT DEDUCTIBLE UNDER THE HEAD 'PROFITS AND


GAINS OF BUSINESS OR PROFESSION (SECTION 40, 40A, 43B)

The following expenses given by sections 40, 40A and 43B are expressly disallowed
by the Act while computing income chargeable under the head “Profits and gains of
business or profession”.

1. Interest, Royalty, Fees for Technical Services Payable Outside India or


Payable to a Non-Resident [Section 40(a)(i)] -
Disallowance of expenditure under section 40(a)(i) -
If TDS default is committed in respect of payment/credit given to a foreign
company/non-resident, the expenditure is disallowed in the hands of payer under
section 40(a)(i). These provisions are given below –
24
Case-1 : TDS is Deductible but not Deducted : 100 % of such expenditure is
disallowed in the current Year-
 If tax is deducted in any subsequent year, the expenditure (which is disallowed in
the current year) will be deducted in the year in which TDS will be deposited by
the assessee with the Government

Case-2 : Tax is deductible (and is so deducted) during the current financial year but it
is not deposited on or before the due date of submission of return of income under
section 139(1) : 100 % of such expenditure is disallowed in the current year
 If tax is deposited with the Government after the due date of submission of return
of income, the expenditure (which is disallowed in the current year) will be
deductible in that year in which tax will be deposited
Note :
If the following three conditions are satisfied, the assessee (i.e., the payer) is supposed
to deduct tax at source (TDS) under section 195—
1. The amount paid is interest, royalty, fees for technical services or any other
sum (not being salary).
2. The aforesaid amount is chargeable to tax in India in the hands of the
recipient.
3. The aforesaid amount is paid/payable to a non-resident. If the above three
conditions are satisfied, the assessee (the payer) is supposed to deduct tax at
source and deposit the same with the Government.

2. Disallowance of Expenditure in respect of any Payment / Credit to a Resident


[Section 40(a)(ia)]
- If TDS default is committed in respect of the above payment/credit given to a
resident, 30 % of such expenditure is disallowed in the hands of payer under section
40(a)(ia). These provisions are given below –

TDS Default Is such Expenditure Is such Expenditure Deductible


Deductible in the in any Subsequent Previous
Current Previous Year Year
Case 1 - TDS is deductible 30 % of such If tax is deducted in any
but not deducted. expenditure is subsequent year, the
disallowed in the expenditure (which is
current year disallowed in the current year)
will be deducted in the year in
which TDS will be deposited
by the assessee with the
Government

25
Case 2- TDS is deductible 30% of such If tax is deposited with the
(and is so deducted) during expenditure is Government after the due date
the current financial year disallowed in the of submission of return of
but it is not deposited on or current year income, the expenditure
before the due date of (which is disallowed in the
submission of return of current year) will be deductible
income under section in that year in which tax will
139(1) be deposited

Note :
In respect of the following payments/credit to a resident, tax is deductible under
Chapter XVII-B of the Income-tax Act (i.e., Sections 192 to 206AA)
1. Salary
2. Payment in respect of life insurance policy
3. Interest
4. Payment in respect of deposits under NSS
5. Dividends
6. Payment on account of certain units
7. Winnings from lottery or crossword puzzles
8. Rent
9. Winnings from horse races
10. Payment on purchase of immovable property
11. Payments to contractors
12. Technical/professional fees, royalty, fees to a part time director
13. Commission or brokerage (including insurance
14. Payment of compensation on acquisition of immovable commission) property

3. Default pertaining to Non-Deduction / Non-Deposit of Equalisation Levy


[Section 40(a)(ib)] -
Any consideration paid or payable (to a non-resident for a specified service on which
equalisation levy is applicable) will be disallowed from the assessment year 2017-18
in the following cases—
i) Equalisation levy is deductible and such levy has not been deducted.
ii) Equalisation levy is deductible (and it is so deducted) but it is not deposited
[on or before the due date of submission of return of income under section
139(1)].

If, however, equalisation levy is deducted/deposited in a subsequent year, the


aforesaid consideration shall be allowed as a deduction in computing the income of
the previous year in which such levy has been paid.

26
4. Disallowance of royalty, license fees, etc., in case of State Government
Undertakings [Section 40(a)(iib)] -
The following shall not be allowed as deduction from the assessment year 2014-15 –
 Any amount paid by way of royalty, license fee, service fee, privilege fee, service
charge or any other fee or charge (by whatever name called), which is levied
exclusively on a State Government undertaking by the State Government.
 Any amount which is appropriated (directly or indirectly) from a State
Government Undertaking by the State Government.

5. Salary Payable outside India without Tax Deduction [Section 40(a)(iii)] -


Section 40(a)(iii) is applicable if salary is paid outside India or paid to a non-resident
and tax has not been paid to the Government nor deducted at source under the
Income-tax Act.

6. Tax on Non-Monetary Perquisite paid by the Employer [Section 40(a)(v)] -


The provisions of section 40(a)(v) are given below –
i) The employer provides non-monetary perquisites to employees.
ii) Tax on non-monetary perquisites is paid by the employer.
iii) The tax so paid by the employer is not taxable in the hands of employees by
virtue of section 10(10CC).
iv) While calculating income of the employer, the tax paid by the employer on non-
monetary perquisites is not deductible under section 40(a)(v).

7. Amounts Not Deductible in respect of Payment to Relatives[ Section 40A(2)]


For an amount to be disallowed under this Section, three conditions have to be
fulfilled:
 the payment is in respect of any expenditure;
 the payment has been made or is to be made to a specified person in respect of
such expenditure;
 the payment for the expenditure is considered excessive or unreasonable having
regard to:
 The fair market value of the goods, services or facilities; or
 the legitimate business needs of the assessee's business or profession; or
 the benefit derived by or accruing to the assessee from the payment.

If the above conditions are fulfilled, the Assessing Officer can disallow the
expenditure to the extent he considers it excessive or unreasonable by the above
objective standards or otherwise.

Section 40A(2) is applicable in the following cases (list is not complete, only
important cases are given) –
 Payment made by an individual to his or her relative.
27
 Payment made by a company to a director of the company or any relative of
the director.
 Payment made by a firm/AOP/HUF to a partner/member or a relative of
partner/member.
 Payment made to an individual who has a substantial interest in the business of
the payer or a relative of such individual.
 Payment made to a company who has a substantial interest in the business of
the payer, any director of such company or relative of such director.
 Payment made to a firm/AOP/HUF who has a substantial interest in the
business of the payer or partner/ member of such person or relative of
partner/member.

8. Amounts Not Deductible in respect of Expenditure exceeding Rs. 10,000 (Rs.


35,000 if an assessee makes payment for Plying, Hiring or Leasing Goods
Carriages) [Section 40A(3)] -
The provisions of section 40A(3) are given below —

Disallowance is attracted under section 40A(3) if the following conditions are


satisfied —
 The assessee incurs any expenditure which is otherwise deductible under the other
provisions of the Act for computing business/profession income (e.g., expenditure
for purchase of raw material, trading goods, expenditure on salary, etc.). The
amount of expenditure exceeds Rs. 10,000 (Rs. 35,000 if an assessee makes
payment for Plying, Hiring or Leasing Goods Carriages).
 A payment (or aggregate of payments made to a person in a day) in respect of the
above expenditure exceeds Rs. 10,000 (Rs. 35,000 if an assessee makes payment
for Plying, Hiring or Leasing Goods Carriages).
 The above payment is made otherwise than by an account payee cheque or an
account payee demand draft or use of electronic clearing system through a bank
account. If all the above conditions are satisfied, then 100 % of such payment will
be Disallowed.

Exceptions - The above rule i.e. Section 40A(3) is not applicable to a few cases given
below –
 Payment made to a bank (including private sector banks, co-operative bank,
credit societies), LIC, etc.
 Payment made to Government.
 Payment through banking system.
 Payment made by book adjustment by an assessee in the account of the payee
against money due to the assessee for any goods supplied or services rendered
by him to the payee.

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 Payment made to a cultivator, grower or producer in respect of the purchase of
agricultural or forest produce or product of animal husbandry (including
livestock, meat, hides and skins) or dairy or poultry farming or fish or fish
products or products of horticulture or apiculture (even if these products have
been subjected to some processing provided the processing has been done by
the cultivator, grower or the producer of the product).
 Payment made to a producer in respect of the purchase of the products
manufactured or processed without the aid of power in a cottage industry.
 Payment made to a person who ordinarily resides or carries on business in a
village not served by any bank.
 Payment of terminal benefits, such as gratuity, retrenchment compensation,
etc., not exceeding Rs. 50,000.
 Payment made by an assessee by way of salary to his employee after deducting
tax and when such employee is temporarily posted for a continuous period of
15 days or more in a place other than his normal place of duty or on a ship and
does not maintain any account in any bank at such place or ship.
 Payment required to be made on a day on which the banks were closed either
on account of holiday or strike.
 Payment made by any person to his agent who is required to make payment in
cash for goods or services on behalf of such person.
 Payment made by an authorised dealer or a money changer against purchase of
foreign currency or travellerscheques in the normal course of his business.
 Following Table showing the Examples towards Nature of Transactions with
Disallowed Amount :

Nature of Transactions Disallowed Amount


1. Generally X pays salary to his 1. Rs. 10,500, being 100% of salary paid
employees by account payee cheques. by bearer cheque to C, will be
Salary of December 2018 is, however, disallowed.
paid to three employees A, B and C by
bearer cheques (payment being Rs. 6,000,
Rs. 10,000 and Rs. 10,500, respectively).
2. X Ltd. purchases goods on credit from a. Nothing will be disallowed out of
Y Ltd. on May 6, 2018 for Rs. 86,000 the payment of Rs. 5,000 in cash
which is paid as follows— on May 11, 2018, as the payment
a. Rs. 5,000 in cash on May 11, does not exceed Rs. 10,000.
2018; b. 100% of Rs. 30,000 will be
b. Rs. 30,000 by a bearer cheque on disallowed.
May 31, 2018; c. Nothing will be disallowed out of
c. Rs. 51,000 by an account payee Rs. 51,000.
cheque on May 16, 2018.
29
3. Z Ltd. purchases goods on credit from 3. Though the amount of payment
A Ltd. on May 10, 2018 for Rs. 6,000 and exceeds Rs. 10,000, nothing shall be
on May 30, 2018 for Rs. 5,000. The total disallowed. To attract disallowance, the
payment of Rs. 11,000 is made by a amount of bill as well as the amount of
crossed cheque on June 1, 2018. payment should be more than Rs. 10,000.
4. A Ltd. purchases goods on credit from a 4. Out of the payment of Rs. 50,000, Rs.
relative of a director on June 20, 2018 for 8,000 (being the excess payment to a
Rs. 50,000 (market value: Rs. 42,000). relative) shall be disallowed under
The amount is paid in cash on June 25, section 40A(2). As the payment is made
2018. in cash and the remaining amount
exceeds Rs. 10,000, 100% of the balance
(i.e., Rs. 42,000) shall be disallowed
under section 40A(3).
5. B Ltd. purchases raw material on credit 5. Out of the payment of Rs. 36,000, Rs.
from A who holds 20 per cent equity share 27,000 (being the excess payment to a
capital in B Ltd. (the amount of bill being person holding a substantial interest)
Rs. 36,000, market price being Rs. 9,000). shall be disallowed under section 40A(2).
It is paid in cash on July 26, 2018. The remaining amount (i.e., Rs. 9,000)
does not exceed Rs. 10,000. Nothing
shall be disallowed under section 40A(3)
even if the payment is made in cash.

9. Disallowance in respect of Provision for Unapproved Gratuity Fund [Section


40A(7)]:
Gratuity is a liability which normally arises according to the length of the service of
the employees' of the assessee. The liability would generally accrue year after year.
However, due to practical difficulties in computing the deduction allowable on accrual
basis, it has been provided under section 40A(7) that deduction on account of
provision for gratuity shall be allowed only when:—
i) the amount of gratuity has actually become payable during the previous year to
the employees' (provided deduction has not been claimed under clause (b) below);
or
ii) when a provision has been made for payment of a sum by way of any contribution
towards an approved gratuity fund.

Therefore, no deduction shall be allowed in respect of any provision made for the
payment of gratuity to the employees, even though the assessee may be following the
mercantile system of accounting, unless it is a provision for the purpose of payment of
a sum by way of any contribution towards an approved gratuity fund.

In other words, any provision for unapproved gratuity fund (for meeting future
liability) is not deductible.
30
10. Amount Not Deductible in respect of contributions to Non-Statutory Funds
[Section 40A(9)] -
Any sum paid by the assessee as an employer by way of contribution towards
Recognised Provident Fund, or Approved Superannuation Fund or an Approved
Gratuity Fund, is Deductible to the extent it is required by any law.

What is not Deductible -


If the following conditions are satisfied, then contribution or payment is not
deductible by section 40A(9) —
1. The contribution/payment is made by an assessee as an employer.
2. It is paid towards setting up (or formation of) any trust, company, association
of persons, body of individuals, society or it is paid by way of contribution to
any fund.

The contribution or payment is not required by any law.

11. Certain Deductions to be Allowed only on Actual Payment Basis [Section


43B]
Section 43B is applicable only if the taxpayer maintains books of account on the basis
of mercantile system of accounting. The provisions of section 43B are given below—
Certain Expenses are Deductible on Actual Payment Basis -

The following expenses (which are otherwise deductible under the other provisions of
the Income-tax Act) are deductible on payment basis
i. any sum payable by way of tax, duty, cess or fee (by whatever name called
under any law for the time being in force);
ii. any sum payable by an employer by way of contribution to provident fund or
superannuation fund or any other fund for the welfare of employees;
iii. any sum payable as bonus or commission to employees for service rendered;
iv. any sum payable as interest on any loan or borrowing from a public financial
institution (i.e., ICICI, IFCI, IDBI, LIC and UTI) or a State financial
corporation or a State industrial investment corporation;
v. interest on any loan or advance taken from a scheduled bank or a co-operative
bank other than a primary agricultural credit society or a primary co-operative
agricultural and rural development bank;
vi. any sum payable by an employer in lieu of leave at the credit of his employee;
and
vii. any sum payable to the Indian Railways for the use of railway assets.

The above expenses are deductible in the year in which payment is actually made.
There is, however, one exception given below.

31
Exception - Certain Expenses are Deductible on Accrual Basis -

If the aforesaid payment is actually made on or before the due date of submission of
return of income, deduction can be claimed on Accrual Basis.
 Due date of submission of return of income in the case of a company (or in the
case of a taxpayer whose books of account are required to be audited under any
law) is September 30 of the assessment year.
 In the case of any taxpayer (having international or specified domestic
transactions) due date of submission of return of income is November 30 of the
assessment year.
 In all other cases, the due date of submission of return of income is July 31 of the
assessment year.

7.9 DEEMED PROFITS CHARGEABLE TO TAX AS BUSINESS INCOME


UNDER PROFITS AND GAINS OF BUSINESS OR PROFESSIONS
[SECTION 41]

1. Recovery against any Allowance or Deduction Allowed earlier [Section 41(1)]


(A) Recovery by the Same Assessee [Section 41(1)(a)]:
Where an allowance or deduction has been made in the assessment for any year in
respect of
i. loss,
ii. expenditure or
iii. trading liability incurred by the assessee

And subsequently, during any previous year, he (the same assessee) has obtained,
whether in cash or in any other manner, whatsoever—
i. any amount in respect of such loss or expenditure; or
ii. some benefit in respect of such trading liability by way of remission or
cessation thereof,

Then, the amount obtained by the assessee or the value of benefit accruing to him
shall be deemed to be profit and gains of business or profession and accordingly
chargeable to income-tax as the income of that previous year.

It may be mentioned that the business or profession, in respect of which the allowance
or deduction has earlier been made, may or may not be in existence in the previous
year in which such amount is obtained or the benefit accrued to him.

(B) Recovery by the Successor in Business or Profession [Section 41(1)(b)]:


If in the above case, instead of the assessee, the successor in business has obtained,
whether in cash or in any other manner whatsoever,—
32
a. any amount in respect of which loss or expenditure was incurred by the
predecessor; or
b. some benefit in respect of trading liability referred to in clause (A) above by
way of remission or cessation thereof,
the amount obtained by successor in business or the value of benefit accruing to the
successor in business shall be deemed to be income under the head profits and gains
from business or profession of the successor of that previous year.

2. Balancing Charge on Assets of an undertaking engaged in Generation or


Generation and Distribution of Power [Section 41(2)].
Where any building, machinery, plant or furniture:
a. which is owned by the assessee;
b. in respect of which depreciation is claimed under section 32(1)(i) ;
c. which was or has been used for the purposes of business,
is Sold, Discarded, Demolished or Destroyed and the 'Moneys Payable' in respect of
such building, machinery, plant or furniture, as the case may be, together with the
amount of scrap value, if any, exceeds the 'written down value', then, so much of the
excess as does not exceed the difference between the 'actual cost' and the 'written
down value' shall be chargeable to income-tax as income of the business of the
previous year in which the moneys payable for the building, machinery, plant or
furniture became due.

3. Profit on Sale of Capital Assets used for Scientific Research [Section 41(3)].
Where any capital asset used in scientific research is sold without having been used
for other purposes and the sale proceeds, together with the amount of deduction
allowed under section 35, exceed the amount of the capital expenditure incurred on
purchase of such asset, such surplus (i.e., sale price) or the amount of deduction
allowed, whichever is less, is chargeable to tax as business income in the year in
which the sale took place.

4. Recovery out of Bad Debts Allowed as a Deduction [Section 41(4)]:


Where any bad debt has been allowed as deduction under section 36(1)(vii) and the
amount subsequently recovered on such debt is greater than the difference between the
debt and the deduction so allowed, the excess realisation is chargeable to tax as
business income of the year in which the debt is recovered.

5. Amount withdrawn from Special Reserve Created and Maintained by certain


Financial Institutions [Section 41(4A)]:
Where a deduction has been allowed in respect of any special reserve created and
maintained under section 36(1)(viii), by certain financial institution, banking
company, co-operative bank and a housing finance company etc. if any amount is
subsequently withdrawn from the special reserve, it shall be deemed to be the profits
33
and gains of business or profession and accordingly be chargeable to income-tax as
the income of the previous year in which such amount is withdrawn, whether the
business is in existence in that previous year or not.

6. Adjustment of Loss [Section 41(5)]


Generally, loss of a business cannot be carried forward after 8 years. An exception is,
however, provided by section 41(5). This exception is applicable if the following
conditions are satisfied:
 The business or profession is discontinued.
 Loss of such business or profession pertaining to the year in which it is
discontinued could not be set-off against any other income of that year.
 Such business is not a speculation business.
 After discontinuation of such business or profession, there is a receipt which is
deemed as business income under section 41(1), (3), (4) or (4A).

The unabsorbed loss pertaining to the year in which business/profession was


discontinued is permitted to be set off against notional business income under section
41(1), (3), (4) or (4A) even after 8 years. It can be set off even if the return of loss is
not submitted in time.

7. Recovery after Discontinuance of Business or Profession [Section 176(3A), (4)]-


That there may be income received after the discontinuance of the business or
profession which will also be treated as deemed income of the previous year in which
it is received.
i. Recovery of any sum in case of Discontinued Business [Section 176(3A)]:
Where any business is discontinued in any year, any sum received after the
discontinuance shall be deemed to be the income of the recipient and charged to
tax accordingly in the year of receipt, if such sum would have been included in
the total income of the person who carried on the business had such sum been
received before such discontinuance.
ii. Recovery of any sum in case of Discontinued Profession [Section 176(4)]:

Where any profession is discontinued in any year on account of the cessation of the
profession by, or the retirement or death of, the person carrying on the profession, any
sum received after the discontinuance shall be deemed to be the income of the
recipient and charged to tax accordingly in the year of receipt, if such sum would have
been included in the total income of the aforesaid person had it been received before
such discontinuance.

34
7.10 DEDUCTION IN RESPECT OF EXPENDITURE INCURRED ON
SETTING UP OF A SPECIFIED BUSINESS [SECTION-35AD] :

1. To whom Deduction Under Section-35AD shall be allowed :


Conditions-1 : Specified Business -
Deduction under section 35AD shall be allowed to the assessee who is carrying on any
of the following specified business:
 Setting up and operating a cold chain facility;
 Setting up and operating a warehousing facility for storage of agricultural
produce;
 laying and operating a cross-country natural gas or crude or petroleum oil
pipeline network for distribution, including storage facilities being an integral
part of such network;
 the business of building and operating anywhere in India, a hotel of two-star or
above category, as classified by the Central Government;
 building and operating, anywhere in India, a hospital with at least 100 beds for
patients;
 developing and building a housing project under a scheme for slum
redevelopment or rehabilitation framed by the Central Government or a State
Government, as the case may be, and notified by the Board in this behalf in
accordance with the guidelines as may be prescribed;
 developing and building a housing project under a scheme for affordable
housing framed by the Central Government or a State Government, as the case
may be, and notified by the Board in this behalf in accordance with the
guidelines as may be prescribed;
 production of fertilizer in India;
 setting up and operating an Inland Container Depot or Container Freight Station
notified and approved under the Customs Act, 1962;
 bee-keeping and production of honey and beeswax; and
 setting up and operating a warehousing facility for storage of sugar
 laying and operating a slurry pipeline for the transportation of iron ore;
 setting up and operating a semiconductor wafer fabrication manufacturing unit,
if such unit is notified by the Board in accordance with the prescribed
guidelines;
 developing or maintaining and operating or developing maintaining and
operating a new infrastructure facility

Condition-2 :
 Specified business should be new business -

35
The specified business should not be set up by splitting up, or the reconstruction, of a
business already in existence. Moreover, it should not be set up by the transfer of old
plant and machinery.

 20 per cent old machinery is permitted -


If the value of the transferred assets does not exceed 20 per cent of the total value of
the machinery or plant used in the business, this condition is deemed to have been
satisfied.

 Second-hand imported machinery is treated as new -


Any 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—
i) Such machinery or plant was not, at any time previous to the date of the
installation by the assessee, used in India.
ii) Such machinery or plant is imported into India from any country outside India.
iii) No deduction on account of depreciation in respect of such machinery or plant has
been allowed or is allowable under the Act in computing the total income of any
person for any period prior to the date of the installation of the machinery or plant
by the assessee.

Condition 3 - Audit of books of account -


Books of account of the assessee should be audited.

2. Nature and Amount of Deduction Under Section-35AD:


100% Deduction shall be allowed an account of any expenditure of capital nature
incurred wholly and exclusively for the purpose of the above specified business
carried on by such assessee during the previous year in which such expenditure in
incurred by him.

However, this is subject to the following 3 Propositions


 Expenditure incurred on the acquisition of any land or goodwill or financial
instrument is not eligible for any deduction under section 35AD.
 Deduction under section 35AD is not available (with effect from the assessment
year 2018-19) pertaining to any expenditure in respect of which payment (or
aggregate of payments) made to a person in a day (otherwise than by an account
payee cheque/draft/use of electronic clearing system through a bank account)
exceeds Rs. 10,000.

Expenditure incurred prior to the commencement of operation, wholly and


exclusively, for the purpose of any specified business, shall be allowed as deduction
during the previous year in which the assessee commences the operation of his
36
specified business, if the amount is capitalized in the books of account of the assessee
on the date of commencement of operation.

1. Expenditure incurred prior to commencement of operation to be allowed in


the year of commencement of operation Under Section-35AD:
The expenditure incurred, wholly and exclusively, for the purposes of any specified
business, shall be allowed as deduction during the previous year in which he
commences operations of his specified business, if the expenditure is incurred prior to
the commencement of its operations; andthe amount is capitalized in the books of
account of the assessee on the date of commencement of its operations.

2. Conditions to be satisfied by the Specified Business to apply the Section-


35AD:
This section applies to the specified business which fulfils all the following
conditions:
 it is not set up by splitting up, or the reconstruction, of a business already in
existence;
 it is not set up by the transfer to the specified business of machinery or plant
previously used for any purpose;
 where the business is of laying and operating a cross country natural gas or crude
or petroleum oil pipelines network it should satisfy the following conditions also:
i) it is owned by a Indian or by a consortium of such companies or by an
authority or a board or a corporation established or constituted under any
Central or State Act;
ii) it has been approved by the Notified Petroleum and Natural Gas Regulatory
Board;
iii) it has made such proportion of its total pipeline capacity available for use on
common carrier basis by any person other than the assessee or an associated
person as prescribed by the Petroleum and Natural Gas Regulatory Board;
and
iv) any other condition as may be prescribed.
 Any asset in respect of which a deduction is claimed and allowed under section
35AD, shall be used only for the specified business for a period of eight years
beginning with the previous year in which such asset is acquired or constructed.

Further, if such asset is used for any purpose other than the specified business during
the period of 8 years specified in section 35AD(7A), otherwise then by way of a mode
referred to in section 28(vii), the total amount of deduction so claimed and allowed in
any previous year in respect of such asset, as reduced by the amount of depreciation
allowable in accordance with the provisions of section 32 as if no deduction had been
allowed under section 35AD, shall be deemed to be income of the assessee chargeable

37
under the head "Profits and gains of business or profession" of the previous year in
which the asset is so used.

3. Consequences Of Claiming Deduction Under Section 35AD -


The following consequences should be noted :
 If deduction is claimed and allowed under section 35AD, the assessee shall not be
allowed any deduction in respect of the specified business under the provisions of
Chapter VIA under sections 80HH to 80RRB or under section 10AA for the same
or any other assessment year.
 No deduction in respect of the expenditure in respect of which deduction has been
claimed shall be allowed to the assessee under any other provisions of the
Income-tax Act.
 Any sum received or receivable on account of any capital asset, in respect of
which deduction has been allowed under section 35AD, being demolished,
destroyed, discarded or transferred shall be treated as income of the assessee and
chargeable to income-tax under the head “Profits and gains of business or
profession”.
 Any loss computed in respect of the specified business shall not be set off except
against profits and gains, if any, of any other specified business. To the extent the
loss is unabsorbed, the same will be carried forward for set off against profits and
gains from any specified business in the following assessment year and so on (no
time limit for carry forward of such loss).
 If the assessee owns two units one of them qualifies for deduction under section
35AD and the other one is not eligible for the same and there is inter-unit transfer
of goods or services between the two units, then for the purpose of section 35AD
calculation will be made as if such transactions are made at the market value.
 An asset (in respect of which a deduction is claimed and allowed under section
35AD) shall be used only for the specified business for a period of 8 years
beginning with the previous year in which such asset is acquired or constructed. If
such asset is used for any purpose other than the specified business, the total
amount of deduction so claimed and allowed in any previous year in respect of
such asset (as reduced by the amount of depreciation allowable in accordance
with the provisions of section 32 as if no deduction had been allowed under
section 35AD) shall be deemed to be business income of the assessee of the
previous year in which the asset is so used.

However, this provision will not apply to a company which has become a sick
industrial company under section 17(1) of the Sick Industrial Companies (Special
Provisions) Act within the time period of 8 years as stated above.

When Maintenance of Books of Accounts becomes Compulsory (Section 44AA)

38
The provisions regulating compulsory maintenance of books of account are given
below.

1. Persons carrying on “Specified Professions” [Section 44AA(1)] :


For the purpose of section 44AA and Rule 6F legal, ‘specified professions’ includes
…medical, engineering, architectural, accountancy, technical consultancy, or interior
decoration or any other notified profession [i.e., authorised representative, film artist,
company secretary and information technology].

(A) Circumstances where Maintaining the Prescribed Books of Account is


Necessary :
In these cases, if annual gross receipts (of any one or more of preceding 3 years) do
not exceed Rs. 1,50,000, the taxpayer is required to maintain such books of account as
may enable the Assessing Officer to compute his taxable income under the Income-tax
Act.

If, however, gross receipts are more than Rs. 1,50,000 (of all preceding 3 years), the
taxpayer will have to maintain books of account prescribed by Rule 6F [i.e., cash
book, journal, ledger, copies of bills issued by the taxpayer, etc.] as discussed below :
Prescribed Books Of Account and Documents to be kept and maintained under section
44AA(3) by person carrying on Certain Professions [Rule 6F]:

As per Rule 6F(1), any person carrying on legal, medical, engineering or architectural
profession or the profession of accountancy or technical consultancy or interior
decoration or authorised representative or film artist is required to maintain prescribed
books of account and documents.

The prescribed Books of Account and other documents under Rule 6F(2) are as
follows:
i. a cash book;
ii. a journal, if the accounts are maintained according to the mercantile system of
accounting;
iii. a ledger;
iv. carbon copies of bills, whether machine numbered or otherwise serially
numbered wherever such bills are issued by the person and carbon copies or
counter foils of machine numbered or otherwise serially numbered receipts
issued by him excepting if the bill or receipts of an amount less than Rs. 25;
and
v. original bills wherever issued to the person and receipts in respect of
expenditure incurred by the person or, where such bills and receipts are not
issued and the expenditure incurred does not exceed Rs.50 , payment vouchers
prepared and signed by the person.
39
The vouchers mentioned above may not be prepared if the cash book maintained by
the person contains adequate particulars in respect of the expenditure incurred by him.
As per Rule 6F(3) a person carrying on medical profession shall, in addition to the
above books of account and documents, keep and maintain the following also:
a. a daily case register in Form No. 3C;
b. an inventory under broad heads, as on the first and the last day of the previous
year, of the stock of drugs, medicines and other consumable accessories used for
the purpose of his profession.

(B) Circumstances where Maintaining the Prescribed Books of Account shall Not
be Necessary :
The above Rule 6F(2) of maintaining the prescribed books of account and other
documents shall not apply in relation to any previous year in case of any person—
i. if his total gross receipts in the specified profession do not exceed Rs. 1,50,000
in any one of 3 years immediately preceding the previous year, or
ii. where the specified profession has been newly setup in the previous year, his
total gross receipts in the profession for that year are not likely to exceed Rs.
1,50,000.

However, such person shall have to maintain such books of account and other
documents as may enable the Assessing Officer to compute his total income.

Thus a person carrying on a specified profession shall be required to maintain


specified books of account:
 if his gross receipts in all the three preceding previous years exceed
Rs.1,50,000, orif it is a new profession which is set up in the previous year, it
is likely to exceed Rs.1,50,000 in that previous year.

2. Persons carrying on “Non-Specified Professions” or any Business [Section


44AA(2)]
 if his total income from business or profession exceeds Rs.1,20,000 or his total
sales or gross receipts from such business or profession exceed Rs.10,00,000
in any of the three years immediately preceding the relevant previous year
shall keep and maintain books of account and other documents.
 where the business or profession is newly set up in any previous year, he shall
keep and maintain books of account and other documents if, during the
relevant previous year, either his total income is likely to exceed Rs.1,20,000
or the total sales or gross receipts are likely to exceed Rs.10,00,000.

However, in the case of Individuals and Hindu Undivided Family


(HUF) carrying on business or profession, the monetary limits of income and
40
total sales or turn over or gross receipts, etc specified above for maintenance
of books of accounts has been increased from Rs.1,20,000 to
Rs.2,50,000 and from Rs.10,00,000 to Rs.25,00,000, respectively.

Conversely, if the annual income and/or annual receipts/turnover exceed these


figures (in any one or more of preceding 3 years), the taxpayer is required to
maintain such books of account as may enable the Assessing Officer to
compute his taxable income under the Income-tax Act (books are not
prescribed by Board).

 where the profits and gains from the business are deemed to be the profits and
gains of the assessee under section 44AE (relating to goods carriages) or
section 44BB (relating to business of exploration, etc. of mineral oils in case of
non-resident) or section 44BBB (relating to foreign companies engaged in the
business of civil construction, etc. in certain turnkey power projects), as the
case may be, and the assessee has claimed his income to be lower than the
profits or gains so deemed to be the profits and gains of his business, as the
case may be, during such previous year, he shall keep and maintain books of
account and other documents.

 where the provisions of section 44AD(4) (see Note below) are applicable in his
case and his income exceeds the maximum amount which is not chargeable to
income-tax in any previous year, he shall have to keep and maintain books of
account and other documents.

3. When maintenance of Books of Account Not Necessary .


There is no need to maintain any books of account and documents if the following
conditions are satisfied:
i) Assessee is carrying on a business or a profession (not being a profession
referred to in para 6.36a above); and the income or total sales or gross receipts,
as the case may be, is less than the specified amount.
If he is covered under sections 44AD, 44ADA, 44AE, 44BB or 44BBB, he should not
declare income lower than that which is prescribed under these relevant sections.

4. Consequences of Failure to Keep Accounts, etc:


Section 271A prescribes penalty provisions for failure to keep and maintain books of
account, etc., and also for not retaining them for the prescribed period.
The quantum of penalty imposable is fixed at Rs. 25,000.

Illustration 01 :Mr. Gopi carrying on business as proprietor converted the same into a
limited company by name Gopi Pipes (P) Ltd. from 01-07-2019. The details of the
assets are given below:
41
Block - I WDV of plant & machinery (rate of depreciation @ 15%)
Rs. 12,00,000
on 01.04.2019
Block - II WDV of building (rate of depreciation @ 10%) on
Rs. 25,00,000
01.04.2019

The company Gopi Pipes (P) Ltd. acquired plant and machinery in December 2019 for
Rs10,00,000. It has been doing the business from 01-07-2019. Compute the quantum
of depreciation to be claimed by Mr. Gopi and successor Gopi Pipes (P) Ltd. for the
assessment year 2020-21. Assume that plant and machinery were purchased by way of
account payee cheque.

Solution :
Computation of depreciation allowable to Mr. Gopi for A.Y. 2020-21
Particulars Rs Rs
Block 1 Plant and Machinery (15% rate)
WDV as on 1.4.2019 12,00,000
Depreciation@15% 1,80,000
Block 2 Building (10% rate)
WDV as on 1.4.2019 25,00,000
Depreciation@10% 2,50,000
Total depreciation for the year 4,30,000
Proportionate depreciation allowable to Mr. Gopi
for 91 days (i.e., from 1.4.2019 to 30.6.2019) [i.e., 1,06,913
91/366 x Rs. 4,30,000)

Computation of depreciation allowable to Gopi Pipes (P) Ltd. for A.Y.2020-21


Particulars Rs
(i) Depreciation on building and plant and machinery
Proportionately for 275 days (i.e. from 1.7.2019 to 31.3.2020) 3,23,087
(275/366 x Rs 4,30,000)
(ii) Depreciation@ 50% of 15% on Rs 10 lakh, being the value of
plant and machinery purchased after conversion, which was put 75,000
to use for less than 180 days during the P.Y. 2019-20
Depreciation allowable to Gopi Pipes (P) Ltd. 3,98,087

Note: In the case of conversion of sole proprietary concern into a company, the
depreciation should be first calculated for the whole year as if no succession had taken
place. Thereafter, the depreciation should be apportioned between the sole proprietary
concern and the company in the ratio of the number of days for which the assets were

42
used by them. It is assumed that in this case, the conditions specified in section
47(xiv) are satisfied.

Illustration 02
Sai Ltd. has a block of assets carrying 15% rate of depreciation, whose written down
value on 01.04.2019 was Rs40 lacs. It purchased another asset (second-hand plant and
machinery) of the same block on 01.11.2019 for Rs14.40 lacs and put to use on the
same day. Sai Ltd. was amalgamated with Shirdi Ltd. with effect from 01.01.2020.
You are required to compute the depreciation allowable to Sai Ltd. &Shirdi Ltd. for
the previous year ended on 31.03.2020 assuming that the assets were transferred to
Shirdi Ltd. at Rs60 lacs. Also assume that the plant and machinery were purchased by
way of account payee cheque.

Solution :
Statement showing computation of depreciation allowable to Sai Ltd. &Shirdi
Ltd. for A.Y. 2020-21

Particulars Rs
Written down value (WDV) as on 1.4.2019 40,00,000
Addition during the year (used for less than 180 days) 14,40,000
Total 54,40,000
Depreciation on Rs 40,00,000 @ 15% 6,00,000
Depreciation on Rs 14,40,000 @ 7.5% 1,08,000
Total depreciation for the year 7,08,000
Apportionment between two companies:
(a) Amalgamating company, Sai Ltd.
Rs 6,00,000 × 275/366 4,50,820
Rs 1,08,000 × 61/152 43,342
4,94,162
(b) Amalgamated company, Shirdi Ltd .
Rs 6,00,000 × 91/366 1,49,180
Rs 1,08,000 × 91/152 64,658
2,13,838

Notes:
i) The aggregate deduction, in respect of depreciation allowable to the
amalgamating company and amalgamated company in the case of amalgamation
shall not exceed in any case, the deduction calculated at the prescribed rates as if
the amalgamation had not taken place. Suchdeduction shall be apportioned
between the amalgamating company and the amalgamated company in the ratio of
the number of days for which the assets were used by them.

43
ii) The price at which the assets were transferred, i.e., Rs 60 lacs, has no implication
in computing eligible depreciation.

Illustration 03
A car purchased by Dr. Soman on 10.08.2016 for Rs5,25,000 for personal use is
brought into professional use on 1.07.2019 by him, when its market value was
Rs2,50,000. Compute the actual cost of the car and the amount of depreciation for the
assessment year 2020-21 assuming the rate of depreciation to be 15%.

Solution :
As per section 43(1), the expression “actual cost” would mean the actual cost of asset
to the assessee. The purchase price of Rs 5,25,000 is, therefore, the actual cost of the
car to Dr. Soman. Market value (i.e. Rs 2,50,000) on the date when the asset is
brought into professional use is not relevant. Therefore, amount of depreciation on car
as per section 32 for the A.Y.2020-21 would be Rs 78,750, being Rs 5,25,000 x 15%.

Note:
Explanation 5 to section 43(1) providing for reduction of notionaldepreciation from
the date of acquisition of asset for personal use todetermine actual cost of the asset is
applicable only in case of buildingwhich is initially acquired for personal use and
later brought intoprofessional use. It is not applicable in respect of other assets.

Illustration 04
Mr. Gamma, a proprietor started a business of manufacture of tyres and tubes for
motor vehicles on 1.1.2019. The manufacturing unit was set up on 1.5.2019. He
commenced his manufacturing operations on 1.6.2019. The total cost of the plant and
machinery installed in the unit is Rs120 crore. The said plant and machinery included
second hand plant and machinery bought for Rs20 crore and new plant and machinery
for scientific research relating to the business of the assessee acquired at a cost of
Rs15 crore. Compute the amount of depreciation allowable under section 32 of the
Income-tax Act, 1961 in respect of the assessment year 2020-21. Assume that all the
assets were purchased by way of account payee cheque.

Solution :
Computation of depreciation allowable for the A.Y. 2020-21 in the hands of Mr.
Gamma
Particulars Rs (in Crore)
Total cost of plant and machinery 120.00
Less: Used for Scientific Research (Note 1) 15.00
105.00
Normal Depreciation at 15% on ` 105 crore 15.75
44
Additional Depreciation:
Cost of plant and machinery 120.00
Less: Second hand plant and machinery (Note 2) 20.00
Plant and machinery used for scientific research, the whole of
the actual cost of which is allowable as deduction under
35.00
section
35(1) (iv) read with section 35(2)(ia) (Note 2) 15.00
85.00
Additional Depreciation at 20% 17.00
Depreciation allowable for A.Y.2020-21 32.75

Notes:
1. As per section 35(2)(iv), no depreciation shall be allowed in respect of plant and
machinery purchased for scientific research relating to assessee’s business, since
deduction is allowable under section 35 in respect of such capital expenditure.
2. As per section 32(1)(iia), additional depreciation is allowable in the case of any
new machinery or plant acquired and installed after 31.3.2005 by an assessee
engaged in, inter alia, the business of manufacture or production of any article or
thing, at the rate of 20% of the actual cost of such machinery or plant. However,
additional depreciation shall not be allowed in respect of, inter alia, –

i) any machinery or plant which, before its installation by the assessee, was used
either within or outside India by any other person;
ii) any machinery or plant, the whole of the actual cost of which is allowed as a
deduction (whether by way of depreciation or otherwise) in computing the income
chargeable under the head “Profit and gains of business or profession” of any one
previous year.In view of the above provisions, additional depreciation cannot be
claimed in respect of - (i) Second hand plant and machinery; (ii) New plant and
machinery purchased for scientific research relating to assessee’s business in
respect of which the whole of the capital expenditure can be claimed as deduction
under section 35(1)(iv) read with section 35(2)(ia) & (iv).

Illustration 05
Mr. X, set up a manufacturing unit in Warangal in the state of Telangana on
01.06.2019. It invested Rs30 crore in new plant and machinery on 1.6.2019. Further,
he invested Rs25 crore in the plant and machinery on 01.11.2019, out of which Rs5
crore was second hand plant and machinery. Compute the depreciation allowable
under section 32. Is Mr. X entitled for any other benefit in respect of such investment?
If so, what is the benefit available?

45
Solution :
Computation of depreciation under section 32 for Mr. X for A.Y. 2020-21
Particulars Rs(in crores)
Plant and machinery acquired on 01.06.2019 30.000
Plant and machinery acquired on 01.11.2019 25.000
WDV as on 31.03.2020 55.000
Less: Depreciation @ 15% on Rs 30 crore 4.500
Depreciation @ 7.5% (50% of 15%) on Rs 25 crore 1.875
Additional Depreciation@35% on Rs 30 crore 10.500
Additional Depreciation@17.5% (50% of 35%) on 20.375
3.500
Rs 20 crore
WDV as on 01.04.2020 34.625

Computation of deduction under section 32AD for Mr. X for A.Y. 2020-21
Particulars Rs(in crores)
Deduction under section 32AD @ 15% on ` 50 crore 7.50
Total benefit 7.50

Illustration 06
Mr. Suraj, a proprietor, commenced operations of the business of a new three-star
hotel in Madurai, Tamil Nadu on 1.4.2019. He incurred capital expenditure of Rs50
lakh during the period January, 2019 to March, 2019 exclusively for the above
business, and capitalized the same in his books of account as on 1st April, 2019.
Further, during the P.Y. 2019-20, he incurred capital expenditure of Rs2 crore (out of
which Rs. 1.50 crore was for acquisition of land) exclusively for the above business.
Compute the income under the head “Profits and gains of business or profession” for
the A.Y.2020-21.

Solution
Computation of profits and gains of business or profession for A.Y. 2020-21
Particulars Rs
Profits from the specified business of new hotel in Madurai (before
25 lakh
providing deduction under section 35AD)
Less: Deduction under section 35AD
Capital expenditure incurred during the P.Y.2019-20
(excluding the expenditure incurred on acquisition of land) = Rs 200 50 lakh
lakh – Rs 150 lakh
Capital expenditure incurred prior to 1.4.2019 (i.e., prior to
commencement of business) and capitalized in the books of account as 50 lakh
on 1.4.2019
Total deduction under section 35AD for A.Y.2020-21 100 lakh

46
Loss from the specified business of new hotel in Madurai (75 lakh)
Profit from the existing business of running a hotel in Coimbatore 120 lakh
Net profit from business after set-off of loss of specified business
45 lakh
against profits of another specified business under section 73A

7.11 LET US SUM UP

As we know that a person‘s income can be divided under five heads like Salary,
House property, Capital gains, income from other sources and Profits and gains of
Business or Profession. Out of these heads ‗Profits and gains of Business or
Profession‘ are most important and largest head. The income from business to which a
person is chargeable under this head represents not the gross receipts from the
business but the profits and gains derived from there. For instance, in the case of a
businessman, the gross sale proceeds would not be the basis for levying tax but it is
net profit or the profit or gain as determined in accordance with sections 28 to 44DB.
The chargeability to tax under Section 28 is based primarily upon the condition that
the assessee must have carried on a business or profession at any time during the
accounting year, though not necessarily throughout the accounting year. There are two
parts of this head one is business and second is profession.

7.12 KEY WORDS

 Business: A business is an organization where people work together. In


a business, people work to make and sell products or services.
 Profession: A paid occupation, especially one that involves prolonged training
and a formal qualification.
 Allowance: An allowance is an amount of money given or allotted usually at
regular intervals for a specific purpose.
 Deduction: It is a reduction of income that is able to be taxed and is commonly a
result of expenses, particularly those incurred to produce additional income.
 Vocation: A vocation is an occupation to which a person is especially drawn or
for which they are suited, trained, or qualified.
 Trade Association: A trade association, also known as an industry trade group,
business association, sector association or industry body, is an organization
founded and funded by businesses that operate in a specific industry.
 Compensation: Compensation refers to the act of providing a person with money
or other things of economic value in exchange for their goods, labor, or to provide
for the costs of injuries that they have incurred.
 Revenue Expenditure: A revenue expenditure is a cost that is charged
to expense as soon as the cost is incurred.

47
 Amortisation: The action or process of gradually writing off the initial cost of an
asset.
 Preliminary Expenses: The expenses incurred when a company is formed and
before the start of any business operations are termed as preliminary expenses
 Special Reserve: Specific reserves are the amount set aside for a specific purpose
and cannot be used for any other reason.

7.13 FURTHER READIINGS

 Income tax Law and practice, Makta Jain/ Rakesh Jain, V.K. Global Pub. Pvt.
Ltd., New Delhi
 Income Tax Law and Pratcice-Saha, Dash- Himalaya Publishing House.
 Pagare, Dinkar. Law and Practice of Income Tax. Sultan Chand and Sons, New
Delhi.
 Lal, B.B. Income Tax Law and Practice. Konark Publications, New Delhi
 Gour and Narang, Income tax: Law and practice, kalyani Publishers
 Dr. Vinod Kumar Singhania, e-filing of Income Tax Returns and Computation
ofTax,
 Taxmann Publication Pvt. Ltd, New Delhi. Latest version.

7.14 TERMINAL QUESTIONS

Q1 : Describe expressly allowed deduction at the time of calculating profit of


business or profession.
Q2 : Explain the deductions that are expressly disallowed in computing the income
from business or profession.
Q3 : Explain the incomes that are chargeable under the head business or profession.
Q4 : What is the procedure of calculating the profit in case of business/profession?
Give a Performa of corrected profit and loss account.
Q5 : Write notes on the following: (i) Expenditure on Scientific research (ii) Tea
development account (iii) Capital expenditure of Telecommunication services.
Q6: The net profit of business of Mr. Baveesh as disclosed by its P&L account
wasRs:3,25,000 after charging the following:Municipal taxes on house
property let out Rs:3,000Bad debt written off Rs:15,000Provision for bad and
doubtful debts Rs: 16,000 Provision for taxation Rs: 15,000 Depreciation Rs:
25,000Depreciation allowance as per rule is Rs:20,000.Compute taxable
business profit.
Q7 : From the followings profit and loss account compute the income from
business.

48
Q8 : Dr. Biju is a medical practitioner in Mahe. From the following, calculate his
income from profession for the AY 2020-21:

Q9 : The following is the Receipts and Payments account of Mr. Akhilesh, a


practicing Chartered Accountant for the year ended 31-03-2020:
Receipts Rs: Payments Rs:
Audit fee 19,210 Office expenses 10,000
Consultation 10,000 Office rent 5,000
Tribunal appearance 15,000 Salaries and wages 12,050
Miscellaneous 20,000 Printing and Stationeries 1,000
Interest on Govt. security 10,000 subscription 3,000
Rent received 10,000 books(annual 1,300
Presents from clients 10,000 Travelling expenses 5,800
Interest on bank loan 3,000
Donation to National
5,000
Defence
49
Fund

Purchase of publication) Loan from bank was taken for the construction of the house
in which he lives. MRV of the house is Rs: 8,000 and the local taxes Rs: 800 p.a. One-
fourth of travelling expenses are not allowable. Compute income from profession for
the A Y 2020—21.

Q10 : Calculate the amount of depreciation on the assets of a mill: Factory building
W.D.V. on 01-04-2012 Rs: 14,00,000 Additions made on 01-06-2012 Rs: 6,00,000
Rate of depreciation 10% The part of factory building which was destroyed by fire,
for which the insurance company accepted the claim for Rs: 60,000 and scrap value
realised amounted to Rs:10,000

Q11 :From the following figures, you are required to calculate the depreciation
admissible during the previous year:

Computation of Depreciation

Particulars Plant & Machinery Building


Rate = 15% Rate = 10%
W.D.V at the beginning of the year 3,75,000 15,00,000
Add: Purchase 4,50,000 Nil
Total 8,25,000 15,00,000
Less: sales 7,75,000 3,00,000
W.D.V. 50,000 12,00,000
Depreciation 7,500 1,20,000

50
UNIT-8 CAPITAL GAINS

Structure :
8.0 Objectives
8.1 Introduction
8.2 Transfer of Capital Assets for taxation of Capital Gain
8.3 Computation of period of holding an asset for computation of Capital
Gain
8.4 Methods of Computing Capital Gain
8.5 Deemed Cost of Acquisition of Assets for computing Capital Gain
8.6 Cost of Acquisition of assets for completion of Capital Gain
8.7 Calculation of Capital Gain in some special cases
8.8 Let us Sum up
8.9 Keywords
8.10 Further Readings
8.11 Terminal Questions

8.0 OBJECTIVES

After studying this unit, you should be able to :


 Explain the meaning of the term capital gains;
 List the capital gains exempt from tax;
 Discuss the deductions allowed from long-term capital gains;
 Compute the income chargeable under the .head capital gains.

8.1 INTRODUCTION

You know 'capital gains' is a separate head of income and any income arising out of
sale or transfer of a capital' asset is charged to tax under this head. In this unit, you
will study the meaning of capital gains, items included in capital gains capital gains
exempt from tax and the deductions allowed from capital gains. You will also study
how the taxable income from capital gains is calculated. Any profits or gains arising
from the transfer of a capital asset effected in the previous year shall be chargeable to
income-tax under the head 'Capital Gains', and shall be deemed to be the income of
the previous year in which the transfer took place. The above definition can be split up
into three parts:
 Capital Asset
 Transfer of Capital Asset
 Profits or Gains

51
8.2 CAPITAL ASSETS, CAPITAL GAIN & TRANSFER OF CAPITAL
ASSETS FOR TAXATION OF 'CAPITAL GAIN'

1. Basis of Charge in case of Capital Gain [Section 45(1)]


Any profits or gains arising from the transfer of a capital asset effected in the previous
year, shall be chargeable to income-tax under the head 'Capital Gains' and shall be
deemed to be the income of the previous year in which the transfer took place unless
such capital gain is exempt under section 54, 54B, 54D, 54EC, 54EE, 54F, 54G,
54GA or 54GB.

The following are the essential conditions for Taxing capital gains:
A. There must be a capital asset;
B. The capital asset must have been transferred;
C. There must be profits or gains on such transfer, which will be known as capital
gain;
D. Such capital gain should not be exempt under section 54, 54B, 54D, 54EC,
54EE, 54F, 54G, 54GA or 54GB.

If the above conditions are satisfied, the capital gain shall arise and taxed in the
previous year in which the asset is transferred, subject to certain exceptions..
Note : In case of profit or gain from insurance claim, due to damage or destruction of
property, there will be capital gain, although no asset has been transferred in such
case.

2. Capital Asset for Computing Capital Gain [Section 2(14)]


“Capital asset” means : -Property of any kind, whether fixed or circulating, movable
or immovable, tangible or intangible. Besides, it Includes the following –
a) Any rights in or in relation to an Indian company, including rights of management
or control or any other rights whatsoever.
b) Property of any kind held by an assessee (whether or not connected with his
business or profession).
c) Any securities held by a Foreign Institutional Investor which has invested in such
securities in accordance with the regulations made under the SEBI Act. but Does
Not Include––
i. any stock-in-trade [other than the securities referred to in sub-clause (b)
above], consumable stores or raw materials held for the purposes of his
business or profession,
ii. personal effects, that is to say, movable property (including wearing apparel
and furniture), held for personal use by the assessee or any member of his
family dependent on him. However, the following assets shall not be treated
as personal effects though these assets are moveable and may be held for
personal use:
52
 jewellery;
 archaeological collections;
 drawings;
 paintings;
 sculptures; or
 any work of art.
iii. Agricultural land in India, which is not an urban agricultural land. In other
words, it must be a rural agricultural land;
iv. Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999 or
deposit certificates issued under Gold Monetisation Scheme, 2015 notified
by the Central Government.

3. Types of Capital Assets:


Capital assets are of two types:
1. Short-Term Capital Asset (STCA)
2. Long-Term Capital Asset (LTCA)

(1) Short-Term Capital Asset - STCA [Section 2(42A)]:


A capital asset held by an assessee for Not more than 36 months immediately
preceding the date of its transfer is known as a short term capital asset.
Exceptions :
i) The following assets shall be treated as short-term capital assets if they are held
for Not more than 12 months (instead of 36 months mentioned
above) immediately preceding the date of its transfer:
a. a security including shares (other than unit) listed in a recognised stock
exchange in India
b. a unit of an equity oriented fund
c. a zero coupon bond
ii) The following assets shall be treated as short-term capital assets if they are held
for Not more than 24 months (instead of 36 months/12 months mentioned
above) immediately preceding the date of its transfer:
a. Share of a company (not being a share listed in a recognised stock
exchange in India)
b. An immovable property being land and building or both.

Hence, if unlisted share or immovable property is transferred after 24 months from the
date of its acquisition, the gain arising from the transfer of share or immovable
property shall be treated as long-term capital gain.

(2) Long-Term Capital Asset - LTCA [Section 2(29A)]:


It means a capital asset which is not a short-term capital asset.

53
In other words, if the asset is held by the assessee for more than 36 months/24
months/12 months, as the case may be, such an asset will be treated as a long-term
capital asset

(3) Meaning of Capital Assets in Graphical Chat (Section 2(14) :

(4) Types of Capital Gains


Since there are two types of Capital Assets, there will be two types of Capital Gains,
i.e :
 Section 2 (42B) Short Term Capital Gain : Gain arising on the transfer of short
term capital asset.
 Section 2 (29B) Long Term Capital Gain : Gain arising on the transfer of long
term capital asset.

(5) Transfer of Capital Assets to arise Capital Gain


Capital gain arises only when there is a transfer of capital asset. If the capital asset is
not transferred or if there is any transaction which is not regarded as transfer (See para
7.3b), there will not be any capital gain. However, in case of profits or gains from
insurance claim due to damage or destruction of property, there will be capital gain
although no asset has been transferred in such case.

 What is Transfer of Capital Assets [Section 2(47)]:


Transfer, in relation to capital asset, includes:
54
i. the sale, exchange or relinquishment of the asset; or
ii. the extinguishment of any rights therein; or
iii. the compulsory acquisition thereof under any law; or
iv. in a case where the asset is converted by the owner thereof into, or is treated
by him, as stockin-trade of a business carried on by him, such conversion or
treatment; or
v. the maturity or redemption of zero coupon bonds; or
vi. any transaction involving the allowing of the possession of any immovable
property to be taken or retained in part performance of a contract of the nature
referred to in section 53A of the Transfer of Property Act, 1882; or
vii. any transaction (whether by way of becoming a member of, or acquiring
shares in a cooperative society, company or other association of persons or by
way of any agreement or any arrangement or in any other manner whatsoever)
which has the effect of transferring, or enabling the enjoyment of any
immovable property.

 Transactions Not regarded as Transfer of Capital Assets [Sections 46 and


47]:
The meaning of transfer is given in section 2(47), whereas transactions not regarded as
transfer are covered u/ss 46 and 47. In many transactions although there is a transfer,
but these are not considered to be transfer for purposes of capital gains.

Some of the relevant transactions which are not regarded as transfer are:
i. where the assets of a company are distributed to its shareholders on liquidation
of a company, such distribution shall not be regarded as transfer in the hands
of the company [Section 46(1)];
ii. any distribution of capital assets on the total or partial partition of Hindu
Undivided Family [Section 47(i)];
iii. any transfer of a capital asset under a gift or will or an irrevocable trust
[Section 47(iii)];
iv. any transfer of a capital asset by a company to its 100% subsidiary company
provided the subsidiary company is an Indian company [Section 47(iv)];
v. any transfer of a capital asset by a 100% subsidiary company to its holding
company, if the holding company is an Indian company [Section 47(v)];
vi. any transfer in a scheme of amalgamation of a capital asset by the
amalgamating company to the amalgamated company, if the amalgamated
company is an Indian company [Section 47(vi)];
vii. any transfer in a scheme of amalgamation of shares held in an Indian company
by the amalgamating foreign company to the amalgamated foreign company if
certain conditions are satisfied.

55
viii. any transfer, in a demerger, of a capital asset by the demerged company to the
resulting company, if the resulting company is an Indian company [Section
47(vib)];
ix. any transfer in a demerger, of a capital asset, being a share or shares held in an
Indian company, by the demerged foreign company to the resulting foreign
company, if certain conditions are satisfied.
x. any transfer or issue of shares by the resulting company, in a scheme of
demerger to the shareholders of the demerged company if the transfer or issue
is made in consideration of demerger of the undertaking [Section 47(vid)];
xi. any transfer by a shareholder, in a scheme of amalgamation, of shares held by
him in the amalgamating company if certain conditions are satisfied:
xii. any transfer, made outside India, of a capital asset being rupee denominated
bond of an Indian company issued outside India, by a non-resident to another
non-resident; [Section 47(viiaa)]

 Transfer in case of Immovable and Movable Property


Different rules are applicable in case of movable/immovable assets to find out when a
capital asset is “transferred”.

1. Transfer in case of Immovable property when documents are registered -


Title to immovable assets will not pass till the conveyance deed is executed or
registered.

2. Transfer in case of -
Immovable Property when documents are not registered -
Even if the documents are not registered but the following conditions of section 53A
of the Transfer of Property Act are satisfied, ownership in an immovable property is
“transferred”—
a. there should be a contract in writing;
b. the transferee has paid consideration or is willing to perform his part of the
contract; and
c. the transferee should have taken possession of the property.

When these conditions are satisfied, the transaction will constitute “transfer” for the
purpose of capital gains.

3. Transfer in case of Movable Property -


Title to a movable property passes at the time when property is delivered pursuant to a
contract to sell. Entries in the books of account are not relevant for determining date
of transfer.

56
4. Transfer of Capital Asset in Table Chat Format [Section 2(47)]

5. Capital Gain should arise in the previous year in which transfer took place
Normally, capital gain arises in the previous year in which the transfer of the asset
takes place even if the consideration for the transfer is received or realised in a later
year.

There are, however, 4 exceptional cases where capital gain is taxable not in the year of
transfer of the asset, but in some other year. These exceptions are:
i) damage or destruction of any capital asset by fire or other calamities
ii) conversion of capital asset into stock-in-trade (discussed in para 7.13c);
iii) compulsory acquisition of an asset (discussed in para 7.13f).
iv) transfer of capital asset, being land or building or both by an individual HUF
under a specified agreement with the developer [Section 45(5A)]

8.3 COMPUTATION OF ‘PERIOD OF HOLDING OF AN ASSET' FOR


COMPUTING GAPITAL GAIN [EXPLANATION 1(I) TO SECTION
2(42A)]

1. The period of Holding of an Asset [Explanation 1(i) to Section 2(42A)] :


2. Holding period in case of Shares or any other Security [Explanation 1(i)(e) and
(f)]
1. The period of Holding of an Asset [Explanation 1(i) to Section 2(42A)] :

Case Exclusion / Inclusion of Period


(i) Shares held in a company in liquidation
Exclude the period subsequent to the
date of liquidation
(ii) Property acquired in any mode given Include the holding period of previous
under section 49(1) (e.g. by way of gift owner also.
will, etc.)
(iii) Shares in an Indian Amalgamated Include the holding period of shares in
57
Company acquired in a scheme of the Amalgamating Company by the
Amalgamation Assessee.
(iv) Shares in Indian Resulting company include the holding period of shares in
acquired in case of demerger the Demerged Company by the
Assessee
(v) (a) Trading or clearing rights of Include the period for which the person
recognised stock exchange pursuant to its was a member of the recognised stock
demutualisation or corporatisation exchange in India
(b) equity shares in a company acquired by Include the period for which the person
a person pursuant to the demutualisation or was a member of the recognised stock
corporatisation of recognised stock exchange in India
exchange
(vi) Capital asset, being a unit of a business Include the period for which the share
trust, allotted pursuant to transfer of share or shares were held by the assessee.
or shares as referred to in section 47(xvii)
(vii) Unit or units, which becomes the Include the period for which the unit or
property of the assessee in consideration of units in the consolidating scheme of the
a transfer referred to in section 47(xviii) mutual fund were held by the assessee
(ix) Share or debenture of a company, Include the period for which the bond,
which becomes the property of the assessee debenture, debenture-stock or deposit
in the circumstances mentioned in section certificate, as the case may be, was
47(x) of the Act. (le. conversion of bonds held by the assessee prior to the
or debentures into shares or debentures of conversion.
the same_company)
(x) In the case of a capital asset, being Include the period for which the
equity shares in a company, which becomes preference shares were held by the
the property of the assessee in assessee
consideration of a transfer referred to in
section 47(xb) (i.e. conversion of
preference share into equity share)
(xi) In the case of a capital asset, being a Include the period for which the unit or
unit or units, which becomes the property units in the consolidating plan of a
of the assessee in consideration of a transfer mutual fund scheme were held by the
referred to in section 47(xix) (i.e. transfer assessee
of units held in the consolidating plan of a
mutual fund scheme to consolidated plan of
the scheme).

2. Holding period in case of Shares or any other Security [Explanation 1(i)(e) and
(f)]
The period of Holding , in the following circumstances will be computed as under :

58
1. Right to subscribe to shares or any The period shall be reckoned from
other securities(may be called as the date of allotment of such financial
financial assets subscribed to by the asset.
assessee on the basis of right to
subscribe to such financial assets.
2 Right to subscribe to share or any other —do——
securities acquired by a person in
whose favour the right has been
renounced by the existing holder.
3 Period of holding of the right by a The period shall be reckoned from
person who has renounced the right, the date of offer of such right by the
company or institution to the date of
renouncemern, which in normal
circumstances will be short-term.
4 Period of holding of a financial asset The period will be reckoned from
allotted without any payment and on the dare of allotment of such financial
the basis of holding of any other asset (not from the date of allotment of
financial asset e.g. bonus shares. the original shares).
5. Period of holding of specific security The period shall be reckoned from the
or sweat equity shares allotted or date of allotment or transfer of such
transferred, directly or indirectly, by specific security or sweat equity share.
the employer free of cost or at a
concessional rate to his employees
(including former employees).
6. Share or shares of a company, which is The period shall be recknoned from the
acquired by the non-resident assessee date on which a request for such
on redemption of Global Depository redemption was made
Receipts referred to in section 11 5AC(
1 )(b)

8.4 METHOD OF COMPUTING CAPITAL GAIN [SECTION 48]

Capital gains are of two types:


1. Short-term capital gain which arises on the transfer of a short-term capital asset;
and
2. Long-term capital gain which arises on the transfer of a long-term capital asset.

Short-term capital gain is the excess of the full value of consideration over the
aggregate of the following three:
a. cost of improvement;
b. expenses of transfer;

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c. cost of acquisition of the asset.

Whereas in the case of long-term capital gain, the capital gain shall be the excess of
the full value of consideration over the aggregate of the following three amounts:
i. Expenses of transfer;
ii. Indexed cost of acquisition of the asset;
iii. Indexed cost of improvement.

From capital gain, computed as above, certain exemptions are available under sections
54/54B/ 54D/54EC/54F/54G/ 54GA/54GB. The capital gain after claiming the said
exemption(s) is known as taxable long-term or short-term capital gain.

A format to compute the capital gain is given below:

Computation of Short-Term Capital Gain :


Full Value of Consideration —
Less : (a) Expenditure incurred wholly and exclusively in

connection with such a Transfer,
(b) Cost of acquisition —
(c) Cost of improvement — —
Gross short-term capital gains —
Less: Exemption, if available, uls 54B/54D154G/S4GA —

Taxable Short-term capital gains.

Computation of Long-Term Capital Gain :


Full value of consideration —
Less: (a) Expenditure incurred wholly and exclusively in

connection with such a transfer
(b) Indexed Cost of acquisition —
(c) Indexed Cost of improvement — —
Long-term capital gains —
Less: Exemption if available u/s

54154B/54D/54EC/54EFJ/54F/54G/54GA/ 54GB

Taxable long-term capital gains

(A) Full Value of Consideration (Section 48) in lieu of Capital Asset for
Calculating Capital Gain
Full value of consideration is the consideration received or receivable by the transferor
in lieu of assets, which he has transferred. Such consideration may be received in cash

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or in kind. If it is received in kind, then fair market value of such assets is taken as full
value of consideration. Full value of consideration does not mean market value of that
asset which is transferred.

Adequacy of Consideration -
Adequacy or inadequacy of consideration is not a relevant factor for the purpose of
determining full value consideration. However, in the case of transfer of land or
building (or both), if stamp duty value is more than 105 per cent of sale consideration,
the stamp duty value is taken as full value of consideration.

Receipt of Consideration -
It makes no difference whether (or not) “full value of consideration” is received
during the previous year. Even if consideration is not received, capital gain is
chargeable to tax in the year of transfer.

If consideration is not Determinable -


Where in the case of a transfer, consideration for the transfer of a capital asset(s) is not
determinable, then for the purpose of computing capital gains, the fair market value of
the asset shall be taken to be the full market value of consideration [sec. 50D].

(B) Expenditure on Transfer of Capital Asset for Calculating Capital Gain


Expenditure incurred wholly and exclusively in connection with transfer of capital
asset is deductible from full value of consideration. The expression “expenditure
incurred wholly and exclusively in connection with such transfer” means expenditure
incurred which is necessary to effect the transfer.
Examples of such expenses are:
 brokerage or commission paid for securing a purchaser,
 cost of stamp,
 registration fees borne by the vendor,
 travelling expenses incurred in connection with transfer,
 litigation expenditure for claiming enhancement of compensation awarded in
the case of compulsory acquisition of assets.

(C) Cost of Acquisition of an Asset for Calculating Capital Gain


Cost of acquisition of an asset is the value for which it was acquired by the assessee.
 Expenses of capital nature for completing or acquiring the title to the property
are includible in the cost of acquisition.
 Interest on money borrowed to purchase asset is part of actual cost of asset.
 The amount paid for discharge of a mortgage is part of “cost of acquisition”, if
the mortgage was not created by the transferor.
For instance... , on June 1, 2013, X took a loan of Rs. 5 lakh by mortgaging his house
property. X could not repay the loan during his lifetime and after his death on July 2,
2015, the property (with mortgage) is transferred to Mrs. X. Mrs. X transfers the
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property on May 2, 2017 and before transfer, a sum of Rs. 7.2 lakh is paid to clear the
mortgage. Rs. 7.2 lakh will be deductible as part of cost of acquisition of the property
while calculating capital gains in the hands of Mrs. X.

If, however, loan is taken by Mrs. X, then repayment of loan will not be deductible as
part of cost of acquisition of the property while calculating capital gains in the hands
of Mrs. X.

(D) Cost of Improvement to the Capital Asset for Calculating Capital Gain
Cost of improvement is capital expenditure incurred by an assessee in making any
additions / improvement to the capital asset. It also includes any expenditure incurred
to protect or complete the title to the capital assets or to cure such title. Any
expenditure incurred to increase the value of the capital asset is treated as cost of
improvement.

Improvement cost incurred before April 1, 2001 -


Cost of improvement incurred before April 1, 2001 is never taken into consideration.
This rule does not have any exception.

(E) How to covert Cost of Acquisition / Improvement into Indexed Cost of


Acquisition / Improvement.
 Indexed Cost of Acquisition is calculated as follows : -

 Indexed Cost of Improvement is calculated as follows : -

 Cost of Inflation Index for different Previous Years : -

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8.5 DEEMED COST OF ACQUISITION OF ASSET FOR COMPUTING
CAPITAL GAIN

1. Cost of Acquisition of Asset to the Previous Owner to calculate Capital


Gain [Section 49(1)]
If a person has acquired a capital asset in the circumstances specified under section
49(1), then to calculate capital gain at the time of transfer of such asset cost to the
previous owner is taken as cost of acquisition. This rule is always applicable and does
not have any exception. Circumstances specified by section 49(1) are as follows–
a. acquisition of property on any distribution of assets on the total or partial partition
of a Hindu undivided family;
b. acquisition of property under a gift or will;
c. acquisition of property —
i. by succession, inheritance or devolution, or
ii. on any distribution of assets on the dissolution of a firm, body of
individuals or other association of persons where such dissolution had
taken place before April 1, 1987, or
iii. on any distribution of assets on the liquidation of a company, or
iv. under a transfer to a revocable or an irrevocable trust, or
v. by a wholly-owned Indian subsidiary company from its holding company,
or
vi. by an Indian holding company from its wholly-owned subsidiary
company, or
vii. under a scheme of amalgamation, or
viii. under a scheme of demerger; or
ix. under a scheme of conversion of private company/unlisted company into
LLP;
x. on any transfer in the case of conversion of firm/sole-proprietary concern
into company; or
d. acquisition of property, by a Hindu undivided family where one of its members
has converted his selfacquired property into joint family property after December
31, 1969.

Important Points :
The following points should be duly considered —
 No option - If a capital asset was acquired in any one of the modes given above,
then cost to the previous owner shall be taken as “cost of acquisition” for the
purpose of calculating capital gain at the time of its transfer. There is no option in
this regard.
 Last previous owner - Where the previous owner has acquired the property in the
aforesaid manner, the previous owner of the property means the last previous

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owner who had acquired the property by means other than those discussed above.
Cost of any improvement of the asset borne by the previous owner, or the
assessee, will be added to such cost.
 Period of holding of previous owner - In order to find out whether the capital
asset is short-term or long-term in the above cases, the period of holding of the
previous owner shall be taken into consideration.
 Indexation - The benefit of indexation will be available from the year in which
the asset was first held by the previous owner.

2. Cost of Acquisition of Shares of Amalgamated Company [Section 49(2)]:


Where the shareholder of an amalgamating company gets the shares of the
amalgamated company in lieu of the shares held by him in an amalgamating company,
the cost of acquisition of such shares of the amalgamated company shall be deemed to
be the cost of acquisition to him of the shares of the amalgamating company.

For example...,
X purchases 100 shares of R Company Ltd. for Rs.10 each on 5.11.2014. In 2015-16,
R Company Ltd. amalgamates into S Company Ltd. and under the scheme of
amalgamation, X receives 10 shares of S Company Ltd. in lieu of the 100 shares of R
Company Ltd. The cost of acquisition of 10 shares of S Company Ltd. will be Rs.1000
i.e. the cost of acquisition of the shares of R Company Ltd. in lieu of which he has
received the shares of S Company Ltd.

3. Cost of Acquisition in the case of Shares/Debentures acquired on


Conversion of Bonds or Debentures or Debentures Stock or Deposit
Certificates [Section 49(2A)]:
As regards share or debenture of a company which became the property of the
assessee in consideration of a transfer referred to in section 47(x) and (xa) i.e. bonds
or debentures or debentures stock or deposit certificates are converted into shares or
debentures, the cost of acquisition of the shares/ debentures issued on such conversion
shall be deemed to be that part of the cost of the debenture/debenture stock/deposit
certificate, in relation to which such an asset is acquired by the assessee.

For example...,
X has subscribed to 10 partly convertible debentures of Rs.100 each of R Co. Ltd. on
4.4.2015. On 5-2-2017, he receives 4 shares of Rs.10 each per debenture and the
remaining value of the debenture is Rs.50 i.e. the 4 shares have been received by him
in lieu of a part of the cost of the debenture which is Rs.50. Therefore, the cost of 4
shares shall be Rs.50.

In case of a capital asset, being a share or debenture of a company, which becomes the
property of the assessee in the circumstances mentioned in section 47(x) of the Act,
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there shall be included the period for which the bond, debenture, debenture-stock or
deposit certificate, as the case may be, was held by the assessee prior to the
conversion [Rule 8AA(2)].

Example:
In the above case if these 4 share are sold on 6-8-2017, its period of holding shall be
taken from 4-4-2015 to 5-8-2017.

Similarly, cost of acquisition of shares received upon exchange of Foreign Currency


Exchangeable Bond shall be the price at which corresponding bond was acquired.

4. Cost of specified security or sweat equity share already treated as


perquisites under section 17(2)(vi) [Section 49(2AA)]:
Where the capital gain arises from the transfer of specified security or sweat equity
share, which has already been taxed under the head salary as perquisite, the cost of
acquisition of such security or share shall be the fair market value which has been
taken into account for the purpose of valuation of perquisite.

5. Cost of the right of partner on conversion of company to Limited Liability


Partnership [Section 49(2AAA)]:
Where the capital asset being rights of a partner referred to in section 42 of the
Limited Liability Partnership Act, 2008 became the property of the assessee on
conversion of company to Limited Liability Partnership, the cost of acquisition of the
asset shall be deemed to be the cost of acquisition to him of the share or shares in the
company immediately before its conversion.

6. Cost of acquisition of the units of the consolidated scheme acquired in lieu


of units held in a consolidating scheme [Section 49(2AD)]
Where the capital asset, being a unit or units in a consolidated scheme of a mutual
fund, acquired in lieu of units held in a consolidating scheme, the cost of acquisition
of the asset shall be deemed to be the cost of acquisition to him of the unit or units in
the consolidating scheme of the mutual fund.

7. Cost of acquisition of equity share on conversion of preference share into


equity share [Section 49(2AE)]:
Where the capital asset, being equity share of a company, became the property of the
assessee on conversion of preference share into equity share, the cost of acquisition of
the asset shall be deemed to be that part of the cost of the preference share in relation
to which such asset is acquired by the assessee.

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8. Cost of acquisition of the units in the consolidated plan of mutual fund
scheme [Section 49(2AF)]:
Where the capital asset, being a unit or units in a consolidated plan of a mutual fund
scheme, acquired in consolidating plan, the cost of acquisition of the asset shall be
deemed to be the cost of acquisition to him of the unit or units in the consolidating
plan of the scheme of the mutual fund.

9. Cost of acquisition of the shares in the resulting company [Section


49(2C)]:
It shall be the amount which bears to the cost of acquisition of shares held by the
assessee in the demerged company the same proportion as the net book value of the
assets transferred in a demerger bears to the net worth of the demerged company
immediately before such demerger.

"Net worth" for this section shall mean the aggregate of the paid up share capital and
general reserves as appearing in the books of accounts of the demerged company
immediately before demerger.

If the shares of the resulting company are later on transferred, then for computation of
nature of capital gain, the period for which the shares were held in demerged company
shall also be considered [Section 2(42A)].

10. Cost of acquisition of the original share of the demerged company


[Section 49(2D)]
It shall be deemed to have been reduced by the amount as so arrived at under sub-
section (2C) above i.e. original cost of acquisition — cost of acquisition of the shares
in the resulting company.

11. Cost of acquisition of property received without consideration or for


inadequate consideration [Section 49(4)]:
Where the capital gain arises from the transfer of a property, the value of which has
been subject to income tax under section 56(2)(vii) [now 56(2)(x)], the cost of
acquisition of such property shall be deemed to be value which has been taken into
account for section 56(2)(vii) [now 56(2)(x)]. Similarly, cost of acquisition of shares
acquired by a firm or a closely held company without consideration or for inadequate
consideration will be the value which has been taken into account and has been
subjected to tax under section 56(2)(viia) [now 56(2)(x)].

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12. Cost of acquisition of an asset declared under the Income Declaration
Scheme, 2016 [Section 49(5)] [Inserted w.e.f. A.Y. 2017-18]
Where the capital gain arises from the transfer of an asset declared under the Income
Declaration Scheme, 2016, and the tax, surcharge and penalty have been paid in
accordance with the provisions of the Scheme on the fair market value of the asset as
on the date of commencement of the Scheme (i.e. on 1.6.2016), the cost of acquisition
of the asset shall be deemed to be the fair market value of the asset which has been
taken into account for the purposes of the said Scheme.

13. Cost of acquisition of the share in the project being land and building in a
joint development agreement referred in section 45(5A) [Section 49(7)
inserted by the Finance Act, 2017, w.e.f. A.Y. 2018-19]:
Where the capital gain arises from the transfer of a capital asset, being share in the
project, in the form of land or building or both, referred to in section 45(5A), not
being the capital asset referred to in the proviso to the said sub-section, the cost of
acquisition of such asset, shall be the amount which is deemed as full value of
consideration in that sub-section.

8.6 COST OF ACQUISITON OF ASSETS FOR COMPUTATION OF


CAPITAL GAIN [SECTION 55(2)]

Cost of acquisition is the price which the assessee has paid, or the amount which the
assessee has incurred, for acquisition of the asset. Expenses incurred for completing
the title are a part of the cost of acquisition. Interest on money borrowed for acquiring
capital assets will form part of cost of asset. Similarly, Sum paid for Discharge of
Mortgage debt shall be regarded as Cost of Acquisition under Section 48 read with
Section 55(2) of the Act. Here we mentioned the various situations for determining the
Cost of Acquision of Assets for Computation of Capital Gain.

1. Cost of Acquisition being the Fair Market Value as on April 1, 2001 -


In the following cases, the assessee may take, at his option, either actual cost or the
fair market value of the asset as on April 1, 2001 as cost of acquisition:
i) where the capital asset became the property of the assessee before April 1, 2001;
or
ii) where the capital asset became the property of the assessee by any mode referred
to in section 49(1) and the capital asset became the property of the previous
owner before April 1, 2001.

The following points should be duly considered —


i) Adopting fair market value on April 1, 2001 (in place of actual cost of
acquisition) is optional. An assessee may (or may not) opt for it.

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ii) The option is available only when an asset was acquired by the assessee [or by the
previous owner in case section 49(1) is applicable] before April 1, 2001.
iii) When option is available, the cost of the asset or fair market value as on April 1,
2001, whichever is higher, is taken as the cost of acquisition.
iv) The option is not available in the case of depreciable assets.
v) Further option is not available in respect of transfer of a capital asset being
goodwill of a business; trade mark/ brand name associated with a business; right
to manufacture, produce or process any article or thing; right to carry on
business/profession; tenancy right; route permits or loom hours (whether self
generated or otherwise).

2. Cost of Acquisition of goodwill of a business or a trade mark or brand name


associated with business or right to manufacture, produce or process any article or
things or right to carry on any business or profession, tenancy rights, stage carriage
permits or loom hours [Section 55(2)(a)]:
It shall be as under:
i) in case it is acquired in any mode given under clause (i) to (iv) to section 49(1)
—it will be cost to the previous owner if the previous owner paid for it but
where it was self generated by the previous owner, it will be taken as nil.
ii) in case such asset is purchased by the assessee —it means the amount of
purchase price.
iii) in any other case —it shall be taken as nil as it will be self generated.

3. Cost of Acquisition of Right Shares [Section 55(2)(aa)]:


Where an assessee, by virtue of holding certain shares, becomes entitled to subscribe
to any additional shares then:
i) the cost of acquisition of the original shares shall remain unchanged i.e. it shall
be the amount actually paid for acquiring the original shares;
ii) the cost of acquisition of the right shares, when the assessee subscribes to the
shares on the basis of the said entitlement, shall be the amount actually paid for
acquiring the right shares;
iii) the cost of acquisition of the right to acquire such shares, when such a right is
renounced in favour of any other person, shall be taken to be nil;
iv) as regards, the person in whose favour the right to subscribe to the shares has
been renounced, the cost of acquisition of such right share shall be the amount
paid by him to the company for acquiring the shares plus the amount paid to the
person renouncing the right.

4. Cost of Acquisition of Bonus Shares or any other Financial Asset allotted


without payment [Section 55(2)(aa) (iiia)]:
(A) Bonus shares or financial asset allotted without payment after 1.4.2001:

68
The cost of acquisition in relation to the financial assets (i.e., share or any other
security) allotted to the assessee on or after 1.4.2001 (1.4.1981 upto A.Y. 2017-18)
without any payment and on the basis of holding of any other financial asset, shall be
taken to be nil. Therefore, the cost of bonus shares/security shall be taken to be nil and
the entire sale consideration received on the transfer of the bonus shares/security shall
be treated as capital gains.

(B) Bonus shares or financial asset allotted without payment before 1.4.2001:
If bonus shares have been allotted to the assessee before 1.4.2001 (1.4.1981 up to
A.Y. 2017-18), although the cost of such bonus shares is nil, the assessee may opt for
market value as on 1.4.2001 as the cost of acquisition of such bonus shares.

5. Cost of Acquisition of Depreciable Assets [Section 50]:


As already discussed under the chapter on 'Profits and gains of business and
profession', all depreciable assets except in case of electricity companies are part of
block of assets.

Where the full value of the consideration as a result of the transfer of any part or entire
block of asset exceeds the cost of acquisition of that block of depreciable assets, there
will be a capital gain, which will always be a short-term capital gain. The cost of
acquisition of a block of depreciable assets is the written down value of the block at
the beginning of the year plus actual cost of any asset falling within the same block,
acquired during the year.

In other words, the excess of the sale consideration over the aggregate of the
following three amounts shall be the short-term capital gain:
a. expenditure in connection with the transfer;
b. the written down value of the block of assets in the beginning of the year; and
c. the actual cost of any asset falling within the block of asset acquired during the
previous year.

Such an excess shall be deemed to be the capital gain arising from the transfer of short
term capital assets.

6. Compulsory Acquisition of a Capital Asset -


The special rules given below are applicable where the Government has acquired an
asset of a person by way of compulsory acquisition. These rules are also applicable
when consideration is approved or determined by the Central Government or RBI
(even if there is no compulsory acquisition).
Initial compensation -
Initial compensation† is taken as full value of consideration. Capital gain is
chargeable to tax in the year in which the initial compensation (or part thereof) is first
69
received. Indexation benefit is, however, available up to the year in which the asset is
compulsorily acquired.

Additional compensation -
If a Court/Tribunal/authority enhances compensation, it will be taxable in the year in
which enhanced compensation or additional compensation is received. For this
purpose cost of acquisition and cost of improvement are taken as nil. However,
litigation expenses or incidental expenditure for obtaining additional compensation is
deductible.

If the enhanced compensation is received by any other person (because of the death of
the transferor or for any other reason), it is taxable as income of the recipient.

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8.7 CALCULATION OF CAPITAL GAIN IN VARIOUS SPECIAL CASES

1. Capital Gain from Zero Coupon Bonds


 Maturity and redemption of zero coupon bond to be regarded as a transfer
[Section 2(47)]: As per clause (b) above, the payment of and benefit from zero
coupon bond shall be received or receivable from the issuing company/fund only
at the time of maturity or redemption. Consequently, clause (iva) has been
inserted in section 2(47) to provide that the maturity or redemption of a zero
coupon bond shall be regarded as a transfer.

 Transfer of zero coupon bond will be subject to capital gain tax:


The profits arising on the transfer of such zero coupon bond shall be chargeable under
the head "capital gains". Further, if such zero coupon bonds are held for not more than
12 months, such capital asset shall be treated as shortterm capital asset and hence shall
be subject to short-term capital gain. On the other hand, where these bonds are held
for more than 12 months, such capital gain shall be treated as long-term capital gain.

 Taxability of long-term capital gain from zero coupon bond [Proviso to section
112(1)]: The long-term capital gain on zero coupon bonds shall be chargeable to
tax at 10% of long-term capital gain without indexation of cost of such bonds.

2. Capital Gain in case of amount Received from an Insurer on account of


Damage or Destruction of any Capital Asset [Section 45(1A)]:
Where any person receives at any time during any previous year any money or other
assets under an insurance from an insurer on account of damage to, or destruction of,
any capital asset, as a result of—
i. flood, typhoon, hurricane, cyclone, earthquake or other convulsion of nature;
or
ii. riot or civil disturbance; or
iii. accidental fire or explosion; or
iv. action by an enemy or action taken in combating an enemy (whether with or
without a declaration of war), then, any profits or gains arising from receipt of
such money or other assets shall be chargeable to income-tax under the head
"Capital gains".

In which previous year the capital gain shall arise:


In the above case, the capital gain shall be deemed to be the income of the previous
year in which such money or other asset was received.

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What shall be full value of consideration in this case?:
It shall be value of any money or the fair market value of other assets for the date of
such receipt.

3. Capital Gain in the case of Transfer of Depreciable Assets [Section 50] -


The following rules are applicable –
 Capital gain arises only in two cases -
If a depreciable asset is transferred, capital gain (or loss) will arise only in the
following two cases –
i) When on the last day of the previous year written down value of the block of
assets is 0 (zero) [sec. 50(1)].
ii) When the block of assets is empty on the last day of the previous year [sec.
50(2)].
In no other case capital gain is chargeable to tax, when a depreciable asset is
transferred. This rule is equally applicable whether depreciation is allowed in the
current year (or any of earlier years).

 Cost of acquisition -
In the above two cases, cost of acquisition shall be the aggregate of the following–
o Step 1 : Find out written down value of block of assets at the beginning of the
previous year.
o Step 2 : Add: Actual cost of‡ any asset(s) falling within that block of asset
acquired by the assessee during the previous year (whether put to use or not).

 Always Short-Term -
On transfer of depreciable assets gain (or loss) is always short-term capital gain (or
loss). It can never be treated as long-term capital gain (or loss).

4. Capital Gain on Conversion of Capital Asset into Stock-in-Trade [Section


45(2)]-
If capital asset is converted into stock-in-trade during a previous year relevant to the
assessment year 1985-86 (or any subsequent year), the following special rules are
applicable–
i) The conversion of capital asset into stock-in-trade is treated as a 'transfer' within
the meaning of section 2(47).
ii) However, section 45(2) provides that although such a conversion of capital asset
into stock-in trade will be a transfer of the previous year in which the asset is so
converted, but the capital gain will not arise in the previous year in which the
asset is converted, it will arise in the previous year in which such converted
asset is sold or otherwise transferred.
iii) Indexation of cost of acquisition and improvement, if required, will be done till
the previous year in which such conversion took place.
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iv) Further, the fair market value of the asset, as on the date of such conversion,
shall be deemed to be full value of the consideration of the asset.
v) The sale price minus market value as on the date of conversion shall be treated
as business income and taxed under the head 'Profits and gains of business and
profession'.

5. Capital Gain on Transfer of Capital Asset by a Partner / Memeber to a


Firm/AOP/BOI as Capital Contribution [Section 45(3)]-
A capital asset is transferred by a partner to his partnership firm by way of his capital
contribution (or otherwise). It is treated a “transfer” and capital gain will be taxable in
the hands of the partner. The amount recorded in the books of account is taken as full
value of consideration. This rule is also applicable when a member transfers a capital
assets to his association of persons or body of individuals.

Example :
X, Y and Z form a partnership firm. Soon after formation of the firm, X brings a house
property as his capital contribution on August 20, 2018. On the date of transfer fair
market value of the house is Rs. 20,00,000. However, the amount recorded in the
books of firm is Rs. 18,00,000. The house was purchased by X in 2005-06 for Rs.
2,50,000. Find out the amount of capital gain.

Solution :
Capital gain will be taxable in the hands of X for the assessment year 2019-20 –
Full value of consideration (i.e., amount recorded in the Rs. 18,00,000
books of account of the firm)
Less: Indexed cost of acquisition (Rs. 2,50,000 × 280 ÷ Rs. 5,98,291
117)
Long-term capital gain Rs. 12,01,709

6. Capital Gain on Distribution of Capital Assets by a Firm, AOP/BOI to


Partners at the time of Dissolution [Section 45(4)]-
It is treated as transfer. Capital gain is taxable in the hands of firm. The fair market
value of the asset on the date of distribution is taken as full value of consideration.
This rule is also applicable when an asset is transferred by an association of persons or
body of individuals.

Example :
X and Y are two partners of a hardware trading firm. It is dissolved on March 10,
2019. At the time of dissolution, a plot of land owned by the firm is given to X (amount
recorded in books of the firm is Rs. 45,00,000, however, fair market value is Rs.
66,00,000). This plot was purchased by the firm for Rs. 36,00,000 on March 5, 2012.
Find out the amount of capital gain.
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Solution :
Capital gain will be taxable for the assessment year 2019-20 –
Full value of consideration (i.e., fair market value on the Rs. 66,00,000
date of distribution)
Less: Indexed cost of acquisition (Rs. 36,00,000 × 280 ÷ Rs. 54,78,261
184)
Long-term capital gain Rs. 11,21,739

7. Capital Gain on Compulsory Acquisition of a Capital Asset [Section 45(5)]-


The special rules given below are applicable where the Government has acquired an
asset of a person by way of compulsory acquisition. These rules are also applicable
when consideration is approved or determined by the Central Government or RBI
(even if there is no compulsory acquisition).

Initial Compensation -
Initial compensation† is taken as full value of consideration. Capital gain is
chargeable to tax in the year in which the initial compensation (or part thereof) is first
received. Indexation benefit is, however, available up to the year in which the asset is
compulsorily acquired.

Additional Compensation -
If a Court/Tribunal/authority enhances compensation, it will be taxable in the year in
which enhanced compensation or additional compensation is received. For this
purpose cost of acquisition and cost of improvement are taken as nil. However,
litigation expenses or incidental expenditure for obtaining additional compensation is
deductible.

If the enhanced compensation is received by any other person (because of the death of
the transferor or for any other reason), it is taxable as income of the recipient.

8. Computation of Capital Gains in case of Joint Development Agreement


[Section 45(5A)] [W.e.f. A.Y. 2018-19]
Where the capital gain arises to an assessee, being an individual or a Hindu undivided
family, from the transfer of a capital asset, being land or building or both, under a
specified agreement, the capital gains shall be chargeable to income-tax as income of
the previous year in which the certificate of completion for the whole or part of the
project is issued by the competent authority provided the following conditions
satisfied :

1. the assessee should be an individual or HUF


2. he holds the land or building or both
74
3. he transfers such land or building or both to the developer
4. he has entered into a specified agreement with such developer for developing a
real estate project. (For meaning of specified agreement see box above)

If the above conditions are satisfied, the capital gains shall be chargeable to income-
tax as income of the previous year in which the certificate of completion for the whole
or part of the project is issued by the competent authority.

Full value of the Consideration for Computing the Capital Gain under Section
45(5A):
The stamp duty value of his share (i.e. share of the individual or HUF), being land or
building or both, in the project on the date of issuing of said certificate of completion
as increased by any monetary consideration received, if any, shall be deemed to be the
full value of the consideration received or accruing as a result of the transfer of the
capital asset.

9. Capital Gain on Conversion of Debentures / Bonds into Shares [Section


47(x), 49(2A) and rule 8AA] :
When any debentures or part thereof of a company are converted into shares of that
company, the transaction is not considered as a transfer and hence no capital gain is
chargeable.

However, when these shares are, thereafter, actually transferred, capital gain shall
arise and be chargeable in the previous year in which the shares are transferred. The
cost of acquisition of the shares shall be that part of the cost of debenture in relation to
which shares were acquired by the assessee. [Section 49(2A)]

Further, for the purpose of computing the period of holding of such shares, the period
for which the bond, debenture, debenture-stock or deposit certificate, as the case may
be, was held by the assessee prior to the conversion shall also be included. [Rule
8AA(2)]

10. Capital Gain on Transfer of Shares / Debentures in the hands of Non-


Residents (Proviso 1 to Section 48 and Rule 115A) :
If a non-resident acquires shares in, or debentures of, an Indian company by utilizing
foreign currency, the gain will be calculated in the same foreign currency, which was
initially utilized in acquiring shares/debentures. After calculating capital gain in
foreign currency, it will be converted into Indian currency.

The aforesaid rule is not optional but it is compulsory and applicable whether the asset
is short-term or long-term. The benefit of indexation is not available, even if the asset
is long-term.
75
Capital Gain will now be computed as under :
Full value of consideration (converted into foreign currency at -
average TT buying and TT selling rate on date of sale)
Less: (i) expenses on transfer (converted into foreign currency at -
average TT buying and TT selling rate on the date of sale)
(ii) cost of acquisition (converted into foreign currency at - -
average TT buying and TT selling rate on the date of
acquisition)
Capital gain in foreign currency -

11. Capital Gain on Transfer of Self-Generated Capital Assets :


An asset which does not cost anything to the assessee in terms of money in its creation
or acquisition, is a self-generated asset. Generally there is no capital gain on transfer
of self-generated assets as the cost of acquisition of such assets cannot be computed.
But certain amendments have been made in the Income-tax Act and now capital gain
arising on the transfer of the following assets is chargeable to tax:
i. goodwill of a business. There will, however, be no capital gain on sale of
goodwill of a profession;
ii. trademark or brand name associated with the business;
iii. right to manufacture, produce or process any article or thing, for a
consideration e.g. patent, copyright, formula, design;
iv. right to carry on any business or profession,
v. tenancy rights;
vi. route permits;
vii. loom hours.

When a self-generated capital asset is transferred, the following special rules are
applicable –
Self-generated goodwill of a business, right to manufacture/produce an
article/thing or right to carry on business or profession -
In the case of transfer of these capital assets, cost of acquisition and cost of
improvement are taken as nil. Expenses on transfer are, however, deductible on the
basis of actual expenditure.

Self-generated assets being tenancy right, route permit, loom hours, trade mark
or brand name associated with a business -
In the case of transfer of these self-generated capital assets, cost of acquisition is taken
as nil. Cost of improvement and expenses on transfer are, however, deductible on the
basis of actual expenditure.

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Any other Self-Generated asset -
In the case of transfer of any other self-generated capital asset, capital gain is not
chargeable to tax.

Fair Market Value on April 1, 2001 -


Option not available - Even if the aforesaid assets self-generated were acquired before
April 1, 2001, the option of adopting the fair market value on the said date is not
available.

12. Capital Gain on Transfer of Bonus Shares -


If bonus shares were allotted before April 1, 2001, cost of acquisition is the fair
market value on April 1, 2001. If bonus shares are allotted after April 1, 2001, cost of
acquisition is taken as zero.

13. Capital Gain on Transfer of Right Entitlement -


Amount realized by an existing shareholder by selling rights entitlement (i.e., right to
acquire additional shares in the company at a pre-determined price) is taxable in the
year of transfer of the right entitlement. Cost of acquisition of right entitlement is
always taken as zero and the capital gain is deemed as short-term capital gain.

14. Capital Gain on Transfer of Securities in Demat Form -


Demat account is a safe and convenient means of holding securities just like a bank
account is for funds. The idea of dematerialised account is to avoid the need to hold
physical shares. The shares are virtually being bought and sold through the banking
account.
 For computing capital gain chargeable to tax, the cost of acquisition and period
of holding of any security in demat form shall be determined on the basis of
First-in-First-Out (FIFO) method.

15. Capital Gains on Distribution of Assets by Companies in Liquidation [Sec


46]:
Where the assets of a company are distributed to its shareholder on its liquidation,
such distribution shall not be regarded as a transfer by the company. Therefore, there
will be no capital gain to the company.

However, where a shareholder on the liquidation of a company, receives any money or


other asset from the company in lieu of the shares held by him, such a shareholder
shall be chargeable to income-tax under the head 'Capital gains' in respect of the
money and the asset so received. In this case, the consideration price for capital gain
purposes shall be money received and/or the market value of the other assets on the
date of distribution minus deemed dividend within the meaning of section 2(22)(c).
77
Sale of Assets Received on Liquidation:
As per section 55(2)(b)(iii), if the asset (other than cash) acquired by the shareholder,
at the time of liquidation, is subsequently transferred by the shareholder; then for the
purpose of computation of capital gain of such transfer, the cost of acquisition of such
asset shall be the market value of the asset on the date of distribution. In this case,
deemed dividend will not be deducted.

16. Computation of Capital Gains in the case of Transfer of Land and Building
or in Real Estate Transactions [Section 50C] -
Section 50C is applicable if the following conditions are satisfied—
i) There is a transfer of land or building or both. The asset may be long-term capital
asset or short-term capital asset. It may be depreciable or non-depreciable asset.
ii) Stamp duty value adopted (or assessed or assessable) by the Stamp duty authority
in respect of such transfer, is more than 105 % of sale consideration.
If the above conditions are satisfied, the value adopted by the Stamp duty
authority shall be taken as “full value of consideration” for the purpose of
computation of capital gains. In other words, section 50C is applicable only in
those cases, where stamp duty value is more than 105 % of actual consideration .

17. Capital Gains on Purchase by Company of its Own Shares or Other


Specified Securities [Section 46A]:
Where a shareholder or a holder of other specified securities receives any
consideration from any company for purchase of:
a. its own shares held by such shareholder or
b. other specified securities held by holder of other specified securities,
then, subject to the provisions of section 48, the difference between the cost of
acquisition and the value of consideration received by the shareholder or the holder of
other specified securities, as the case may be, shall be deemed to be the capital gains
arising to such shareholder or the holder of other specified securities, as the case may
be, in the year in which such shares or other specified securities were purchased by the
company.

18. Capital Gain on Sale of Land and Building to be computed separately in case
of Building Constructed by the Assessee:
Where the assessee acquires land and constructs the building on the same in any
subsequent previous year then, for the purpose of computation of capital gain, the
period of holding of the land and period of holding of the building shall be separately
determined as below :
 The period of holding of land shall be from the date of purchase of land till the
date of sale of the house property.
 On the other hand, the period of holding of the building shall be from the date of
completion of building till the date of sale of the house property.
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Thus, for computing capital gain, the indexation of cost, if required, will be computed
separately for the land and for the building.

Illustration:1: Mr. Vishal sold his residential house for Rs:4,50,000 in November,
2019. Indexed cost of this house was Rs: 1,80,000. He paid 3 % of sale as commission
to broker. He purchased another house on 26th January, 2020 for Rs:2,00,000.
Compute his capital gains for the AY 2020-21

Solution:
Computation of capital gains for the AY 2020-21
Particulars Rs: Rs:
Selling price of the house 4,50,000
Less: Brokerage 13,500
Indexed cost 1,80,000 1,93,500
Long term capital gain 2,56,500
Less: Cost of new house 2,00,000
Taxable Capital Gain 56,

Illustration:2: Mr. Irfan provides you the following information to the sale of
residential house. Calculate his capital gain for the AY 2020-21.
House purchased in January, 1999 Rs:4,83,000
Sold the house in August, 2019 Rs:30,00,000
Purchased another residential house in November, 2012 Rs:2,00,000
Invested in bond issued by NHAI Bonds u/s 54EC Rs:1,00,000 The Cost Inflation
Index in 1998-99 was 161 and for 2019-20 was 852.

Solution:
Computation of capital gains for the AY 2020-21
Particulars Rs: Rs:
Sale of asset in August,2019 30,00,000
Less: Indexed cost of acquisition(483000x 852/161 ) 25,56,000
Capital Gain 4,44,000
Less: Exemption u/s 54 being cost of house
2,00,000
purchased within one year
Exemption u/s 54EC 1,00,000 3,00,000
Taxable Capital Gain 1,44,000

Illustration 03: Mr. Ananda murthy showed his block of assets as on 1-4-2019 at a
WDV of Rs:1,50,000. He purchased another asset within the block during the year
2019-20 for Rs:40,000.The entire block of assets is sold during the previous year for
Rs:2,00,000. Calculate capital gain for the assessment year 2020-21.

79
Solution:
Computation of capital gains for the AY 2020 - 21
Particulars Rs:
W.D.V. of assets as on 01-04-2019 1,50,000
Add: Assets purchased during P.Y. 40,000
1,90,000
Less: Selling Price 2,00,000
Short Term Capital Gain 10,000

Illustration 04:Mr. Varma purchased a plot in 1986-87 for Rs: 1,40,000. It was sold
on 15-1-2020 for Rs:15,80,000 and he paid Rs:1,00,000 as brokerage. He invested
Rs:2,00,000 in NHAI bonds on 31-3-2020 and Rs: 3,10,000 in bonds issued by Rural
Electrification Corporation Ltd. on 1-8- 2020. Compute his taxable capital gain, if the
CII for 1986-87 was 140 and for 2019-20 is 852.

Solution:
Computation of capital gains for the AY 2020-21
Particulars Rs: Rs:
Selling price of plot 15,80,000
Less: Brokerage 1,00,000
Indexed cost (1,40,000 x 853/140) 8,52,000 9,52,000
LTCG 6,28,000
Less: Exempt u/s 54EC : NHAI Bonds purchased
2,00,000
within 6 months from the date of transfer of LTCA
Taxable Capital Gains 4,28,000

Note: Bonds of Rural Electrification Corporation Ltd. not purchased within 6 months
from the date of transfer of LTCA, hence, not entitled to exemption.

Illustration:5: Agricultural land purchased in 1994-95 for Rs: 75,000 sold for Rs:
7,20,000 on 01-05-2012. The assessee purchased another piece of agricultural land on
01-08-2019 for Rs:80,000 and deposited Rs:50,000 in Capital Gains Account Scheme,
1988. Compute the Capital Gain chargeable to tax for the AY 2020-21. CII in 1984-85
was 125 and in 2019-20 is 852.

Solution:
Computation of capital gains for the AY 2020-21
Particulars Rs: Rs:
Selling price of agri. land 7,20,000
Less: Indexed Cost (75,000 x 852/125) 5,11,200
LTCG 2,08.800

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Less: Cost of new agri. land 80,000
Deposit in Capital Gains Account 50,000 1,30,000
Taxable Capital Gains 78,800

Illustration:6: From the following information of Narayana murthy, compute the


capital gains for the AY 2020- 21: Cost of acquisition of residential house in 1983-84
Rs:3,48,000. Sale consideration on 01-07-2019 Rs: 31,00,000. Cost of acquisition of
new house prior to the date of filing the IT return Rs:8,00,000. The CII in 1983-84 and
in 2019-20 was 116 and 852 respectively.

Solution:
Computation of capital gains for the AY 2020 -21
Particulars Rs:
Selling price of house 31,00,000
Less: Indexed cost (3,48,000 x 852/116) 25,56,000
LTCG 5,44,000
Less: Cost of new house 8,00,000
Taxable Capital Gains Nil

Illustration:7: From the following particulars, calculate capital gains: Self-generated


goodwill of a business sold for Rs: 14,00,000. Bonus shares in B.Ltd. (not listed) and
(being STCA) sold for Rs:8,00,000. Business income Rs: 60,000. LTCl in the transfer
of a building Rs: 40,000. Face value of bonus shares sold Rs:6,00,000.

Solution:
Computation of Capital Gains for the AY 2020-21
Particulars Rs:
Selling price of self-generated
14,00,000
goodwill(assumed LTCA)
Less: Cost Nil
LTCG 14,00,000
Less: LTCL on sale of building 40,000
LTCG 13,60,000
Selling price of bonus share 8,00,000
Less: Cost Nil
STCG 8,00,000
Taxable Capital Gain 21,60,000

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8.8 LET US SUM UP

Any profits or gains arising from the transfer of a capital asset affected in the previous
year shall be chargeable to income-tax under the head 'Capital Gains'. Capital asset
means property of any kind held by an assessee whether or not connected with his
business' or profession, but does not include stock-in-trade, personal effects and,
agricultural land in India. Capital assets are of two types-long-term and short-term.
Long-term capital assets are those which are held by the assessee for more than
36 months before transfer and short-capital assets are those which are held by the
assessee for not more than 36 months before transfer.

Capital gains arising from the transfer of short-term capital assets are called short-term
capital gains and capital gains arising from the transfer of long-term capital assets are
called long-term capital gains.

Transfer of a capital asset means sale, exchange or extinguishment of any rights


therein, or its compulsory acquisition under any law or its conversion into stock-in-
trade etc. The income chargeable under the head 'Capital Gains' shall be computed by
deducting from the full value of the consideration received or accruing as a result of
the transfer of the capital assets: (i) expenditure incurred wholly and exclusively in
connection with the transfer, and (ii) the cost of acquisition of the capital asset and
cost of any. improvement thereto.

Only long-term capital gains are exempt from tax under Section 53,54,54E, and 54F,
subject to the fulfillment of certain conditions. Similarly ,capital gains are also exempt
under sections 54B, 54D and 54G subject to fulfillment of certain conditions. In the
case of long-term capital gains an initial deduction of Rs. 10,000 is made and
thereafter on the balance of such capital gain deduction at specified percentage will be
allowed on specified nature of capital gains. The net balance left thereafter shall be
taxable capital gain.

In case of long-term capital losses also deduction shall be made in the same manner as
is done in respect of long-term capital gains u/s 48(2) and the balance of the amount
shall be net long-term capital loss to be set-off and/or carry forward.

8.9 KEY WORDS

 Capital Asset: Capital asset means property of any kind held by an assessee,
whether or not connected 'with his business or profession except stock-in-trade,
personal effects and agricultural land in India.

82
 Capital Gains: Profits or gains arising from the transfer of a capital asset is called
capital gain.
 Long-term capital gain : Capital gain arising from the-transfer of an asset held
for more than 36 months (in case of shares for more than 12 months) is called
long-term capital gain.
 Short-term capital gain : Capital gain arising from the transfer of an asset held
for not more than 36 months (in case of shares for not more than 12 months) is
called short-term capital gain.
 Transfer : Transfer in relation to a capital asset includes the sale, exchange or
relinquishment of an asset, the extinguishment of any rights therein, or
compulsory acquisition thereof under any law or conversion of an asset into
stock-in-trade

8.10 FURTHER READINGS

 Income tax Law and practice, Makta Jain/ Rakesh Jain, V.K. Global Pub. Pvt.
Ltd., New Delhi
 Income Tax Law and Pratcice-Saha, Dash- Himalaya Publishing House.
 Pagare, Dinkar. Law and Practice of Income Tax. Sultan Chand and Sons, New
Delhi.
 Lal, B.B. Income Tax Law and Practice. Konark Publications, New Delhi
 Gour and Narang, Income tax: Law and practice, kalyani Publishers
 Dr. Vinod Kumar Singhania, e-filing of Income Tax Returns and Computation
ofTax,
 Taxmann Publication Pvt. Ltd, New Delhi. Latest version.

8.11 TERMINAL QUESTIONS

Q1 : What does the term 'Capital Gains' signify under the Income Tax Act?
Q2 : Explain the following terms in the context of the I.T.' Act
a) Capital Assets
b) Short Term Capital Assets
c) Transfer of Capital Assets
Q3 : Discuss the provisions of the Income-tax Act regarding exemption of capital
gains U/S54E?
Q4 : A is the owner of a car. On 1-4-2019, he starts a business of purchase and sale
of motor cars. He treats the above car as part of the stock-in-trade of his new
business. He sells the same on 31-3-2020 and gets a profit of Rs 1 lakh.
Discuss the tax implication in his hands under the head “Capital gains”.
Q5 : X converts his capital asset (acquired on June 10, 2003 for Rs 60,000) into
stock-in trade on March 10, 2019. The fair market value on the date of the
83
above conversion
was Rs 5,50,000. He subsequently sells the stock-in-trade so converted for Rs
6,00,000 on June 10, 2019. Discuss the year of chargeability of capital gain.
Q6 : In which of the following situations capital gains tax liability does not arise?
 Mr. A purchased gold in 1970 for Rs 25,000. In the P.Y. 2019-20, he gifted it
to his son at the time of marriage. Fair market value (FMV) of the gold on the
day the gift was made was ` 1,00,000.
 A house property is purchased by a Hindu undivided family in 1945 for Rs
20,000. It is given to one of the family members in the P.Y. 2019 20 at the
time of partition of the family. FMV on the day of partition was Rs 12,00,000
 Mr. B purchased 50 convertible debentures for ` 40,000 in 1995 which are
converted into 500 shares worth ` 85,000 in November 2019 by the company

Q7 : Mr. A converts his capital asset acquired for an amount of Rs 50,000 in June,
2003 into stock-in-trade in the month of November, 2016. The fair market
value of the asset on the date of conversion is Rs 4,50,000. The stock-in-trade
was sold for an amount of Rs 6,50,000 in the month of September, 2019. What
will be the tax treatment?

84
UNIT-9 INCOME OF OTHER SOURCES

Structure
9.0 Objectives
9.1 Introduction
9.2 Income Chargeable under the head income from other sources
9.3 Winning from lotteries, crossword puzzle, card games etc
9.4 Interest on Securities
9.5 Income from letting out machinery, plant or furniture
9.6 Amount expressly disallowed in computing the income from other
sources
9.7 Deduction allowed in computing the income from other sources
9.8 Let us sum up
9.9 Key Words
9.10 Further Readings
9.11 Terminal Questions

9.0 OBJECTIVES

After studying this 'Unit you should be able to:


 List the incomes falling under the head 'Income from other sources';
 Explain in detail the provisions of income tax for dividends and interest on
securities;
 Discuss the set off and carry forward of losses

9.1 INTRODUCTION

You have read about three heads of income. Income specific to a particular head is
included in and charged to tax under that head. Income from other sources is a head of
income which includes all those incomes which are:
 Listed in the definition of income,
 Not exempt from tax, and
 Not included in any specific head i.e., salaries, house property, capital gains
etc.
 This means it is a residual head which includes all those incomes which are not
included in a specific head.

In this unit you will study in detail the incomes included under this head and the
provisions of income tax relating to them. You will also study about the set-off and
carry forward of losses.
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9.2 INCOME CHARGEABLE UNDER THE HEAD 'INCOME FROM
OTHER SOURCES' (SECTION 56)

As per section 56(1), income of every kind, which is not to be excluded from the total
income under this Act, shall be chargeable to income-tax under the head "Income
from Other Sources" if it is not chargeable to Income-tax under any of the first four
heads specified in Section 14.

In other words, the following conditions must be satisfied before an income can be
taxed under the head "Income from Other Sources":
i. There must be an income;
ii. Such income is not exempt under the provisions of this Act;
iii. Such income is not chargeable to tax under any first four heads viz., "Income
from Salary", "Income from House Property", "Profits and Gains of Business
or Profession" and "Income from Capital Gain".

Income from other sources is, therefore, a residuary head of income.

Sub-section (2) of section 56 specifies nine incomes which are always taxable under
the head “Income from other sources". The following Eleven (11) incomes are always
taxable under the head “Income from other sources” —

Name of Incomes Descriptions


1. Dividend Dividends, other than the dividends referred to in
section 115-O. However, w.e.f. A.Y. 2017- 18,
certain dividends received from domestic
companies shall be chargeable to tax in
accordance with the provisions of section
115BBDA even if the tax has been paid by the
domestic company under section 115-O;
2. Winning from Lotteries, etc. It includes 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 whatsoever. These
receipts are chargeable to tax under the head
“Income from other sources”.
3. Employees' Contribution Any sum received by the assessee from his
towards Staff Welfare Scheme employees as contribution to any provident fund,
or any other welfare fund for the employees
provided it is not taxable under the head 'Profits
and Gains of Business or Profession'.

86
4. Interest on Securities Interest on debentures, Government
securities/bonds is taxable under the head “Income
from other sources” provided the income is not
chargeable to Income-tax under the head profits
and gains of business or profession.
5. Rental Income of Income from machinery, plant or furniture
Machinery, Plant or Furniture belonging to the assessee and let on hire, provided
the income is not chargeable to Income-tax under
the head profits and gains of business or
profession.
6. Rental income of leting out Where the assessee lets on hire, the machinery,
of Plant, Machinery or plant or furniture belonging to him and also
Furniture along with letting buildings, and letting of buildings, is inseparable
out of Building and (the two from the letting of the said machinery, plant or
lettings are not separable) furniture, the income from such letting, if it is not
chargeable to income-tax under the head profits
and gains of business or profession.
7. Sum Received under Key any sum received under a Key man Insurance
man Insurance Policy Policy, including the sum allocated by way of
bonus on such policy, if such income is not
taxable under the head "Salaries" or "Profits and
gains of business or profession".
8. Gift Any sum of money, the aggregate value of which
exceeds Rs. 50,000 is received without
consideration or property (whether movable or
immovable) is received without consideration or
property is received for an inadequate
consideration by any person on or after 1.4.2017,
if the amount of such gift or inadequate
consideration exceeds Rs. 50,000
9. Interest on Compensation or Income by way of interest received on
Enhance Compensation compensation or on enhanced compensation shall
be assessed under the head “Income from other
sources” in the year in which it is received.
However, 50% of such interest is deductible under
section 57(iv). Consequently, only 50% of such
interest is taxable.
10. Advance Money Received Where any sum of money, received as an advance
in the course of negotiations or otherwise in the course of the negotiations for
for transfer of a Capital Asset. transfer of a capital asset, is forfeited and the
negotiations do not result in transfer of such
capital asset, then, such sum shall be chargeable to
87
income-tax under the head “Income from other
sources”.
11. Compensation on Any compensation or other payment referred to in
Termination of Employment or section 56(2)(xi) [i.e., compensation on
Modification of Terms of termination of employment or modification of
Employment terms of employment] is treated as income from
other sources.

Examples of Incomes Included under the head 'Income from Other Sources'
Following are some of the other incomes which are normally chargeable to tax under
this head because these are not covered under any of the four specified heads:
1. income from sub-letting of a house property by a tenant;
2. casual income;
3. insurance commission;
4. family pension (payments received by the legal heirs of a deceased employees);
5. director's sitting fee for attending board meetings;
6. interest on bank deposits/deposits with companies;
7. interest on loans;
8. income from undisclosed sources;
9. remuneration received by Members of Parliament;
10. interest on securities of foreign governments;
11. examiner ship fees received by a teacher from an institution other than his
employer;
12. total interest till date on employee's contribution to an unrecognised provident
fund at the time when the payment of lump sum amount from the unrecognised
provident fund is due;
13. rent from a vacant piece of plot of land;
14. agricultural income from agricultural land situated outside India; (xv) interest
received on delayed refund of income-tax;
15. income from royalty, if it is not income from business or profession;
16. Director's commission for standing as a guarantor to bankers;
17. Director's commission for underwriting shares of a new company;
18. Gratuity received by a director who, under the relevant contract, is not an
employee or servant of the company, is assessable as income from other sources;
19. Income from racing establishment;
20. Income from granting of mining rights;
21. Income from markets, fisheries, rights of ferry or moorings;
22. Income from grant of grazing rights;
23. Interest paid by the Government on excess payment of advance tax, etc.;
24. Income received after discontinuance of business.

88
9.3 WINNINGS FROM LOTTERIES, CROSSWORD PUZZLES, HORSE
RACES AND CARD GAMES [SECTION 56(2)(IB)]

Any winnings from:


i) Lotteries,
ii) Crossword puzzles,
iii) Races including horse races,
iv) Card games and other games of any sort,
v) Gambling or betting of any form or nature whatsoever, are chargeable to tax
under Section 56 under the head 'income from other sources'.

1. Special rate of Income-tax in case of winnings from lotteries, crossword


puzzles, races, etc. [Section 115BB]:
Although, winnings from lotteries, etc. is part of total income of the assessee, such
income is taxable at a special rate of Income-tax, which at present, is
 30% + education cess @ 2% + SHEC @ 1%.

Deduction of any expenses, allowance or loss not allowed from such winnings:
According to section 58(4), no deduction in respect of any expenditure or allowance,
in connection with such income, shall be allowed under any provision of the Income-
tax Act. However, expenses relating to the activity of owning and maintaining race
horses are allowable.

In other words, the entire income of winnings, without any expenditure or allowance,
will be taxable. In fact, deduction under sections 80C to 80U on Deductions from
Gross Total Income will also not be available from such income although such income
is a part of the total income.

As lottery income is taxed at flat rate, the basic exemption of income (say Rs.
5,00,000) is not available to the assessee.

2. Grossing up of Lottery Income, etc.:


As in the case of some other incomes, there is also a provision for tax to be deducted
at source from income from winning of lotteries, horse races and crossword puzzles.
The rate of TDS in the case of such incomes is 30% if the income exceeds Rs. 10,000.
Such tax deducted at source is income and the amount received is net income after
deduction of tax at source. In this case, such net income will have to be grossed up as
under:

If a person wins a lottery of Rs.2,00,000, tax must have been deducted @ 30% and net
amount received by the assessee would be Rs. 1,40,000 (2,00,000 – 60,000). Grossing
up would be done as:
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1,40,000 × [ 100 ÷ (100-30)] = Rs. 2,00,000

9.4 INTEREST ON SECURITIES UNDER THE HEAD 'INCOME FROM


OTHER SOURCES' [SECTION 56(2)(ID)]

1. Meaning of Interest on Securities


Income, by way of interest on securities, is chargeable under the head "income from
other sources", if such income is not chargeable to income-tax under the head, "Profits
and Gains of Business or Profession".

According to Section 2(28B) "Interest on securities" means:


a. Interest on any security of the Central Government or a State Government;
b. Interest on debentures or other securities for money issued by, or on behalf of
a local authority or a company or a corporation established by Central, State or
Provincial Act.

Thus securities may be divided into following categories:


i) Securities issued by Central/State Governments;
ii) Debentures/bonds issued by a local authority;
iii) Debenture/bonds issued by companies;
iv) Debenture/bonds issued by a corporation established by a Central, State or
Provincial Act i.e. autonomous and statutory corporations.

2. Chargeability of Interest on Securities :


 Income by way of interest on securities is taxable on “receipt” basis, if the
assessee maintains books of account on “cash basis”.
 It is taxable on “due” basis when books of account are maintained on
mercantile system.
 Interest is taxable on “receipt” basis, if such interest had not been charged to
tax on due basis for any earlier previous year.

3. Accrual of Interest on Securities :


Interest on securities does not accrue everyday or according to the period of holding of
investment. For instance, if one holds 7% securities from January 1, 2019 to February
28, 2019, it cannot be said that interest of two months has accrued to the security
holder. Generally, interest becomes due on due dates specified on securities. For
instance..., if specified due dates of interest of particular securities are March 1 and
September 1 every year, interest of six months falls due on each such date and holder
of securities on these dates will be entitled to interest of six months on each such date.

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4. Grossing up of Interest on Securities :
Gross interest [i.e., Net Interest + TDS (Tax Deducted at Source] is Taxable.
Net interest is grossed up in the hands of recipient if tax is deducted at source by the
payer.

Net interest (if tax is deducted at source) in the hands of the recipient should be
grossed up by multiplying it by the following fraction :

Net Interest x 100 ÷ [100 - Rate of TDS (tax deduction at source)]

5. Deductions for Expenses from Interest on Securities [Section 57(i) and (iii)]:
As discussed in the case of dividends, the following deductions will also be allowed
from the gross interest on securities:
1. Collection charges [Section 57(i)]:
Any reasonable sum paid by way of commission or remuneration to a banker,
or any other person for the purpose of realising the interest.
2. Interest on loan [Section 57(iii)]:
Interest on money borrowed for investment in securities can be claimed as a
deduction.
3. Any other expenditure [Section 57(iii)]:
Any other expenditure, not being a expenditure of a capital nature, expended
wholly and exclusively for the purpose of making or earning such income can
be claimed as a deduction.

6. Avoidance of Tax in respect of Interest on Securities (Section 94)


Interest on securities does not accrue from day to day but on certain fixed dates. If, on
the eve of due date of payment of interest, a person transfers securities to another
person and reacquires the same or similar securities after interest has been received by
the transferee, the transferor would be able to evade tax in respect of such interest. To
prevent this malpractice, section 94 provides certain checks under sub-sections (1) and
(2).

(A) Bond Washing Transactions [Section 94(1)]


A bond washing transaction is narrated as a transaction which consists of selling
securities (to a friend or relative) some time before the due date and acquiring back the
same (or similar) securities after the due date of interest is over. This practice is
generally adopted by high-income class assessees to evade the tax while transferring
securities to low-income class assessees on the eve of due date of payment of interest.
If this practice is not checked, interest is includible in the total income of the
transferee, as interest is chargeable in the hands of the person who is legal owner of
securities on the due date of payment of interest.

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To prevent the avoidance of tax in this manner, section 94(1) provides that where a
security owner transfers the securities on the eve of due date of interest and reacquires
them, the interest received by the transferee will be deemed as income of the
transferor and, accordingly, it will be included in the total income of the transferor and
not of the transferee.

(B) Sales Cum-Interest on Securities [Section 94(2)]


Another method of avoiding tax is sale of securities cum-interest. Section 94(2)
provides that if an assessee, having beneficial interest in securities during the previous
year, sells them in such a way that either no income is received or income received is
less than the sum he would have received if interest had accrued from day to day, then
income from such securities for such year would be deemed as income of such person.

EXCEPTIONS -
Deeming provisions of section 94(1)/(2), discussed above, are not applicable if the
security owner proves to the satisfaction of the Assessing Officer that —
a. There has been no avoidance of income-tax; or
b. The avoidance of income-tax was exceptional and not systematic and there
was not any avoidance of income tax under section 94(1)/(2) in his case,
during three years preceding the previous year.

9.5 INCOME FROM LETTING OUT OF MACHINERY, PLANT OR


FURNITURE [SECTION 56(2)(II)]

Income from machinery, plant or furniture, belonging to the assessee and let on hire,
is chargeable as income from other sources, if the income is not chargeable to income-
tax under the head "Profits and Gains of Business or Profession".

1. Income from Composite Letting of Machinery, Plant or Furniture and


Buildings [Section 56(2)(iii)]:
If an assessee lets on hire machinery, plant or furniture and also building and letting of
building is inseparable from letting of machinery, plant or furniture, income from such
letting is taxable as income from other sources, if the same is not chargeable to tax
under the head “Profits and gains of business or profession”.

On the basis of the judicial pronouncements, the following broad conclusions can be
drawn:
 If there is letting of machinery, plant and furniture and also letting of the
building and the two lettings form part and parcel of the same transaction or the
two lettings are inseparable (in the sense that letting of one is not acceptable to
the other party without letting of the other; for instance, letting of cinema house
along with letting of furniture) then such income is taxable under section
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56(2)(iii) under the head “Income from other sources” (if it is not taxable as
business income). This rule is applicable even if sum receivable for the two
lettings is fixed separately.

 If a building is let out but other assets like machinery, plant or furniture are not
given on rent. However, certain amenities like lift services, air-conditioning, fire
fighting facilities, etc., are provided, then section 56(2)(iii) is not applicable.
The essential requirement of section 56(2)(iii) is that there should be letting of
plant, machinery or furniture and also letting of building.

For instance, if the owner of a building only undertakes to instal and operate an
air-conditioning plant and to instal, and maintain a lift in the building for the
benefit of all the tenants at specified charges (maybe on “no profit no loss basis”
or some other basis), there is no letting of air-conditioning plant and lifts to the
tenants. Consequently, in such case incomes from letting of building is taxable
under section 22 under the head “Income from house property” and amount
collected for providing different amenities shall be taxable under section 56(1).

The aforesaid rule is applicable even if the assessee receives composite rent from his
tenant towards building as well as services/amenities. The portion of rent attributable
to the building should only be assessed as “Income from house property” and balance
portion attributable to amenities must be assessed as “Income from other sources”.

2. Deductions permissible from Letting out of Machinery, Plant or Furniture


and Buildings [Section 57(ii) and (iii)]:
The following deductions are allowable:
i) Current repairs, to the premises held otherwise than as tenant.
ii) Insurance premium against risk of damage or destruction of the premises.
iii) Repairs and insurance of machinery, plant or furniture.
iv) Depreciation based upon block of assets, in the same manner as allowed under
section 32 in the case of Income from Business and Profession subject to the
provisions of section 38 i.e. if it is partly let and partly used for own purpose,
deduction of expenses (including depreciation) shall be allowed to the extent it
is let out.
v) Any other expenditure: Any other expenditure, not being a expenditure of a
capital nature, laid out or expended wholly and exclusively for the purpose of
making or earning such income can be claimed as a deduction.

Share Premium in excess of the Fair Market Value to be treated as Income [Section
56(2)(viib)]

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Section 56(2)(viib) is applicable as follows –
 Recipient is a company (not being a company in which the public are
substantially interested).
 It receives consideration for issue of shares (preference shares or equity shares)
from a resident person.
 The consideration received for issue of shares exceeds the face value of such
shares. In other words, shares are issued at a premium.

If the above conditions are satisfied, the aggregate consideration received for such
shares as exceeds the fair market value of the shares, shall be chargeable to income-
tax in the hands of recipient-company under section 56(2)(viib) under the head
“Income from other sources”.

The above provisions are not applicable in the following two cases –
a. where the consideration for issue of shares is received by a venture capital
undertaking from a venture capital company or a venture capital fund; or
b. where the consideration for issue of shares is received by a company from a
class or classes of person as notified† by the Central Government.

The fair market value of the shares shall be the higher of the value—
a. as may be determined in accordance with the method given in rules 11U and
11UA ; or
b. as may be substantiated by the company to the satisfaction of the Assessing
Officer, based on the value of its assets, including intangible assets, being
goodwill, know-how, patents, copyrights, trademarks, licenses, franchises or
any other business or commercial rights of similar nature.

Interest on Compensation or Enhanced Compensation [Section 56(2)(viii)]


As per section 145A(b), any interest received by an assessee on compensation or
enhanced compensation, as the case may be, shall be deemed to be the income of the
year in which it is received.

Further, as per section 56(2)(viii), income by way of interest received on


compensation or on enhanced compensation referred to in section 145A(b) above shall
be taxable under the head income from other sources in the previous year in which
such interest is received.

Deduction from such interest [Section 57(iv)]:


In the case of above interest which is taxable under the head income from other
sources, a deduction of a sum equal to 50% of such income shall be allowed to the
assessee and no deduction shall be allowed under any other clause of section 57.

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Example :
Mr. X whose property was compulsorily acquired in 2013 received enhanced
compensation of Rs. 9,00,000 on 15.11.2017 which includes Rs.2,40,000 as interest
on such enhanced compensation. Discuss the taxability of such compensation.

Solution:
Enhanced compensation of Rs. 9,00,000 – Rs. 2,40,000 = Rs. 6,60,000 shall be
taxable under the head capital gain. Whereas interest on enhanced compensation shall
be taxable under the head income from other sources as under:

Particulars Amount (Rs.)


Interest on Enhanced Compensation Received 2,40,000
Less : Deduction @ 50% 1,20,000
Balance Taxable 1,20,000

Forfeiture of Advance Received for Transfer of a Capital Asset to be Taxed


under the head "Income from Other Sources" [Section 56(2)(ix)]
According to section 56(2)(ix), any sum of money, received as an advance or
otherwise in the course of negotiations for transfer of a capital asset shall now be
taxable under the head income from other sources if:
1. Such sum is Forfeited; and
2. The negotiations do not result in transfer of such capital asset.

Income of any Person to include not only Gift of Money from any person(s) but also
the Gift of Property (whether Movable or Immovable) or Property acquired for
inadequate consideration [Section 56(2)(x), w.e.f. A.Y. 2018-19]

(1) Where any Person Receives, in any previous year, from any Person or
Persons on or after 1.4.2017 :
The following income, it shall be chargeable to income tax under the head "income
from other sources" as per section 56(2)(x):

Particulars of Income Amount Taxable under the head


'Income from Other Sources'
(A) Any sum of money,—
— without consideration, the aggregate The whole of the aggregate value
value of which exceeds Rs. 50,000 of such sum
(B) Any immovable property,—
(i) without consideration, the stamp duty The Stamp Duty Value of such
value of which exceeds Rs. 50,000; property
(ii) for a consideration which is less than the stamp duty value of such
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the stamp duty value of the property by property as exceeds the
an amount exceeding Rs. 50,000. consideration received
(C) Any property, other than
immovable property,—
(i) without consideration, the aggregate The whole of the aggregate fair
fair market value of which exceeds Rs. market value of such property
50,000;
(ii) for a consideration which is less than The aggregate fair market value of
the aggregate fair market value of the such property as exceeds such
property by an amount exceeding Rs. consideration
50,000:

9.6 AMOUNT EXPRESSLY DISALLOWED IN COMPUTING THE


'INCOME FROM OTHER SOURCES' (SECTION 58)

The following expenses are not deductible by virtue of section 58 in computing the
income chargeable under the head 'Income from Other Sources' :

PERSONAL EXPENSES [Section 58(1)(a)(i)] - Any personal expenses of the


assessee is not deductible.

INTEREST [Section 58(1)(a)(ii)] - Any interest (which is chargeable under the Act in
the hands of recipient) which is payable outside India on which tax has not been paid
or deducted at source, is not deductible.

SALARY [Section 58(1)(a)(iii)] - Any payment (which is chargeable under the head
“Salaries” in the hands of recipient and payable outside India), is not deductible if tax
has not been paid or deducted therefrom .

WEALTH TAX [Section 58(1)] - Any sum paid on account of wealth-tax is not
deductible.

TDS DEFAULT [Section 58(1A)] - Disallowance provisions pertaining to TDS


defaults covered by section 40(a)(ia) are applicable .

AMOUNT SPECIFIED BY SECTION 40A [Section 58(2)] - Any expenditure


referred to in section 40A like excessive or unreasonable payments to certain specified
persons [Section 40A(2)] and payments exceeding Rs. 20,000 otherwise than by way
of account payee cheque [Section 40A(3)];

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EXPENDITURE IN RESPECT OF ROYALTY AND TECHNICAL FEES
RECEIVED BY A FOREIGN COMPANY [Section 58(3)] - In the case of foreign
companies, expenditure in respect of royalties and technical service fees as specified
by section 44D is not deductible.

EXPENDITURE IN RESPECT OF WINNINGS FROM LOTTERY [Section


58(4)] - No deduction shall be allowed under any provision of the Act in computing
the income by way of any winnings from lotteries, crossword puzzles, races.

However, expenditure incurred by the assessee for the activity of owning and
maintaining race horses shall be allowed as a deduction while computing the income
from this activity.

9.7 DEDUCTIONS ALLOWED IN COMPUTING THE 'INCOME FROM


OTHER SOURCES'(SECTION 57)

The income chargeable to tax under the head 'Income from Other Sources' is
computed after making the following deductions:

1. Deduction in respect of Employee’s Contribution towards Staff Welfare


Schemes [Section 57(ia)] -
Deduction in respect of any sum received by a taxpayer as contribution from his
employees towards any welfare fund of such employees is allowable only if such sum
is credited by the taxpayer to the employee’s account in the relevant fund before the
due date. For this purpose “due date” is the date by which the assessee is required as
an employer to credit such contribution to the employees’ account in the relevant fund
under the provisions of any law or terms of contract of service or otherwise .

2. Deductions permissible from Letting out of Machinery, Plant or Furniture and


Buildings [Section 57(ii) and (iii)]
The following deductions are allowable:
i) Current repairs, to the premises held otherwise than as tenant.
ii) Insurance premium against risk of damage or destruction of the premises.
iii) Repairs and insurance of machinery, plant or furniture.
iv) Depreciation based upon block of assets, in the same manner as allowed under
section 32 in the case of Income from Business and Profession subject to the
provisions of section 38 i.e. if it is partly let and partly used for own purpose,
deduction of expenses (including depreciation) shall be allowed to the extent it
is let out.
v) Any other expenditure: Any other expenditure, not being a expenditure of a
capital nature, laid out or expended wholly and exclusively for the purpose of
making or earning such income can be claimed as a deduction.
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3. Standard Deduction in the case of Family Pension [Section 57(iia)]
In the case of income in the nature of family pension, the amount deductible is
 Rs. 15,000 or
 33 1/3 % of such income, whichever is less.

For this purpose, “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.

4. Any other Expenses for Earning Income [Section 57(iii)]


Any other expenditure is deductible under section 57(iii) if the following four basic
conditions are satisfied:
a. the expenditure must be laid out or expended wholly and exclusively for the
purpose of making or earning the income;
b. the expenditure must not be in the nature of capital expenditure;
c. it must not be in the nature of personal expenses of the assessee;
d. it must be laid out or expended in the relevant previous year and not in any
prior or subsequent year.

5. Deductions for Expenses from Dividend Income [Section 57(i) and 57(iii)]
The following expenses can be claimed as deductions from gross dividend income
other than the dividends referred to in section 115-O:
a. Collection charges: any reasonable sum paid by way of commission or
remuneration to a banker or any other person for the purpose of realising the
dividend.
b. Interest on loan: Interest on money borrowed for purchasing the shares can be
claimed as a deduction. The interest can be claimed even if no income is earned
by way of dividend on such shares. It has been held by the Supreme Court that if
the expenditure has been laid out for the purpose of earning the dividend income
then whether income is actually earned or not is immaterial and deduction on
account of interest can be claimed.
c. Any other expenditure: Any other expenditure, not being a expenditure of a
capital nature, expended wholly and exclusively for the purpose of making or
earning such income, can be claimed as a deduction.

6. Deductions for Expenses from Interest on Securities [Section 57(i) and (iii)]:
As discussed in the case of dividends, the following deductions will also be allowed
from the gross interest on securities:
a) Collection charges [Section 57(i)]: Any reasonable sum paid by way of
commission or remuneration to a banker, or any other person for the purpose of
realising the interest.

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b) Interest on loan [Section 57(iii)]: Interest on money borrowed for investment in
securities can be claimed as a deduction.
c) Any other expenditure [Section 57(iii)]: Any other expenditure, not being a
expenditure of a capital nature, expended wholly and exclusively for the purpose
of making or earning such income can be claimed as a deduction.

Illustration:01: Mr. S.B.Singh, a College Professor, furnished the following


particulars. You are required to compute income from other sources: Examination
remuneration Rs: 7,000 Royalty from books and articles Rs: 25,000 Winnings from
card games Rs: 6,700 Winnings from State lottery Rs: 30,000 Expenditure on
purchase of lottery tickets Rs: 12,000.

Solution:
Computation of Income from Other Sources For the AY 2020-21
Particulars Rs:
Examination remuneration 7,000
Royalty from books and articles 25,000
Winnings from card games 6,700
Winnings from State lottery 30,000
Income from other sources 68,700

Illustration :02- Compute income from other sources: Dividend (Gross) Rs:9,600
Expenses incurred for its collection Rs: 500 Receipts from letting of plant and
machinery Rs: 10,000 Repairs of Plant and Machinery Rs: 4,000 Insurance premium
in respect of plant and machinery Rs: 2,000 Depreciation allowed for letting Rs:4,000

Solution:
Computation of Income from Other Sources For the AY 2020-21
Particulars Rs: Rs:
Receipts from letting of P&M 10,000
Less: Admissible expenses:
Repairs of P&M 4,000
Insurance premium in respect of P&M 2,000
Depreciation allowed for letting 4,000 10,000
Income from other sources Nil

Illustration:03- Compute income from other sources of Mr. Ajaya kumar for the AY
2020-21. His investments are : 5% govt. securities Rs: 70,000 7.5% Agra Municipal
Bond Rs: 50,000 9% debentures of a company Rs:30,000 7% Capital Investment
Bond Rs: 20,000

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Solution:
Computation of Income from Other Sources For the AY 2020-21
Particulars Rs:
Interest on Govt. Securities (70,000 x 5%) 3,500
Interest on Agra Municipal Bond (5,000 x 7.5 %) 3750
Interest on debentures (30,000 x 9%) 2,700
Interest on Capital Investment Bond Exempt
Income from Other Sources 9,950

9.8 LET US SUM UP

Any income which, though to be included in total income but does not find place
under any other head of income, is taxable under the head 'Income from Other
Sources'. It includes dividends; income from winnings from lotteries, crossword.
puzzles, horse races, card games or betting etc., interest on securities, income from
letting of machinery, plant ,or furniture which is not chargeable as business income,
etc. In case of dividends or interest on securities any commission paid to a banker or
any other person for collecting the dividends or interest on behalf of the assessee is
deductible from such income. In case of income from letting of machinery, plant or
furniture along with letting of buildings, which is chargeable under the head 'Other
Sources' deduction in respect of repairs, insurance premium and depreciation of
buildings, machinery, plant or furniture shall be allowed.

9.9 KEY WORDS

 Bond washing Transactions: When securities are sold near the due date of
interest to some friend or relative with an intention to buy back after the due date
of interest, it is a bogus transaction, as it is a device to avoid tax. Such
transactions are called Bond-washing Transactions.
 Dividends: Any distribution by a company of accumulated profits in any form
which results in reduction of assets or increase of liabilities or distribution at the
time of liquidation of the company, of by way of reduction of capital is called
dividend.
 Interest on Securities: Interest on securities means interest on any security of the
Central or State Government or interest on debentures issued by a local authority
or a company or a Statutory Corporation.
 Inter-head Adjustment: Where in respect of any assessment year the net result
of the computation under any head of income is a loss. He shall be entitled to
have the amount of such loss set-off against his income, if any, under any other
head of income. This is called Inter-head Adjustment.

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 Inter-source Adjustment : When there is more than one source of income under
the same head, the loss from one or more sources is allowed to be set-off against
income from the other source under the same head. It is called Inter-source
Adjustment.
 Less-Tax Securities (both Government and Commercial) :.On such securities
the rate of interest is given. The interest calculated at this rate is gross amount of
interest from which tax is deducted at source.
 Tax-free Commercial Securities: These are issued by a company or some other
business institution. Really, their interest is not tax-free but the tax on this is paid
by the business institution concerned on behalf of the debenture holder over and
above the interest, which is fully paid to the debenture holder.
 Set-off of losses: Setting off losses against the income of the same year.
 Carry forward of losses: The losses which cannot be set off in the same year are
carried to next year to set-off against income of next year.

9.10 FURTHER READINGS

 Income tax Law and practice, Makta Jain/ Rakesh Jain, V.K. Global Pub. Pvt.
Ltd., New Delhi
 Income Tax Law and Pratcice-Saha, Dash- Himalaya Publishing House.
 Pagare, Dinkar. Law and Practice of Income Tax. Sultan Chand and Sons, New
Delhi.
 Lal, B.B. Income Tax Law and Practice. Konark Publications, New Delhi
 Gour and Narang, Income tax: Law and practice, kalyani Publishers
 Dr. Vinod Kumar Singhania, e-filing of Income Tax Returns and Computation
of Tax,
 Taxmann Publication Pvt. Ltd, New Delhi. Latest version.

9.11 TERMNAL QUESTIONS

Q1 : Discuss the various kinds of securities? Explain the rule regarding grossing up
of interest on Tax-Free Commercial Securities.

Q2 : Explain Bond Washing Transactions? How it is a device to avoid tax?

Q3. Mr. Nilesh is the owner of M/s Nilesh Power Laundry. He provides you the
following information for the previous year ended on 31st March, 2016:
(a) Income from business Rs 67,500/‐
(b) 13,500/‐ were recovered from cashier which was allowed as business
expenditure being embezzlement of cash in earlier previous year. This was not
accounted in the books of M/s Nilesh Power Laundry.
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(c) Mr. Nilesh took Pushapak Bhavan on rent of Rs 1,000/‐ p.m.. He sublet this
property to Mr. Sanjay at ` 1,500/‐ p.m. w.e.f. 1st April 2015.
(d) Accrued interest on fixed deposit with Saraswat Co‐operative Bank Ltd. Rs
8,500/‐
(e) Interest on fixed deposits with BWM Toyota Pvt. Ltd. Rs 7,500/‐ (Gross) TDS
Rs 750.
(f) Directorship fees from Sumangal Chemicals Rs 3,000/‐
(g) Interest on debentures amounted to Rs 6,000/‐. He paid Rs 3,000/‐ as interest
on amount borrowed for purchase of Debentures to Mr. John, a German
resident. No tax has been deducted at source nor there is any representative
assessee in India.
(h) Winning from lottery Net Rs 70,000 TDS Rs 30,000. Cost of purchase of
lottery tickets was Rs 1,000. Determine the Gross total income of Mr. Nilesh
for the assessment year 2016‐2017.

Q4. Mr. Salil provides you the following information for the year ended 31st
March 2020.
(a) Received Rs 10,000/‐ as award from Mahatma Phule Krishi Vikas Mandal
instituted in public interest by Government of Maharashtra in respect of
scientific study on dry farming.
(b) Examiner ship fees received from Banaras University Rs 12,500/‐
(c) Salary @ Rs 14,500/‐ p.m. from Chattrapati Shikshan Mandal being a lecturer
including all allowances and perquisites. He is provided conveyance facilities
for the journey from his residence to college. Profession tax deducted at
source Rs 1,440/‐
(d) Royalty from Vidya Prasarak Rs 42,000/‐ for writing a book on
“Commercialisation of Agriculture‐ A need of the day.”
(e) Received Rs 5,000/‐ from H.U.F. as a member of H.U.F. and ` 10,000/‐ as
share in profit of the firm M/s Milan Traders. He did not receive any
remuneration or interest from the firm.
(f) He received an award of appreciation from Thane Municipal Corporation of
Rs 11,000/‐ as “Best Lecturer” of the city on 15th August, 2019.
(g) Honorarium of Rs 500/‐ from Dyan Prasarini for a speech on “Health
Awareness”
(h) He was owning a machine, which was given on hire to Danish Kaneria. He
received hiring charges of Rs 42,000/‐. He incurred Rs 11,800/‐ expenses on
maintenance and depreciation allowable as per income tax rules was
ascertained Rs 12,200/‐ You are required to ascertain the Gross Total Income
chargeable to tax for the assessment year 2020‐2021.

Q5. Mrs. Donald is a Member of Legislative Assembly. During the previous year
2019‐2020 she had the following income:
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(a) As M.L.A. she received a salary of ` 4,000 p.m. and total daily allowance of `
27,000 for attending various sessions and committee meetings.
(b) She held the following investments on which she received interest: 100 13.5%
Debentures of Rs 100 each in Tata Iron & Steel Co. Ltd. 9% fixed deposit of
Rs 10,000 in Central Bank.
(c) She also received dividend of ` 500 from Unit Trust of India.
(d) She won Rs 6,000 in horse races against which she had spent Rs 1,000 on
travelling, etc.
(e) On 1st September, 2015 she purchased a plot of land. She let out the plot at Rs
500 per month from 1st November 2016.
(f) She has let Machinery, Furniture & also Building to Mr. Ajit at a monthly rent
of Rs 3,000. Amount spent in respect of these assets on repairs for the previous
year was Rs 20,000.
(g) She received income tax refund of Rs. 3,400 in respect of excess tax paid
during P. Y. 2015‐16. It included interest of Rs 200.

Compute the gross total income of Mrs. Donald for the assessment year 2020‐2021

103

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