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CONTENTS

CHAPTERS

PAGE NO.S

(1.) BASIC INTRODUCTION AND DEFINITIONS ………………….02 TO 05

(2.) RESIDENTIAL STATUS AND SCOPE OF TOTAL INCOME…. 06 TO 10

(3.) INCOMES EXEMPT FROM TAX ………………………………. . 11 TO 16

(4.) HEADS OF INCOME……………………………………………… 17 TO 17

(5.) INCOME FROM SALARY ………………………………………...18 TO 41

(6.) INCOME FROM HOUSE PROPERTY …………………………..42 TO 52

(7.) PROFITS AND GAINS OF BUSINESS OR PROFESSION ….…53 TO 61

(8.) CAPITAL GAINS……………………………………………..……..62 TO 78

(9.) INCOME FROM OTHER SOURCES ...…………………….….… 79 TO 83

(10.) DEDUCTIONS UNDER CHAPTER VI-A …………………………84 TO 89



Prof. J. Nihit Kishore—98202 25728 TYBCom- INCOME TAX

CH-1

BASIC INTRODUCTION AND DEFINITIONS

Those taxes, the final incidence or burden of which is borne by the person paying

the tax, are known as “ DIRECT TAXES” , for e.g.: Income Tax, whereas, those taxes, thefinal incidence of which is passed to someone else by the person paying the tax, are called

as “ INDIRECT TAXES ”, for e.g.: SALES TAX, EXCISE DUTY, CUSTOMS DUTY,

SERVICE TAX, etc.All taxes, whether direct or indirect are levied by the government, hence, are finally

to be deposited with the government. Those Indirect taxes, which are paid to the

government first and recovered from others later, are called “DUTIES” , for e.g.: Excise

Duty, Customs Duty, etc. whereas, those which are collected first and later on deposited

with the government, are known as “TAXES” for e.g.: Service Tax, Sales Tax, etc. as theyare collected from customers first and later on deposited on with the government.

Therefore, one can say that all duties are necessarily indirect taxes, but all indirect taxes arenot duties.

INCOME TAX ACT, 1961

‘Income Tax’ is a tax charged on income earned during the year, i.e. it is an annualcharge on income. It is payable on a yearly basis. “Constitution” is the Parent Law and all

the Acts enacted in India are subject to the overall framework of the constitution of India

and norms laid down therein. Constitution of India has empowered the ‘CentralGovernment’ of India to levy tax on income and by virtue of this power; the CentralGovernment has enacted Income Tax Act, 1961, by replacing the earlier act called Income

Tax Act, 1922.

According to Section 1 of the Income Tax Act, 1961, the act is to be called as“Income Tax Act, 1961” and it extends to the whole of India. It came into force with effect

from 01st April, 1962. It is implemented and administered through the rules laid down in

the act, circulars issued by the Central Board of Direct Taxes (CBDT) and High Court /Supreme Court decisions on various issues.

Section 2 of the Income Tax Act, 1961 defines various terms and expressions used in

the act, but before that one must understand certain terminologies used in these definitions.

(a.) “MEANS”: When a definition uses a term “means”, then the definition is self

explanatory and exhaustive. It implies that the term so defined means only what is

defined therein and nothing beyond that. For e.g.: Definition of “Assessment Year”.

(b.) “INCLUDES”: When an exhaustive definition is not possible or Legislature wants

to widen the scope of the definition, it uses the term “includes”, in order to give an

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inclusive definition or an illustrative definition. For e.g.: Definition of “Income” or

definition of “Person”.

(c.) “MEANS AND INCLUDES”: When Legislature intends to define a term and also

include certain items, it includes both the terms “means and includes”. For e.g.:

definition of “Assessee”.

DEFINITIONS

[A.] “ASSESSEE”:Section 2 (7) of the act, defines the term “assessee” to mean a Person by whom any tax or any other sum of money is payable under the act and includes :

(i.) Every person in respect of whom, any proceeding under the act has been taken

up, whether in respect of assessment of his own income or income of any

other person,(ii.) A person who is deemed to be an assessee under any provision of the act. For

e.g.: Representative assessee, Agent of Non-Resident, etc.(iii.) A person who is deemed to be ‘an assessee in default’ under any provision of

the act. For e.g.: An employer who fails to deduct tax at source from salary

paid by him to his employee.

[B.] “PERSON”: As per Section 2 (31), Person includes :-

(i.) An Individual,(ii.) A Hindu Undivided Family (H.U.F.),

(iii.) A Company,(iv.) A Firm,(v.) An Association of Persons (A.O.P.) (e.g.:‘Navjeevan Co.Op. Housing

Society’ is an A.O.P.) or Body of Individuals (B.O.I.), whether incorporated

or not,(vi.) A Local Authority (e.g.: MUMBAI MUNICIPAL CORPORATION)

(vii.) Every Artificial Juridical Person not falling in any of the above (e.g.

UNIVERSITY OF MUMBAI)

The term ‘Person’ has been defined in an inclusive manner. If one observes the

definitions of the terms “assessee” and “person” both, then one will find that every

‘assessee’ is necessarily a ‘person’, but every ‘person’ need not necessarily be an‘assessee’.

The term ‘Association of Persons (A.O.P.)’ or ‘Body of Individuals (B.O.I.)’ hasnot been defined anywhere in the Act, but in general sense would mean coming together of

more than one person or more than one individual for some common purpose or goal.

There are mainly two basic differences between an AOP and BOI. An AOP can be formed

by two or more persons, wherein the term ‘person’ would mean the same as defined by

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section 2(31) and on the other hand BOI can be formed by two or more ‘individuals’ only.

And second difference is that an AOP is formed for the purpose or desire to earn income,

whereas such intention is not necessary in case of BOI, BOI may be for non-incomeearning purposes also. For e.g.: Legal Heirs of a deceased person, coming together to

receive income from the estate/property belonging to the deceased, will be said to have

formed Body of Individuals.

[C.] “ASSESSMENT”: The term assessment has not been defined by the act, but itwould mean evaluating or computing the income and determining the income tax

liability of an assessee. According to Section 2 (8) of the act, the term ‘assessment’,

includes ‘reassessment’. Therefore, one can say that ‘Assessment’ is quantification

of Income and Income Tax Liability of an assessee.

[D.] “PREVIOUS YEAR” (P.Y.): The financial year in which the income is earned is

known as Previous Year (and the year in which it is taxed is known as assessmentyear). Income Tax Act, has defined the term in Section 3 as ‘The financial year,

immediately preceding the assessment year’. For e.g.: For the Assessment Year 2010-2011, Previous Year would be 2009-2010 i.e. the Financial Year beginning

on 01st April, 2009 and ending on 31st March, 2010.

But for a Business or a Profession newly set up, the very first Previous Year would begin on the date on which business/profession is set up. For e.g.: If a business

is set up on 17th October, 2009, then first previous year would begin on 17th October,

2009 and end on 31st March, 2010 and thereafter, it would begin on 01st April every

year and end on 31st March, of the next year.Upto Assessment Year 1988-89, assessees were allowed to follow any year as

their previous year, but from Assessment Year 1989-90 onwards this liberty waswithdrawn and now all assesses are required to follow ‘Financial Year’ as their Previous Year.

[E.] “ASSESSMENT YEAR” (A.Y.): Assessment Year has been defined by Section2 (9), to mean ‘A Financial Year, which immediately succeeds the relevant Previous

Year’. For e.g.: For Financial Year 2009-2010, Assessment Year will be 2010-2011.

Income of one financial year is taxed in the next year, which is known as ‘Assessment

Year’.

[F.] “INCOME”: The term ‘Income’ has been defined by Section 2 (24) of the act in a nillustrative manner. According to Section 2 (24), ‘income’ includes;

(a.) Profits and Gains,(b.) Dividend, [Though the term ‘income’ includes ‘dividend’, certain dividends are

exempt from income tax under section 10(34)]

(c.) Voluntary contributions received by Charitable or Religious Trust or Institution,

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(d.) Value of any perquisite, Profit in lieu of salary, Special Allowance or any other

benefit received by an employee from his employer,

(e.) Export Incentive (e.g.: Duty Drawback),(f.) Any Interest, Salary, Bonus, Commission or remuneration received by a partner of

a firm from the firm,

(g.) Capital Gains,(h.) Winnings from Lotteries, Crossword Puzzles, Card Games, Races including Horse

Races, any other game of any sort or from Gambling or Betting of any nature,

(i.) Any sum received by the assessee from his employees towards Welfare Fund,Provident Fund, Superannuation Fund, etc.

(j.) Any sum received under KEYMAN INSURANCE POICY including any Bonus if

any, on such policy,

(k.)Non-Compete Fees, Compensation for not sharing any intangible asset such asKnow-how, Patent, Trademark, etc.

(l.) Any sum referred to in section 56 (2)(v).

# Points to be noted:

(1.) Income from ‘Illegal activities’ is also an income and hence, is taxable.(2.) Income need not be in ‘cash’, it may even be in ‘kind’.

(3.) Gifts of personal nature is not an income. For e.g.: Gifts received on

Birthday or on occasion of Marriage or Festival gifts, etc. But giftsreceived in the course of profession is an income. For e.g.: Gift received by

a doctor from his patient in addition to his professional fees for conducting

a successful operation is an income and is taxable, or an award or trophy

received by a sportsman like cricketer is also an income chargeable to tax.(4.) Income includes ‘Loss’ also, as loss is a negative income.

(5.) ‘Pin money’ (an amount received by wife from her husband towardshousehold expenses, or for her personal expenses, etc.) is not treated asincome of wife.

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CH-2

RESIDENTIAL STATUS AND SCOPE OF TOTAL INCOME

(SECTION 6)

The incidence of tax of an assessee depends upon his residential status. Therefore,

residential status of an assessee plays an important role. Residential Status is to be

determined on a year to year basis, as it may change every year, a person may be Resident in one year and Non-Resident in the other year. Residential status is different from

citizenship/nationality.

[A.] Residential Status of an Individual Assessee:

An assessee being an individual, could be Resident (R.) in India or Non-Resident (N.R.) in

India. If he is Resident in India, then he/she could be ‘Resident and Ordinarily Resident(R.O.R.)’ or he/she could be ‘Resident but Not Ordinarily Resident (R.N.O.R.)’ in India.

This can be better explained with the help of the following chart:-

INDIVIDUAL

RESIDENT (R) NON-RESIDENT (NR)

RESIDENT AND RESIDENT BUT NOTORDINARILY RESIDENT ORDINARILY RESIDENT

(R.O.R.) (R.N.O.R.)

Residential Status of an Individual is determined by Section 6 of the act. AnIndividual is called ‘Resident’ , if he/she satisfies at least one out of the following two

‘Basic’ conditions :-

BASIC CONDITIONS :-

1.) He/She stays in India for 182 days or more during the relevant Previous Year.

(whether it’s a Leap year or not, limit will be 182 days only)

OR

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2.) (a.) He/She is in India for 60 days or more during the relevant Previous Year (whether

it’s a Leap year or not, limit will be 60 days only)

and

(b.) He/She is in India for 365 days or more during the last four Previous Years,

immediately preceding the relevant previous year.

EXCEPTIONS TO THE ABOVE CONDITIONS :- In the following two cases, the

second basic condition as given above is not applicable :-

1.) An Indian Citizen, who leaves India during the previous year, for the purpose of

employment (employment includes job, business or profession also) outside India or

leaves India for employment as a crew member of an Indian Ship.2.) An Indian Citizen or a person of Indian origin, who stays abroad, but comes to India

for a visit during the relevant Previous Year. (A person is said to be of Indian Origin if

he himself or any of his/her parents or grandparents were born in undivided India,

where unndivided India would mean India, Pakistan and Bangladesh of toady’s time).

Residential Status is to be determined on a year to year basis, as it may changeevery year. A person who satisfies either of the two basic conditions mentioned above, will

be treated as a Resident for that Previous Year and person who does not satisfy both the

basic conditions will be treated as Non-Resident (N.R.) for that Previous Year. But in caseof two exceptions, the second basic condition is not applicable at all, hence, such persons

will be Resident only if he/she satisfies the first basic condition of ‘182 days or more’

during the relevant Previous Year, else, he/she will be a Non-Resident for that Previous

Year.

ADDITIONAL CONDITIONS : Under Section 6(6), a Resident, is called as ‘OrdinarilyResident (ROR)’ in India, if both the additional conditions mentioned below are satisfied,

otherwise he/she will be treated as ‘Not Ordinarily Resident (RNOR)’ in India :-

1.) He has been Resident in India (based on two basic conditions mentioned above) in at

least 2 out of last 10 Previous Years immediately preceding the relevant Previous

Year.

AND

2.) He/She has been in India for a period of 730 days or more during the last 7 Previous

Years, immediately preceding the relevant Previous Year.

Therefore, we can say that

R.O.R. : An Assessee, who satisfies at least one of the two basic conditions plus both

the Additional conditions.

R.N.O.R. : An Assessee, who satisfies at least one of the two basic conditions and does

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not satisfy either both or anyone of the Additional conditions.

N.R. : An Assessee, who does not satisfy any of the basic conditions.

Note :

1.) The Date of entering India, as well as the date of leaving India, shall be counted as

stay in India. Where, stay in India is not for the whole day, then physical presence

shall be counted on hourly basis.2.) Stay outside the soil (land) of India, but within the territorial waters of India,

shall also be treated as stay in India. (Territorial Water limits of India = water

limit upto a distance of 20 Nautical Miles from the land of India). For e.g.: Stay in

a Boat moored or anchored within territorial waters of India.3.) February month has 29 days in case of a leap year. (Leap year is that year, which is

divisible by ‘four’ for e.g.: 2008, 2004, 2000, 1996, 1992, 1988, etc.).

4.) There can not be different residential status for different source of income falling

within the same Previous Year i.e. if an assessee is Non-Resident for one income,then he is Non-Resident for all the incomes within the same year, as residential

status is to be determined for a particular year and not for a particular income.5.) A person may be resident in more than one country in the same year. There are

365/366 days in a year. A person may become resident in India by staying for 182

days in India and for rest of the year he may stay in another country and may become resident of that country also. So, it would be wrong to say that a person

who is resident in India is non-resident in all other countries.

6.) Stay in India need not be continuous.

7.) Stay need not be at the same place in India, it could be at any place or places of India.

SCOPE OF TOTAL INCOME:

As we discussed at the beginning of this chapter, that the tax incidence of anassesee, depends upon his/her residential status, let us now understand the tax implication

of an income of an assessee under different residential status, namely, Resident and

Ordinarily Resident (R.O.R.), Resident but not Ordinarily Resident (R.N.O.R.) and Non--Resident (N.R.). This can be better explained with the help of the following table:-

Particulars R.O.R. R.N.O.R. N.R.1.) INDIAN INCOME Taxable Taxable Taxable

2.) FOREIGN INCOME :

a.) Income from Business controlled from

India or a Profession set up in India

Taxable Taxable Not Taxable

b.) Other Foreign Incomes Taxable Not

Taxabl

Not Taxable

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e

Indian Income means the following :

1.) An Income received in India, but has accrued or is deemed to have accrued, or has

arisen or is deemed to have arisen outside India, OR2.) An Income received outside India, but has accrued or is deemed to have accrued or

has arisen or is deemed to have arisen in India, OR

3.) An Income received in India, as well as has accrued or is deemed to have accrued, or

has arisen or is deemed to have arisen in India.

Foreign Income means the following :

An Income which is received outside India, as well as accrued or deemed to have accruedor has arisen or is deemed to have arisen outside India.

If one observes the meaning of ‘Indian Income’ as well as ‘Foreign Income’,then one will find that the line of distinction between the two depends upon two things,

namely, i.) Place of Receipt of income and ii.) Place of accrual of income. The meaning of

both the terms can be better understood with the help of the following :-

PLACE OF ACCRUAL PLACE OF RECEIPT INDIAN/FOREIGN INCOME

1.) In India Outside India Indian Income

2.) Outside India In India Indian Income

3.) In India In India Indian Income

4.) Outside India Outside India Foreign Income

Therefore, an income is a ‘foreign income’ only if the place of accrual, as wellas the place of its receipt both are outside India, otherwise, it will be an Indian income, if

either of them is in India.

Note:

A.) Receipt of Income: In order to decide whether an income is received in India or abroad,

only the first place of receipt shall be considered. In other words, subsequent remittance to

India shall be ignored. For e.g.: If an income is received by Mr. X in U.S.A. and later onremitted by him to his family members in India, then such income will be considered to

have been received in U.S.A. only and not in India.

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B.) Accrual of Income: Place of accrual of income depends upon the location of ‘source’ of

income. If source is located in India, then income has accrued in India, but if source is

located in foreign country, then income is said to have accrued outside India. As per section 9 of the Act, the ‘source’ of an income depends upon the type of income, which is

as follows :-

TYPE OF INCOME LOCATION OF SOURCE OF INCOME

1.) Income from Salaries Location of Place of ‘Employment (Job)’

2.) Income from House Property Location of House Property

3.) Income from Business/Profession Place of set up of Business/Profession

4.) Capital Gains Location of Asset in case of an Immoveable asset

or Place of exchange of an asset in case asset is a

Moveable asset

5.) Interest on Debentures/Bonds Location of company paying it

6.) Income from Bank Interest Location of Bank Account

7.) Dividend Location of company paying it

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CH-3

EXEMPT INCOME

(SECTION 10)

Section 10 o the Income Tax Act, deals with incomes, which do not form part

of an assessee’s total income. In other words Section 10 exempts certain incomes from

chargeability to tax. The following are the incomes which are exempted under section 10:-

[1.] Section 10(1): Agricultural Income: Under this section “Agricultural Income” from

“an Agricultural land” in India is exempt from tax. However, Agricultural Income from

Agricultural Land outside India is not exempt, even Agricultural Income from a Non-Agricultural Land in India or an urban land in India is fully taxable.

[2.] Section 10(2): Share of a member in the income of a Hindu Undivided Family

(H.U.F.): Share in income of HUF received by an individual being a member of that HUF

is exempt in the hands of that individual under this section. Under Income Tax Act, HUF is

an ‘Assessee’, separate from its members and being an assessee, it pays income tax on its

own income separately. If a member of HUF also has to pay tax on his share in the profitsof the HUF, which are already taxed in the hands of HUF, then it would amount to double

taxation. The same income would be taxed twice. Therefore, section 10 (2), exempts such

income in the hands of member of HUF.

[3.] Section 10(2A): Share of a Partner in the profits of the Partnership Firm: Just like

HUF in the above case, Partnership Firm is also an ‘Assessee’ separate from its partnersand has to pay tax on its profits. If partners also have to pay tax on their share in the profits

of the firm, then it would amount to double taxation. Section 10 (2A), therefore, exempts

the share of partners in the profits of the firm received by the partner. (Only share of profitis exempt and not any other remuneration like salary, bonus, commission, interest on

capital, received by partner from the firm).

[4.] Section 10(3): Casual Income: Exemption under this section is now no more availablewith effect from Assessment Year 2003-2004.

[5.] Section 10(5): Amount received as ‘Leave Travel Concession’: Will be separatelydealt with in the Chapter on ‘Income from Salaries’.

[6.] Section 10(7): Allowances or Perquisites received by a Citizen of India being an

employee of Government of India: received outside India from Government of India for services rendered outside India, are fully exempt from tax in India under section 10 (7). But

Salary received by such an Indian Citizen from Government of India for services rendered

outside India, though accrued as well as received outside India, is however, deemed to haveaccrued in India and is accordingly taxable in India.

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[7.] Section 10(10): Amount received as ‘Gratuity’: Will be separately dealt with in the

Chapter on ‘Income from Salaries’.

[8.] Section 10(10A): Amount received as ‘Commuted Pension’: Will be separately

dealt with in the Chapter on ‘Income from Salaries’.

[9.] Section 10(10AA): Amount received as ‘Leave Salary’: Will be separately dealt

with in the Chapter on ‘Income from Salaries’.

[10.] Section 10(10B): Amount received as ‘Retrenchment Compensation’: Will be

separately dealt with in the Chapter on ‘Income from Salaries’.

[11.] Section 10(10C):Compensation received under ‘Voluntary Retirement Scheme’:

Will be separately dealt with in the Chapter on ‘Income from Salaries’.

[12.] Section 10(10CC): Tax on Non-Monetary Perquisites paid by Employer: If tax on

non-monetary or non-cash perquisites received by an employee is paid by his employer,then such tax shall not be added in the income of that employee, as it is exempt from tax in

his hands under section 10 (10CC) with effect from Assessment Year 2003-2004. Such taxas is paid by the employer shall not be allowed to the employer as a deduction on account

of business expenditure under section 40. (Here, exemption is available only on tax paid by

employer on non-monetary perquisites and not on tax paid by him on monetary or cash perquisites).

[13.] Section 10(10D): Maturity Proceeds of a ‘Life Insurance Policy’: Any sum

received by a Policyholder or his Legal Heirs as a maturity proceeds of a Life Insurance policy or any Bonus on such policy from an Insurance Company is fully exempt from tax

in the hands of either a Policyholder or his Legal Heirs under section 10 (10D).However, maturity proceeds of a ‘Keyman Insurance policy’ or any Bonus onsuch policy is not exempt from tax. (For meaning of ‘Keyman Insurance policy’ and its

taxability, refer to Chapter – I )

With effect from Assessment Year 2004-2005, this exemption is not applicableon maturity proceeds of that Life Insurance policy or any Bonus thereon, whose ‘Annual

Premium’ exceeds 20 % of the ‘Sum Assured’, provided policy was issued on or after 01st

April, 2003 (i.e. issued from the day one of the Previous Year 2003-2004, which pertains to

Assessment Year 2004-2005).

[14.] Section 10(11) / (12):Receipts from ‘Provident Fund’: Will be separately dealt with

in the Chapter on ‘Income from Salaries’.

[15.] Section 10(13):Receipts from ‘An Approved Superannuation Fund’: When an

employee retires from his service, due to his retirement age or his ill health or due to hisincapacitation to work more or due to his death, he or his family members would receive an

amount from ‘Superannuation Fund’. Any amount received from an approved

‘Superannuation Fund’ is exempt from tax under section 10 (13), whether received by an

12




employee at the time of his retirement or by his family members or his legal heirs at the

time of his death.

[16.] Section 10(13A):Amount received as ‘House Rent Allowance’ (H.R.A.): An

amount of fixed monthly allowance received by an employee from his employer, towards

paying rent of a house is exempt from tax in the hands of that employee subject to the leastof the followings:- (Balance H.R.A. received will thus be taxable in his hands)

a) Actual H.R.A. received by the employee from his employer for that many num ber

of months for which the house was rented by him. (If House was rented only for three months during the year, then H.R.A. of only three months only shall be

considered here and not for the whole year) OR

b) 50 % of the salary, if rented house is situated at Chennai, Delhi, Mumbai or Kolkata

or 40 % of salary if rented house is situated at any other place other than Chennai,Delhi, Mumbai or Kolkata [Here, ‘Salary’ would mean ‘Basic Salary’ plus

‘Dearness Allowance (D.A.)’ only if D.A. forms part of Retirement Benefits

otherwise only ‘Basic Salary’] OR

c) Excess of rent paid over 10 % of Salary [Here also, the term ‘Salary’ would mean‘Basic Salary’ plus ‘Dearness Allowance (D.A.)’ only if D.A. forms part of

Retirement Benefits otherwise only ‘Basic Salary’]

In (b) and (c) above ‘Basic Salary and D.A.’ of only that many months shall be

considered during which the house was rented and not ‘Basic Salary and D.A.’ of thewhole year.

If an employee resides in his ‘own house’ or he does not pay any rent for the house

where he resides, then answer to point (c) above will be NIL and therefore, the least of (a),

(b) and (c) will also be NIL and nothing will be exempt under section 10 (13A). As a resultof this entire amount received by employee as H.R.A. will become taxable in his hands as a

Salary.

[17.] Section 10(14): ‘Special Allowance’ received: Will be separately dealt with in the

Chapter on ‘Income from Salaries’.

[18.] Section 10(15): Interest on certain securities: Interest received from 7 % Capital

Investment Bonds, notified ‘Relief Bonds’ , Gold Deposit Bonds, notified bonds issued by

‘Local Authority’ and interest received from following notified bonds, securities or

certificates are fully exempt from tax under section 10 (15):-

National Defence Gold Bonds,

National Plan Certificates,

National Plan Savings Certificates, 12 Year National Savings Annuity Certificates,

Treasury Savings Deposit Certificates,

10.5 % Tax Free Bonds issued by HUDCO,

10.5 % Tax Free Bonds issued by National Hydroelectric Power Corporation,

9.25 % Tax Free Bonds issued by Rural electrification Corporation Ltd. (RECL),

N.R.I. Bonds (Second series) issued by State Bank of India,

13




N.R.I. Bonds-1988 issued by State Bank of India,

Special Bearer Bonds,

Post Office Cash Certificates,

Post Office Savings Account,

Post Office Cumulative Time Deposits (CTD),

Special Deposit Schemes, etc. Gold deposit Bonds issued under Gold deposit Scheme, 1999 and notified by

Central Government,

Bonds issued by Local Authority and notified by Central Government,

Notified Bonds.

[19.] Section 10(16): Educational Scholarships: Educational Scholarship received by an

assessee, being a student from any person including Government, to meet the ‘cost of

education’ is fully exempt from tax in the hands of the recipient assessee under section 10

(16). Here, ‘cost of education’ does not mean only ‘Tuition Fees’, but also any other incidental expenses to acquire education. The term ‘Education’ is not restricted to only

those courses leading to a degree. Educational Scholarship is awarded to meet the cost of

education and will be exempt from tax under this section, even if it is not entirely spent for meeting the cost of education.

[20.] Section 10(17): Daily Allowances received by MPs / MLAs / MLCs: DailyAllowances received by Members of Parliament (M.P.s), Members of Legislative

Assembly (M.L.A.s) or Members of Legislative Council (M.L.C.s) is fully exempt from tax

under section 10 (17).

But Salary received by MPs / MLAs / MLCs is not exempt, it is taxable. Though, it iscalled as ‘Salary’, it is always taxable as ‘Income from Other Sources’ and not as ‘Income

from Salary’, as MPs / MLAs / MLCs are not employees of Government.

[21.] Section 10(17A): Awards: Any award received by an assessee whether in cash or in

kind, issued to him in ‘Public Interest’ by ‘Central / State Government’ or by any body /

Institution / organization approved by Central / State Government is fully exempt from taxin the hands of the recipient assessee under section 10 (17A).

But if an award is received from any individual or any private organization then

exemption under section 10 (17A) is not available on such award. Also, if an award isreceived by an employee from his employer, then it will be taxable and taxable as a

‘Salary’ income.

Few examples of such exempt awards are:-

• Sir C. V. Raman Award,

• Sir Jagdish Chandra Bose Award,

• Ramon Magsaysay Award,

• Pope John XIII Award,

• Kennedy International Award,

• Bhartiya Janpith Award,

• National Award for Films,

14




• Dr. Rajendra Prasad Award,

• Cash reward for passing Hindi Examinations, etc.

[22.] Section 10(32): Income of Minor Child: Minor Child is not taxable in respect of his / her own income. Minor Child’s income is taxable in the hands of either of his parents,

by virtue of section 64(1A) on ‘Clubbing of Income’. That parent in whose income, the

income of Minor Child is included / clubbed, is entitled to this exemption under section10(32).

Exemption under section 10(32) is restricted to actual income of Minor Child

clubbed in the hands of that parent or Rs. 1,500/- per Minor Child, whichever is lower.(Here, Minor Child includes a ‘Step Child’ as well as an ‘Adopted Child’, but does not

include an ‘Illegal Child’ or a child born as a result of an illegal marriage.) There is no

restriction on the number of minor children, but exemption will be restricted to Rs. 1,500/- per minor child, per annum.

[23.] Section 10(33): Capital Gain on transfer of Units of US-64 of UTI: Any Capital

Gain arising on transfer of units of US-64 Scheme of Unit Trust of India (U.T.I.) on or after

01st

April, 2002 shall be exempt by virtue of section 10(33), provided units of US-64 wereheld as Capital Asset.

[24.] Section 10(34): Dividend from a ‘Domestic Company’: Any amount received by an

assessee as a Dividend or as an Interim Dividend from shares (whether equity shares or

preference shares) of an ‘Indian Company’ (whether Public Company or a PrivateCompany) is fully exempt from tax by virtue of section 10(34) [earlier this exemption was

covered by section 10(33)]. It would be worth to note here that under section 10(34) what

is exempt from tax is dividend from an Indian domestic company. Therefore, dividend

received from a Foreign Company or from a Co.-Operative Society will not be exempt. Itwill always be taxable and will be taxable as ‘Income from Other Sources’.

[25.] Section 10(35): Income from ‘Units of a Mutual Fund’: Any income, other thanCapital Gains received by an assessee from units of a Mutual Fund, including units of Unit

Trust Of India (U.T.I.), is exempt from tax under section 10(35). [Earlier it was covered by

Section 10(33)].

[26.] Section 10 (36): Long Term Capital Gains on transfer of eligible Equity Shares:

Long Term Capital Gain arising on transfer of eligible equity shares shall be exempt fromtax by virtue of section 10(36), provided such eligible equity shares were acquired on or

after 01st March, 2003, but before 01st March, 2004 and held for a period of 12 months

before their transfer and sold through a recognized Stock Exchange in India. An ‘Eligible

equity share’ would mean either (1.) An equity share acquired by way of a Public Issue(I.P.O.) on or after 01st March, 2003 but before 01st March, 2004, or (2.) An Equity share of

a company, which is listed as on 01st March, 2003 as a BSE-500 INDEX companies on

Mumbai Stock Exchange.

[27.] Section 10(37): Income from Capital Gain on Transfer of Agricultural Land:

Only in the case of an assessee being an Individual or a Hindu Undivided Family, anyCapital Gain arising on transfer of an Agricultural Land situated in a specified area and

15




used by that individual or his/her parents or by HUF for agricultural purposes, shall be

exempt from its chargeability to Income Tax under section 10(37), provided impugned

Agricultural Land was compulsorily acquired by Government under any Law in force or sale consideration of such Agricultural Land was determined by Reserve Bank of India

(RBI) or by Central Government. This exemption was being introduced with effect from

Assessment Year 2005-2006 and exempts only those Capital Gains, which have arisen onsale consideration received on or after 01st April, 2004.

[28.] Section 10(38): Long Term Capital Gain on transfer of Listed Securities: AnyLong Term Capital Gain (Only Long Term Capital Gains and not Short Term Capital

Gains) arising on transfer of Equity Shares listed on a Recognized Stock Exchange in

India, or Equity Oriented Units of Mutual Fund shall be exempt by virtue of Section

10(38), provided such sale transaction attracts Securities Transaction Tax (S.T.T.). Section10(38) has been introduced with effect from Assessment Year 2005-2006.

Examination Hint: Important sections from examination point of view are – Section

10(1), 10(2), 10(2A), 10(5), 10(10), 10(10A), 10(10AA), 10(11) / (12), 10(13A),10(14), 10(34), 10(35), and 10(38).

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CH-4

HEADS OF INCOME

(SECTION 14)

For the purpose of computing total income of an assessee and income taxthereon, section 14 of the act requires all the incomes of an asseessee to be classified under

the following five heads of income:-

(1.) Income from Salaries,

(2.) Income from House Properties,

(3.) Profits and Gains of Business or Profession,

(4.) Capital Gains and

(5.) Income from Other Sources.

Total of incomes under all the five heads of income is known as Gross TotalIncome (G.T.I.) and in the following chapters, we shall discuss all the five heads

individually with the help of practical illustrations.

Expenditure incurred in relation to exempt income: Section 14A: Deductibility of an

actual expenditure incurred to earn an income, depends upon the head of income under

which that income is chargeable to tax, which is discussed with each head of incomeseparately. For e.g.: For an income chargeable to tax under the head Profits and Gains of

Business or Profession, all actual expenditures incurred to earn that income shall beallowed to be deducted, whereas for an income chargeable to tax under the head incomefrom House Properties, all actual expenditures are not allowed to be deducted, but certain

percentage of such income is allowed to be deducted.

But Section 14A of the act requires that under no circumstances, expenditureincurred to earn an exempt income shall be allowed to be deducted. For e.g.: Dividend

from an Indian Company is exempt by virtue of section 10 (34). Any expenditure incurred

to earn such dividend income shall be ineligible as to its deductibility from other taxableincome by virtue of section 14A.

17




CH-5

INCOME FROM SALARIES

(SECTION 15 TO SECTION 17)

In earlier chapter we discussed that there are five heads of income. Now in thischapter, we shall discuss the first head of income i.e. income from ‘Salaries’. To a common

man or a layman, the term ‘salary’ would mean a fixed monthly remuneration received

from employer for work done, but from Income Tax Act point of view the term ‘salary’would mean ‘salary’ as defined under section 17 (1). Under section 17 (1), the term ‘salary’

has been specifically defined in an inclusive manner.

Section 15 of the act talks about the chargeability of an item to tax under this

head as ‘salary’. It explains the basis of charge. According to section 15 the followings are

chargeable to tax under this head:-(a.) Any salary due to an employee, whether received by him or not – this means that

salary is taxable even if not received by employee, but has become due to him.(b.)Any salary received by an employee, whether due or not – this means that salary is

taxable even if it has not become due to him but has been received by him. For e.g.:

Advance Salary.(c.) ‘Arrears of Salary’ – Earlier year’s salary, which has now become due to him and

now received by him.

In other words, any amount due to or received by an employee from his employer

or his ex-employer and coming within the purview of the meaning of the term ‘salary’, asdefined under section 17 (1) is chargeable to tax under the head ‘salary’.

Now a question arises is that what is the definition of the term ‘salary’ as given

by section 17 (1)? But before we jump to the definition, let us understand certain essential

norms of the salary income. In order to understand the meaning of the term salary, one has

to keep in mind the following norms. These norms will simplify the understanding of thedefinition of the term salary.

(a.) Existence of Employer-Employee Relationship or Master-Servant

Relationship: In order to charge an income under this head there must exist an

employer-employee or master-servant relationship between the person liable to pay

and person entitled to receive remuneration. An employer-employee or master-

servant relationship is in contrast to Contractor-Contractee relationship or Principal-Agent relationship. Servant works under direct control and supervision of

his master unlike an agent who controls and supervises his work on his own and

therefore an agent’s remuneration is known as ‘commission’ and is chargeable totax under the head ‘Profits and gains of Business or Profession’ unlike ‘salary

income’ in the hands of a servant or an employee.

(b.) Every person who is employed need not be an Employee: Every person who isan employee, is necessarily employed by another, but every person who is

18




employed by another need not be an employee. For e.g.: A Lawyer employed to

file a legal suit or a Doctor employed to operate a patient are though employed by

their clients to carry out some work are not their employees.

(c.) Only Individuals can have a salary income: Only an Individual assessee can

have employer-employee relationship with the other. Therefore, only individuals

can have salary income unlike partnership firm or a company.(d.) Any payment received from employer: Once employer-employee relationship is

established then any payment received by an employee from his employer is a

salary like fees, commission received from employer. On the other hand, if sameremuneration is received from any other person for the same work, then its not an

income from salary. For e.g.: A Professor who is an employee of XYZ College,

receives a payment for setting/correcting examination papers. – If received from

college, then ‘Salary income’, but if received from University, then ‘Income fromother sources’.

(e.) “Salary” v/s “Wages”: “Salary” and “Wages” are conceptually not different from

each other; both are paid for work done. Normally, Salary is paid for non-manual

work, whereas “Wages” are paid for manual work. Wages are normally, paid ondaily basis whereas salary is normally paid on monthly basis. Income Tax Act

views no difference between salary and wages, both are taxed at the same rate andare taxed under the same head as ‘income from salary’.

(f.) Salary from past / prospective employer : Salary from past employer or ex-

employer is taxable just like salary from present employer, though employer-employee relationship is no more in existence. For e.g.: Pension, Termination

Bonus, etc. Salary from future or prospective employer is also taxable just like

salary from present employer, though employer-employee relationship is yet to be

developed. For e.g.: Join-in Bonus.

(g.) Additional Salary : Salary received in addition to normal salary though not

contracted before, between employer and employee, is also taxable. For e.g.:Overtime salary.

(h.) Net of Tax Salary : If an employee is being offered a Net of tax salary, then what is

taxable in the hands of employee is not only the salary, but also the tax paid on it

by his employer, whether tax is paid by employer voluntarily or under contract or agreement. Tax paid by employer is treated as a perquisite in the hands of the

employee under section 17(2). For e.g.: If an employee is being paid a tax free

salary of Rs. 2,21,000/- and tax paid by the employer on this salary is Rs. 29,000/-

then what is taxable as salary in the hands of employee is not only Rs. 2,21,000/- but Rs. 2,50,000/- i.e. Rs. 2,21,000/- + Rs. 29,000/- of tax paid.

(i.) Salary of M.P. / M.L.A. / M.L.C.: Remuneration to Member of Parliament

(M.P.), Member of Legislative Assembly (M.L.A.) or Member of LegislativeCouncil (M.L.C.) is paid by Government and is called salary. Even though it is

called as salary it is not taxable as salary but is taxable as income from other

sources as there is no employer-employee relationship between Government andM.P./M.L.A./M.L.C. on the other hand.

(n.) Salary of a Partner of a Partnership Firm: Salary, Bonus, Commission or any

other remuneration by whatever name called, other than interest on capital

received by a partner from partnership firm is not taxable as salary, but is taxable

19




as ‘Profits and Gains of Business or Profession’. It is basically not a salary in its

real nature, but is just an appropriation of profits of the firm and again no partner

can be called as an employee of the firm.

(o.) Salary to a Director of a Company: Every director of a company is not

necessarily an employee of the company. He may or may not be an employee.

If as per the agreement with the employer company he is an employee of thecompany then his remuneration will be taxable as ‘salary’, but if he is not an

employee of the company, then his remuneration will be taxable either as ‘Profits

and Gains of Business or Profession’ or as ‘Income from other sources’. Even if aDirector is an employee of a company, if he receives any commission from his

employer company for arranging any loan for the company or for his standing as a

guarantor of his company for the loan taken by his company, such commission or

fees as is received by him will not taxable as ‘salary’, but will be taxable as‘income from other sources’.

(p.) Method of Accounting: Salary is taxable on ‘due’ or ‘receipt’ basis, whichever

is earlier. Method of Accounting followed by assessee is irrelevant. Salary once

taxed on due basis will not be taxed again on receipt basis and similarly, salaryonce taxed on receipt basis will not be taxed again on due basis. In other words,

there will be no double taxation of the same salary.

(q.) Pension: Monthly or periodical Pension received by the assessee after his

Retirement, is taxable as salary till he/she is alive. Same Pension received by the

Family members/Legal Heirs of the assessee upon death of the assessee is taxablein the hands of his/her family members or legal heirs as ‘Family Pension’ and is

taxable as ‘income from other sources’ under section 56 and not as ‘salary’.

(r.) Advance against salary: As we discussed earlier in point (p.) above, salary is

taxable on due or receipt basis whichever is earlier, salary received in advancewill be taxable on receipt basis. For e.g.: Salary for the month of April, 2009 is

if received in March, 2009 then it will be taxable as salary of the year 2008-2009,though it should have been normally taxable in the year 2009-2010.One must understand here that ‘Advance Salary’ is different from ‘Advance

against salary’. Advance Salary is taxable on receipt basis, whereas ‘Advance

against salary’ is not an income only, hence is not taxable, as it is like a loan takenagainst security of salary.

(s.) Salary in ‘Kind’: Salary is taxable whether received in ‘Cash’ or in ‘Kind’. For

e.g.: If 25 Kg. of Rice is received as a salary then market value of rice will be

taxable as salary.

(t.) Arrears of Salary: Arrears of salary is earlier year’s salary which is now being

received by the employee. In other words, arrears of salary is that salary which

was never due to employee earlier, but has now become due and is now beingreceived by him. It is taxable only on receipt basis in the year of receipt just like

Bonus or Commission or Leave Salary and not on due basis. It is taxable as

‘income from salary’ only. Arrears of salary may arise due to ‘revision in pay-- scale with retrospective effect’ or due to ‘court’s order to increase the pay with

retrospective effect’.

(u.) Grade of Salary: When a candidate applies for a job or employment, he/she is

offered a salary in a particular Grade/Scale. For e.g.: Salary is in the Grade of

20




Rs.12,000 – 1000 – 18,000 : this means that he/she is appointed at a monthly

salary of Rs. 12,000/- and it will be increased by Rs. 1,000/- p.m. at the end of

every year, till his/her monthly salary reaches Rs. 18,000/- p.m. and thereafter there will be no increment in the salary. His first year salary will be Rs. 12,000/-

per month and second year salary will be Rs. 13,000/- per month if he continues

his job. Thereafter, it will be increased to Rs. 14,000/- per month in the thirdyear of his service and so on till monthly salary reaches the level of Rs. 18,000/-

(v.) Salary from UNITED NATIONS ORGANIZATION: Salary received from

United Nations Organization (U.N.O.) or any other Allowances or Perquisites or Pension received from U.N.O. is not taxable at all.

Year of Chargeability of Salary: Salary is chargeable to tax in that year in whicheither it has become due or it is received, whichever year is earlier. This rule of

chargeability is however subject to certain exceptions like Bonus, Commission, Arrears

of Salary, Leave Salary are chargeable to tax as salary only on receipt basis i.e. only in

that year in which these are actually received and not in the year in which they have become due.

Place of Accrual of Salary: Salary is deemed to accrue or arise at the place where

services are rendered. Under section 9(1) of the act, Salary for services rendered in

India are deemed to accrue or arise in India. There is only one exception to this rule.Salary received by an Indian Citizen from Government of India for services rendered

outside India is deemed to have accrued or arisen in India (even though services are not

rendered in India). But all perquisites and allowances received by such person from

Government of India outside India are exempt from tax under section 10(7).

Definition of Salary: Let us now understand the meaning of the term ‘Salary’ asdefined by section 17 (1) of the act. Section 17 (1) defines the term ‘Salary’ in an

inclusive manner and it includes eight items. According to it Salary includes:-

1) Wages,

2) Pension or Annuity [After claiming exemption U/S 10 (10A)],

3) Gratuity [After claiming exemption U/S 10 (10)],

4) Fees, Commission, Perquisites, Profits in lieu of or in addition to salary or wages,

5) Advance Salary,

6) Leave Salary [After claiming exemption U/S 10 (10AA)],7) Balance to the credit of Employee’s ‘Recognized Provident Fund’ [After

claiming exemption U/S 10 (11)],

8) Transferred balance to the credit of Employee’s ‘Recognized Provident FundAccount’ (R.P.F. A/C) (transferred from employee’s R.P.F. A/C with previous

employer to employee’s R.P.F. A/C with current employer) [After claiming

exemption U/S 10 (12)].

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Let us now understand the meaning of certain terminologies included in the

above eight items as well as exemption from tax under section 10 available on few of theseeight items.

(1.) Gratuity [Section 10(10)]: Gratuity is a Retirement Benefit. It is a gratuitous paymentin the nature of loyalty bonus. It is normally paid by the employer to employee at the time

of his retirement, but under exceptional circumstances it may be paid during the service

period also. If it is received during the service period whether received by a Governmentemployee or a Non-Government employee, then it is fully taxable as salary and no

exemption under section 10(10) is available from it. But if Gratuity is received after or at

the time of retirement , then exemption under section 10(10) is available as follows:-

[A.] In case of Government Employees: If Gratuity is received by a Government

employee (Employee of Central Government / State Government or of a Local Authority

only and not employee of any Statutory Corporation) after or at the time of retirement, then

it is fully exempt from tax under section 10 (10).

[B.] In case of Non-Government employees: Non-Government employees aredivided in two categories: (i.) Those covered by Payment of Gratuity Act (P.O.G.A.) and

(ii.) Those who are not covered by Payment of Gratuity Act (P.O.G.A.). Exemption to

these Non-Government employees under section 10 (10) is available as follows:-

(i.) For those covered by P.O.G.A.: (ii.) For those not covered by P.O.G.A.:

The Least of the following will be exempt: The Least of the following will be exempt:

15 days Last Each Completed1 .26 days X drawn X year of service or

salary* a part thereof in

excess of 6 months

OR

2. Amount notified by Govt. Rs. 3,50,000/-

OR

3. Gratuity actually received.

Avg. monthly Each complete1 salary based year of service1. 2 X on salary* of X (any excess

last 10 months thereof shall be

salary ignored)

OR

2. Amount notified by Govt. Rs. 3,50,000/-

OR

3. Gratuity actually received.

*Meaning of ‘Salary’: Salary here would mean

‘Basic Salary’ + Dearness Allowance (D.A.)

whether D.A. forms part of Retirement

Benefits or not.

*Meaning of ‘Salary’: Salary here, would mean

‘Basic Salary’ + Dearness Allowance (D.A.)

only if D.A. forms part of Retirement Benefits

+ Commission only if based on turnover (T/O)

22




achieved by the employee.

Salary last drawn: means one month’s salary as

above i.e. Basic Salary + Dearness Allowance

for a period of one month upto the date of

retirement.

Salary of last 10 months: Actual Salary as aboveof last ten months, immediately preceding the

month of retirement. (The month in which

employee retires, shall be ignored while

calculating last 10 months’ salary)

# Points to be noted about ‘Gratuity’:

If Gratuity is received from more than one employer, whether in the same

Previous Year or otherwise, then calculation of exemption under section 10(10)

on Gratuity received from other employer will be done as above only, butamount notified by Government i.e. Rs. 3,50,000/- in above calculation will be

reduced by any exemption claimed earlier on Gratuity received from any earlier

employer. Gratuity received while in service is always taxable irrespective of whether the

employee is a Government employee or a Non-Government employee. No

exemption under section 10(10) will be available on it. Gratuity received by Family Members or Legal Heirs of the employee upon

death of that employee is not taxable at all in the hands of Family Members or

Legal Heirs of that employee.

(2.) Pension [Section 10(10A)]: There are two types of Pension:- (a.)Uncommuted

Pension and (b.) Commuted Pension.(a.) Uncommuted Pension is a monthly or periodical pension received by an employee

after his/her retirement from his/her employment. Uncommuted Pension is alwaystaxable whether the recipient assessee is a Government employee or a Non-Government employee and is always taxable as ‘Salary’, as definition of ‘Salary’ as

is given by section 17 (1) includes ‘Pension’. No exemption under section 10 (10A)

is available on Uncommuted Pension. Where, employee dies, the uncommuted

pension will be received by his Family Members or his Legal Heirs. Suchuncommuted pension received by his Family Members or his Legal Heirs is called

“Family Pension” and is taxable in their hands under section 56 as ‘income from

other sources’ and not as ‘salary’.(b.) Commuted Pension on the other hand is a lump sum payment in lieu of periodical

payments. ‘Commuting’ a pension means, withdrawing a lump sum amount from

Pension Fund of an employee. Exemption under section 10(10A) is available onlyon ‘Commuted Pension’.

Pension Fund is just like a Bank Fixed Deposit (F.D.) and uncommuted

pension (monthly/periodical pension) is just like interest on such Bank F.D. whereas,

commutation of pension is just like withdrawing some amount from Bank F.D. Theway Bank F.D. interest is taxable as an income, uncommuted pension is also taxable as

salary. Assessee can commute the pension or in other words can withdraw a lump sum

23




amount from his Pension Fund at any time and for any number of times, till the time

there is some balance lying in his Pension Fund Account. If one withdraws any amount

from his Bank F.D. then interest receivable thereon will proportionately be reduced. Inthe same way if one commutes the pension, his uncommuted pension will

proportionately reduce. For e.g.: Mr. X, has Rs. 10,00,000/- as balance in his Pension

Fund Account and on that he receives Rs. 10,000/- per month as an uncommutedmonthly pension. If he gets 30 % of his pension commuted, then he will receive a lum p

sum amount of Rs. 3,00,000/- i.e. 30 % of Rs. 10,00,000/- as commuted pension, but on

the other hand his uncommuted monthly pension will proportionately reduce by 30 %and from now onwards Mr. X will receive only Rs. 7,000/- as monthly pension instead

of Rs. 10,000/- as earlier [i.e. Rs. 10,000/- minus (30 % of Rs. 10,000/-)].

Exemption from tax on an amount received as ‘Commuted Pension’ is

available under section 10(10A) and is as follows:-

[A.] In case of Government Employees: In case of Government Employees, though

uncommuted pension is fully taxable, commuted pension is fully exempt under section

10(10A).

[B.] In case of Non-Government Employees: Non-Government Employees aredivided into two categories:- (i.) Those who are in receipt of Gratuity in addition to

commuted pension and (ii.) Those who are not in receipt of any Gratuity in addition to

commuted pension.Exemption to these Non-Government employees under section 10(10A) is

available as follows:-

(i.) For those employees who are in receipt of Gratuity in addition to commuted pension: Amount exempt will be equal to one third (1/3rd) of the total pension

if entire balance lying in Pension Fund Account was commuted or actualamount received as commuted pension, whichever is less.(ii.) For those who are not in receipt of any Gratuity in addition to commuted

pension: Amount exempt will be equal to one half (1/2 or 50 %) of the total

pension if entire balance lying in Pension Fund Account was commuted or actual amount received as commuted pension, whichever is less.

Balance Pension will be taxable and will be taxable as salary.

# Points to be noted about ‘Pension’:

Pension received from United Nations Organization (U.N.O.), whether Commuted or Uncommuted is not taxable at all.

Uncommuted Pension is always taxable, whether received a by Government

Employee or a Non-Government Employee. Here, the term ‘Pension’ is restricted only to pension received from employer or

ex-employer. If uncommuted pension is received from an Insurance Company

under a ‘Pension Policy’, then it is taxable as ‘income from other sources’ and notas ‘salary’.

24




Any commuted pension received from an Insurance Company under a ‘Pension

Policy’ is not an income and hence is not taxable at all.

(3.) Leave Salary encashment: [Section 10(10AA)]: As per service rules, an employee

gets various types of paid leaves like Casual Leave, Sick Leave, Maternity Leave, etc. Anemployee is allowed to go on for leave for that many number of days, which are allowed to

him/her, without having to loose any salary during the period of leave. If employee goes on

leave beyond that many number of days in a year, then he/she will not be paid for thoseexcess days of leave. If he/she does not go on leave for the number of days allowed, then

the balance unutilized leave can be either be carried forward to the next year and utilized in

the next year or will lapse, depending upon the service rules. If employee is allowed to

carry forward the unutilized leave, then that leave will be credited to his/her account. At thetime of retirement if an employee has some unutilized leave standing to his credit then such

leave can be encashed by that employee. In other words, that employee will be paid salary

equivalent to the unutilized leave standing to his/her credit. Such encashment of leave is

called ‘leave salary’. If leave salary is encashed while in service, it is taxable and is taxableas ‘salary’ whether received by a Government employee or a Non- Government employee.

But if it is encashed after or at the time of retirement, then is exempt from tax under section10 (10AA) subject to certain limitations as follows.

[A.] In case of Government Employees: Leave salary received by a Governmentemployee after or at the time of retirement (and not while in service) is fully exempt under

section 10 (10AA).

[B.] In case of Non-Government Employees: Leave salary received by a Non-Government employee after or at the time of retirement (and not while in service) is

exempt under section 10 (10AA) subject to the least of the followings :-

(i.) Cash equivalent of the leave standing to the credit of the employee at the time of his

retirement = (Average salary of last 10 months immediately preceding the date of his

retirement) X leave standing to the credit of employee

Here, for last ten months salary, last ten months shall be taken into consideration upto

the date of retirement.

Salary here, would mean Basic Salary + Dearness Allowance (D.A.) only if D.A. forms

part of Retirement Benefits + Commission only if based on turnover (T/O) achieved by the

employee.

OR

(ii.) Total salary of last ten months immediately preceding the date of retirement. Here also the

term salary would mean Basic Salary + Dearness Allowance (D.A.) only if D.A. forms part of

Retirement Benefits + Commission only if based on turnover (T/O) achieved by the employee.

OR

25




(iii.) Actual amount received as Leave salary encashment.

OR

(iv.) Amount notified by Government which presently is Rs. 3,00,000/-

Whichever is less will be exempt and balance will be taxable as salary.

# Points to be noted about ‘Leave Salary’:

Leave salary received during the service is always taxable, whether received by a

Government employee or a Non-Government employee. Leave salary received at the time of or after the retirement is taxable only in the

case of Non-Government employees, subject to availability of exemption under

section 10 (10A). If Leave salary is received from more than one employer, whether in the same

previous year or in different previous years, then amount of exemption will becalculated as above only, but the amount notified by Government i.e. Rs. 3,00,000/-

will be reduced by any exemption already claimed earlier, if any on Leave salaryreceived from any previous employer.

Leave salary received by Legal Heirs or Family Members of an employee upon

death of employee, (whether Government employee or a Non-Governmentemployee) is not taxable at all in the hands of Legal Heirs or Family Members of

that employee.

(4.) Retrenchment Compensation: [Section 10(10B)]:If an employee is retrenched or

removed by his employer, then employer may have to compensate him for earlytermination of his employment, under Industrial Disputes Act, 1947. Such compensation isexempt in the hands of that employee at the least of the followings:-

(i.) Amount calculated as per provisions of Industrial Disputes Act, 1947. OR (ii.) Amount actually received as Retrenchment Compensation. OR

(iii.) Amount notified by Government which is Rs 5,00,000/-.

Whichever is less will be exempt under section 10(10B) and balance will be taxable

and taxable as ‘salary’.

# Points to be noted about ‘Retrenchment Compensation’:

If Retrenchment Compensation is received from more than one employer,

whether in one previous year or in different previous years, then exemption will

be calculated as above only, but the amount notified by Government i.e. Rs.5,00,000/- will be reduced by the amount of exemption claimed earlier, if any

on Retrenchment Compensation received from any earlier employer.

26




If amount calculated as per provisions of Industrial Disputes Act, 1947 is not

given in the exam, then exemption amount shall be lower of Actual amount

received or amount notified by Government.

(5.) Compensation received under ‘Voluntary Retirement Scheme’ (V.R.S.):[Section 10(10C)]: An amount received by an employee from his employer upon

his/her retiring voluntarily from employment which is known ‘Voluntary Retirement

Scheme (V.R.S.)’ or ‘Voluntary Separation Scheme’ compensation is exempt from taxunder section 10(10C) subject to the least of the followings:-

(i.) Amount actually received as V.R.S. Compensation OR

(ii.) Amount notified by Government which is Rs. 5,00,000/-

(iii.) Amount calculated as per prescribed guidelines of the scheme, which shall not

exceed the lower of the followings:

(a.) Three months salary for each completed year of service. OR

(b.) Actual salary for balance months of service left.Here, salary would mean last drawn (Basic salary + Dearness Allowance).

Exemption under section 10(10C) is once in a life-time exemption. In other words,

once it is claimed by an assessee, it can not be claimed again by that assessee in any

other assessment year.

(6.) Tax on Non-Monetary Perquisites paid by Employer: [Section 10(10CC)]: If tax

on non-monetary or non-cash perquisites received by an employee is paid by his employer,

then such tax shall not be added in the income of that employee, as it is exempt from tax inhis hands under section 10(10CC) with effect from Assessment Year 2003-2004. Such tax

as is paid by the employer shall not be allowed to the employer as a deduction on accountof business expenditure under section 40. (Here, exemption is available only on tax paid byemployer on non-monetary perquisites and not on tax paid by him on monetary or cash

perquisites).

(7.) Value of any Leave Travel Concession: [Section 10(5)]: An employee may receive

Leave Travel Concession or Passage money from his present employer or his ex-employer

for himself and his family members in connection with his proceeding (journey) to any

place in India (journey must be at any place in India only and not outside India, otherwiseexemption under section 10(5) will not be available). Journey may be performed while in

service or after retirement. Exemption under section 10(5) is available with respect to only

two journeys performed in a block of four calendar years (Calendar year and not financialyear i.e. year beginning on 01st January and ending on 31st December), where four years’

block is predefined by the act as beginning from 1982 and ending on 1985 and so on, like

1986-1989, 1990-1993, 1994-1997, 1998-2001, 2002-2005. This means that exemptionunder section 10(5) is available only two times in a block of four calendar years.

Exemption under section 10(5) will be the least of the following:-

(i.) Actual amount of Leave Travel Concession or Passage money received. OR

27




(ii.) Amount spent for the purpose. OR

(iii.) Amount prescribed for exemption by Central Board of Direct Taxes (CBDT)

in this behalf.

# Points to be noted about ‘Leave Travel Concession’:

Exemption under section 10(5) is available irrespective of whether L.T.C. was

received while in service or after retirement.

No distinction is made between Government employee or Non-Governmentemployee.

In order to claim exemption, journey shall be performed at any place within India

only, otherwise exemption will not be available.

Exemption is available for L.T.C. of employee as well as of his Family members.

Family members for this purpose means spouse and two children (whether

dependent or not) and dependent parents, brothers and sisters. Exemption is

available with respect to only shortest route to the destination, though employee

may adopt any other route, other than the shortest route. In any case exemption shall be restricted to the actual expenditure incurred.

Exemption is available only in respect of traveling expenses i.e. for Air Fare, RailFare, Bus Fare or Fare of Recognized Public transport System only. Any other

expenses, though may have been incurred by employee and reimbursed by

employer are not entitled for exemption. For e.g.: Hotel Accommodation charges,Food charges, Lodging and Boarding charges, Auto-Rickshaw charges, Scooter

charges, etc.

(8.) Provident Funds (P.F.): [Section 10(11)]: Provident Fund (P.F.) is a retirement

benefit scheme. Under this, a fixed sum is deducted from employee’s salary as his

contribution and generally, employer also contributes a similar sum as his contribution.Such funds are then invested in interest yielding securities and they earn interest on it. So, a balance in employee’s P.F. A/c comprises of four elements, viz. (i.) Employee’s own

contribution, (ii.) Interest on Employee’s own contribution, (iii.) Employer’s contribution,

and (iv.) Interest on Employer’s contribution. The balance in employee’s P.F. A/c is paid tohim at the time of his retirement or is transferred to his new P.F. A/c with a new employer,

if he/she takes up a new employment with a new employer. P.F. Scheme is developed by

Government, basically to promote compulsory savings.Basically, there are four types of Provident Fund Accounts, namely, (i.) Statutory

Provident Fund (SPF), (ii.) Recognized Provident Fund (R.P.F.), (iii.) Unrecognized

Provident Fund (U.R.P.F.) and (iv.) Public Provident Fund (P.P.F.). Recognized Provident

Fund is a Provident Fund, which is recognized by Commissioner of Income Tax (C.I.T.),whereas, Unrecognized Provident Fund is a Provident Fund, which is not so recognized by

Commissioner of Income Tax (C.I.T.). Its only an employer and an employee who can

contribute to SAF/RPF/URPF and not an outsider. Central Government has also establisheda scheme called Public Provident Fund (P.P.F.), which is a P.F. Scheme open to general

public at large. Any person, whether Salaried or Self-employed can participate in the PPF

Scheme, by opening a PPF A/c with State Bank of India or any of its subsidiaries or any

28




Nationalised Bank. Even a salaried employee, who already maintains a SPF/RPF/URPF

A/c may open a PPF A/c in addition to that. In order to maintain a PPF A/c, one has to

compulsorily contribute a minimum of Rs. 500/- every year to the scheme or more than Rs.500/- in multiples of Rs. 5/- but maximum Rs. 70,000/- in a year. Funds of PPF are

invested in some interest yielding securities. PPF A/c of the accountholder is credited with

a predetermined rate of interest every year on balance lying in the account (current rate of interest is 8 % per annum). Accumulated balance in PPF A/c is repaid together with

interest, after 15 years of maturity period, unless account is extended by accountholder.

SPF/RPF/URPF A/c balance comprises of four things as discussed earlier i.e.contribution of employer and employee and interest thereon, whereas PPF A/c balance can

comprise of only two things, namely (i.) Contribution of Accountholder and (ii.) Interest on

accountholder’s contribution, it cannot a have contribution from employer and accordingly,

question of interest on employer’s contribution does not arise.

# Tax treatment of Provident Funds and Exemption under Section 10(11): It can be

better explained with the help of the following table:-

PARTICULARS S.P.F. R.P.F. U.R.P.F. P.P.F

(1.) Employer’sContribution

Exempt Exempt upto12 % of

employee’s

salary (excess

taxable as

‘Salary’ )

Exempt * Employer doesnot contribute

(2.) Interest onContribution

Exempt Exempt upto9.5 % p.a.

(excesstaxable as

‘Salary’ )

Exempt * N.A.

(3.) Employee’sContribution

Exempt Exempt Exempt Exempt

(4.). Deduction

Under Section80C

Available on

employee’scontribution

Available on

employee’scontribution

Not

Available

Available on

Accountholder’scontribution

# Point to be noted about Pension Fund:

Employee’s own contribution or Accountholder’s own contribution in case of PPFA/c, as shown in item no. (3) in the above table, is not an income of Employee, but

is just an appropriation of his/her income, it therefore can not be taxable in any

case.

Deduction under section 80C is dealt with separately in the chapter on ‘Deductions

under Chapter VI-A’.

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* Employer’s contribution to URPF is exempt in the hands of employee at the time

of contribution, but it becomes taxable as ‘salary’, when balance in URPF A/c isrepaid back to employee.

* Interest on contribution to URPF is exempt in the hands of employee at the time it

is credited to the account, but it becomes taxable as ‘salary’, when balance in URPF

A/c is repaid back to employee. The term Salary shall mean Basic Salary + D.A. forming part of retirement benefits

+ Commission based on fixed Turnover achieved by the employee. [Basic + DA(R)

+ Commn.(T/O)]

(9.) Approved Superannuation Fund (S.A.F.): [Section 10(13)]: Just like Recognized

Provident Fund, Superannuation Fund (S.A.F.) balance comprises of four things,contribution from employer – employee and interest thereon. As far as its tax treatment is

concerned it’s exactly the same as R.P.F. above, nothing is taxable in the hands of

employee, provided S.A.F. is an approved fund. Employee’s own contribution to approvedS.A.F. qualifies for tax rebate under section 88. If S.A.F. is not approved, then tax

treatment is just like U.R.P.F.Nothing is taxable in the hands of Legal Heirs or Family Members of the

employee, if any amount is received by them from S.A.F. upon death of employee.

(10.) Allowances: ‘Allowances’ means a fixed sum paid by employer to employee for

various purposes or to meet various cost of employee, without considering the actualexpenditure. There are basically, two types of allowances viz. (a.) Those which are fully

taxable and (b.) Those which are partly taxable and partly exempt.

(a.) Fully taxable Allowances: The following Allowances are fully taxable as ‘Salary’:-

1) City Compensatory Allowance (C.C.A.) : When an employee is transferred from hisown city or town of residence to another city for employment, which is costlier than

his own city/town of residence, then he may be paid an additional amount per

month by his employer to meet the additional cost of living in city of employment.

Such compensation is known as ‘City Compensatory Allowance (C.C.A.)’ and isfully taxable,

2) Dearness Allownace (D.A.) : is an allowance given by employer to employee above

and over his normal salary, to meet the rise in consumer durables due to rise ininflation. D.A. is fully taxable,

3) Dearness Pay,

4) High Cost of living Allowance,

5) Tiffin/Meal/Lunch Allowance : If a fixed sum is given every month as anallowance, then it is fully taxable, but instead of giving cash, if lunch itself is

provided by employer free of cost, then its not an allowance, but is a perquisite, the

taxability of which is separately discussed under the head ‘perquisites’,6) Medical Allowance : If a fixed sum is given every month by employer as medical

allowance, then it is fully taxable, but instead of that if medical facilities are

provided by the employer or actual medical expenses of employee are reimbursed

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by the employer , then it’s a perquisite, the taxability of which is separately

discussed under the head ‘perquisites’,

7) Domestic Servant’s Allowance : If a domestic servant like Watchman, Sweeper, etcis employed by employee and salary of such servant is reimbursed or is directly

paid by employer then it is fully taxable as an allowance. But instead of that if such

servant is employed by employer only and is provided to the employee, then it’s notan allowance but is a perquisite, the taxability of which is separately discussed

under the head ‘perquisites’,

8) Overtime (O/T) Allowance : An allowance paid by employer to employee for doingovertime work or for working beyond certain contacted number of hours is called

overtime allowance and is fully taxable,

9) Family Allowance,

10) Marriage Allowance,11) Project Allowance,

12) Deputation Allowance,

13) Extra Shift Allowance,

14) Water, Gas, Electricity charges Allowance : Instead of giving an allowance for theseexpenses, if actual cost is reimbursed by the employer or Gas, Electricity, Water are

provided by employer, then are called ‘perquisites’ and are discussed separately,15) Conveyance Allowance : An allowance given by employer to employee for meeting

cost of journey between his/her residence and place of work.

16) Entertainment Allowance : A fixed amount given by employer to his employees for entertaining clients, is called as Entertainment Allowance. It is fully taxable.

(However, a deduction is allowed u/s 16(ii) to Government Employees on account

of Entertainment Allowance)

(b.) Allowances which are partly taxable and partly exempt: The following allowancesare partly taxable and partly exempt. Few of them are partly exempt upto the limits provided by Rule 2A to Rule 2BB and few of them are exempt to the extent they are

actually spent by the employee:-

1.) Section 10(13A ): House Rent Allowance (H.R.A.): (Read with Rule 2A): An

amount of fixed monthly allowance received by an employee from his employer,

towards paying rent of a house is exempt from tax in the hands of that employee

subject to the least of the followings:- (Balance H.R.A. received will thus betaxable in his hands)

d) Actual H.R.A. received by the employee from his employer for that many number

of months for which the house was rented by him. (If House was rented only for three months during the year, then H.R.A. of only three months only shall be

considered here and not for the whole year) OR

e) 50 % of the salary, if rented house is situated at Chennai, Delhi, Mumbai or

Kolkata or 40 % of salary if rented house is situated at any other place other than

Chennai, Delhi, Mumbai or Kolkata [Here, ‘Salary’ would mean ‘Basic Salary’

plus ‘Dearness Allowance (D.A.)’ only if D.A. forms part of Retirement Benefits

otherwise only ‘Basic Salary’] OR

31




f) Excess of Rent paid over 10 % of Salary [Here also, the term ‘Salary’ would

mean ‘Basic Salary’ plus ‘Dearness Allowance (D.A.)’ only if D.A. forms part of

Retirement Benefits otherwise only ‘Basic Salary’]

In (b) and (c) above ‘Basic Salary and D.A.’ of only that many months shall be

considered during which the house was rented and not ‘Basic Salary and D.A.’ of thewhole year.

If an employee resides in his ‘own house’ or he does not pay any rent for the house

where he resides, then answer to point (c) above will be NIL and therefore, the least of (a),(b) and (c) will also be NIL and nothing will be exempt under section 10(13A). As a result

of this entire amount received by employee as H.R.A. will become taxable in his hands as a

Salary.

2.) Section 10(5): Leave Travel Concession: Already discussed in this chapter,

3.) Children’s Education Allowance: is an allowance received by an employee from his

employer for meeting cost of education of his children and is exempt to the extent of thelower of the following two:-

(a.) Actual amount of Children’s Education Allowance received OR

(b.) Rs. 100/- per month per child subject to a maximum of two children only. (Step child

as well as an Adopted child are eligible for exemption but not a child resulting out of an

illegal marriage)

4.) Children’s Hostel Expenditure Allowance: is an allowance received by an employee

from his employer for meetng cost of Hostel expenditure of his children and is exempt to

the extent of the lower of the following two:-(a.) Actual amount of Children’s Hostel Expenditure Allowance received OR

(b.) Rs. 300/- per month per child subject to a maximum of two children only. (Step childas well as an Adopted child are eligible for exemption but not a child resulting out of anillegal marriage).

Exemption is allowable only for those months during which the child stays in a

Hostel, therefore no exemption is allowed if child does not stay in a Hostel.

5.) Allowance for employees working in a Transport system: An allowance received by an

employee working in a transport system like Pilot of an Aircraft, Conductor of a Train,

Captain of a Ship, received from employer being a Transport Undertaking, for meeting personal expenditures is exempt to the extent of the lower of the following two:-

(a.) 70 % of such allowance. OR

(b.) Rs. 6,000/- per month

6.) Transport Allowance: is an allowance received by an employee from his employer for

meeting cost of transport, other than journey between his place of residence and place of work. It is exempt upto the lower of the following two:-

(a.) Actual Allowance received OR

(b.) Rs. 800/- per month

32




This limit of Rs. 800/- per month is increased to Rs. 1,600/- per month, if employee is

orthopaedically / physically handicapped or is Blind (Enhanced limit is only for

physically handicapped or blind employees and not for employees suffering from any other disability like ‘deafness’, ‘dumbness’ or ‘mental retardation’) (If it is received for meeting

cost of journey between his/her residence and place of work, then it is called ‘Conveyance

Allowance’ and is fully taxable),

7.) Uniform/Dress Allowance: Where an employee is mandatorily required to wear a

certain type of dress or uniform like watchman, Army or Navy officials, or is required tofollow a certain type of Dress Code like compulsory wearing of a Neck Tie or Blazer at the

place of employment, then he may be given an allowance by his employer for wear and

tear, ironing or for purchase of that uniform/dress. Such Allowance is exempt to the extent

the amount of allowance is spent for the purpose for which it was given. Balance shall betaxable under the head ‘Salary’.

(11.) Perquisites: [Section 17 (2)]: The term ‘Perquisite’, popularly known amongst us as‘Perks’, has not been properly defined by the act. It has been defined by the act in section

17 (2) in an inclusive manner. According to Section 17 (2) “The term ‘Perquisite’ includesthe followings…..”, but no technical definition is given by the act. In common parlance the

term ‘perquisite’ can be understood as some benefit above and over the salary received by

an employee. It can be a monetary (cash) benefit or a non-monetary (non-cash) benefit i.e.a benefit in kind.

But as far as taxability of perquisites is concerned, we divide them into three

different categories:-

A.] Those Perquisites which are not taxable at all in the hands of any employees,B.] Those Perquisites which are taxable in the hands of all employees,

C.] Those Perquisites which are taxable in the hands of ‘Specified’ employees only. Let us now understand perquisites under all the three categories and their

valuation rules as given by the Income Tax Act. Let us first take up those perquisites which

are not taxable at all in the hands of any recipient employee.

A.] Those Perquisites which are not taxable at all in the hands of any employees: The

following perquisites are totally exempt:

1.) Use of Telephone or Mobile phone provided by employer including telephone or

mobile bill paid/payable by employer,2.) Use of employer’s Computer or Laptop for official as well as personal purposes

by employee, whether Computer or Laptop is owned by the employer or not,

3.) Accommodation provided on transfer of an employee in a Hotel for a period not

exceeding 15 days in aggregate (the term ‘Hotel’ shall include Hotel, Motel, Guest

house as well as Rest house),

4.) ‘Conveyance Facility ’ provided by the employer to an employee for covering

journey between his/her residence and place of work. For e.g.: Employer’s own Bus

33




coming to pick up employees from their residence, just like School Bus. (However,

instead of conveyance facility, if employer provides a fixed sum for commuting

between residence and place of work, then it is called ‘Conveyance Allowance’ andis not a perquisite and is fully taxable),

5.) An amount spent by employer on Training of employees, whether training is

provided at the place of employment or somewhere else, like at training center.Even amount spent by employer on ‘Management Refresher Course’ is also not a

taxable perquisite,

6.) Free meals provided by employer to employee, either at the place of employmentor by way of vouchers (usable at ‘eating joints’ only), are not taxable if cost to

employer is not more than Rs. 50/- per meal. If cost to employer is more than Rs.

50/- per meal then taxable value of this perquisite = Cost to employer in excess of

Rs. 50/- per meal less amount recovered from employee,7.) One time Corporate Membership Fees or Institutional Membership Fees paid by

employer, wherein an employee can enjoy membership benefits only till the time he

is an employee of that employer (However, instead of one time Corporate

Membership Fees, if annual fees is paid/ payable by employer every year, then it isfully taxable perquisite),

8.) Free Transport Facility in a vehicle owned by employer being a Transport

Undertaking: For e.g.: Western Railway providing free transport in a Train to any

of its employees or Indian Airlines providing free transport by aircraft owned by it

to its employees,

10.) Free use of a Health Club or a Sports Club or any similar facility maintained

by employer,

11.) Gift in kind. However, gift in cash is always taxable.

12.) Goods manufactured by employer and sold to employee at concessional price,

13.) Employees’ Group Medical Insurance (Mediclaim) Premium paid by

employer,14.) Employees’ Personal Accident Insurance Premium paid by employer,

15.) Periodicals/Magazines/Journals/Newspaper, etc. provided by employer free of

cost in the office to the employee,

B.] Those Perquisites which are taxable in the hands of all employees: The

following Perquisites are taxable in case of all employees (in case of a non-monetary perquisite, valuation to be done as per rules given in the act, ignoring its fair market

value or any other justifiable method):-

1.) Valuation of Rent Free Unfurnished Accommodation : is taxable whether

provided to a Government Employee or to a Non-Government Employee.

(a.)In the hands of a Government Employee: Valuation to be done as per rules framed

by Central Government in this regard.

34




(b.)In the hands of a Non-Government Employee: The Taxable Value will be given in

the question. However, just for the sake of knowledge of students, the valuation to

be done as per provisions of Income Tax Act, as follows:-

Accommodation is provided

in a place where population

Where Accommodation is

owned by Employer

Where Accommodation is

not owned by Employer

(A.)is < 10 Lacs* Taxable Value = 7.5 % of

Salary of employeeTaxable Value =

(a.) 15 % of salary of the

employee

(B.) is > 10 Lacs* but

< 25 Lacs*

Taxable Value = 10 % of

Salary of employee

OR

(b.) The amount of Lease

Rent paid or payable, by

(C.) > 25 Lacs* Taxable Value = 15 % of

Salary of employee

employer,(a) or (b) whichever is

lower

* Population as per Census of the year 2001.

If the Accommodation is provided in a Hotel or a Motel, then the taxable value will be the lower of the following two:-

(a.) 24% of the Salary,

OR(b.) Actual Charges paid or payable by the employer

Here, Salary = Basic Salary + D.A. (If considered for retirement benefits) + Bonus +

Commission (whether based on turnover achieved by employee or not) + all other taxable

perquisites but excluding any non-monetary perquisite and taxable portion of Employer’sContribution to Employees’ Provident Fund.

2.)Valuation of Rent Free Furnished Accommodation: In point (1.) above we discussed

about rent free unfurnished accommodation, now what if furnished accommodation is

being provided to the employee. Value of furnished accommodation comprises of twocomponents, i.e. value of ‘unfurnished accommodation’ plus value of ‘ furniture’ provided

along with it. Value of ‘unfurnished accommodation’ shall be determined as in point (1.)

above, as usual, whereas value of ‘furniture’ to be included in taxable value of rent freefurnished accommodation, shall be determined as follows:-

(a.) If furniture is owned by employer : taxable value of furniture shall be 10 % of original cost of furniture.

(b.) If furniture is not owned by employer : taxable value of furniture shall be the actual

rental charges paid or payable by the employer for furniture.

3.) Value of Accommodation provided by employer at concessional rent: In point (1.)and (2.) above, we discussed about value of ‘ Rent free accommodation’, but what if some

35




rent was being charged by employer from employee, i.e. value of accommodation provided

at a concessional rent to employee. Taxable value of an accommodation provided by

employer to employee at concessional rent will be the value of rent free accommodation ascalculated in (1.) or (2.) above, as applicable less any amount of rent recovered by

employer from employee.

4.) Any obligation of employee met by employer: This is a monetary perquisite; therefor e

its valuation is not required. Any payment of cash, which primarily is an obligation or duty

of employee to pay, is if made by employer, amounts to an extra benefit received by thatemployee above and over his/her salary and is therefore taxable as a perquisite in the hands

of all employee.

5.) Payment of Life Insurance Premium or any Annuity by employer on the life of

employee: If any premium on life insurance policy of an employee is paid by his/her

employer or an annuity of employee is paid by employer, then it is an extra benefit received

by employee in addition to his/her salary and is therefore taxable as a perquisite in the

hands of all employees. (This is also a monetary perquisite and therefore its valuation is notrequired).

6.) Valuation of any other notified fringe benefits: Value of the following notified fringe

benefits are taxable in the hands of all employees (If valuation of any perquisite is required

to be done, then valuation is to be done as per rules provided by the act and in no other way, even if any other method of computation is more justified):-

Interest free loan of more than Rs. 20,000/- : If any interest free loan is given

or any loan at concessional rate of interest is given by an employer to employee,other than ‘Medical Loan’ and average monthly outstanding balance of loan is

more than Rs. 20,000/- then amount of notional interest on that loan is taxablein the hands of that employee as a perquisite. Notional interest in such caseshall be computed by applying the rate of interest of State Bank of India (SBI)

prevailing on the very first day of the relevant previous year for the loan of the

same purpose. For e.g.: If rate of interest on 1 st day of relevant previous year charged by SBI for Housing loan is 7.25 % and employee has taken a housing

loan from his employer, then notional interest shall be calculated by applying

7.25 % on entire outstanding balance of loan (and not only on loan amount in

excess of Rs. 20,000/-), provided outstanding balance of loan is more than Rs.20,000/-. Taxable value of perquisite in this case shall be Notional interest

calculated as above less any interest charged by employer to employee. Note:

No other method of valuing notional interest shall be followed, how much justifiable it may be. For e.g.: If in the above example, employer lends money

for housing purpose, to general public at the rate of interest of 8.5 % or say at

6.25 % then also notional rate of interest shall be calculated applying the rate of interest charged by SBI only and not by applying 8.5 % or 6.25 % though these

rates may seem more appropriate.

Free Meals costing more than Rs. 50/- per meal : If employer provides free

Tea, Coffee, Non-Alcoholic Beverages/Drinks during office hours, then it is not

36




taxable at all. If meals (Lunch/Dinner) are provided to employees free of cost in

the office or non-encashable coupons or vouchers are provided by employer to

employees free of cost, which can be used only at ‘eating joints’, then suchmeals are not taxable in case of any employee if cost to employer does not

exceed Rs. 50/- per meal. But if cost to employer exceeds Rs. 50/- per meal,

then it becomes taxable in the hands of employee and taxable value = Cost toemployer in excess of Rs.50/- per meal less amount recovered from employee,

if any. Gift, Voucher, Token : If given in cash, then fully taxable, but if given in kind

then fully exempt. Cash gift is not required to be valued.

Use of Moveable Asset : Where any moveable asset of employer (whether

owned by employer or not) other than Computer and Laptop is given by

employer (given and not sold) to employee for using it for personal purposes of employee, then it becomes taxable in the hands of that employee as a perquisite.

Taxable value = 10 % of the original cost of the moveable asset, where asset

is owned by the employer or actual rental charges or hire charges of the asset

where asset is not owned by the employer less any amount recovered from theemployee by employer. Free use of Computer or Laptop is specifically

exempted. Equity or Preference shares in the employer company offered to an employee at

a price lower than the market price of such shares under “Employees’ Stock

Option Plan/Scheme” (ESOP/ESOS), Taxable Value = (Fair Market Value F.M.V. of such shares as on the date of Allotment to employee) less (Amount

paid by employee to acquire such shares)

Sale of Moveable Asset at concessional rate : If any moveable asset (including

Computer and Laptop) owned by employer is sold by employer to employeeeither at concessional rate or free of charge, then taxable value thereof is

included in the income of the employee as a perquisite. Taxable Value = (Costof the asset less depreciation* thereon) less any amount recovered from the

employee by the employer towards the cost of the asset.

*Depreciation shall be charged at the rates as given below:-

On Electronic Items including Computer and Laptop – at 50 % per

annum under Written Down Value (W.D.V.) method .

On Motor Car – at 20 % per annum under Written Down Value

(W.D.V.) method .

On any other moveable asset – at 10 % per annum under Straight

Line Method .

Depreciation shall be charged only for each completed year for which assetwas owned by the employer, depreciation for any incomplete year shall not

be considered.

C.] Those Perquisites which are taxable only in the hands of ‘SPECIFIED’ Employees

only: These are those perquisites which are taxable in the hands of only ‘Specified’

employees. Before dealing with any of these perquisites, let us understand the meaning of

the term ‘Specified’ employee.

37




The following employees are called ‘specified’ employees:-

1. An employee, who is a ‘Director’ in the employer company,

2. An employee, who holds ‘substantial interest’ in the organization of his employer (holding ‘substantial interest’ means holding 20 % or more of voting rights or

‘profit sharing rights’ either individually or jointly with relatives),

3. An employee, who draws a gross salary of more than Rs. 50,000/- per annum,excluding taxable value of any non-monetary perquisite and before claiming any

deduction towards Standard Deduction, Entertainment Allowance or Professional

Tax.

The following Perquisites are taxable in the hands of specified employees only:-

1) Provision of free Domestic Servant : If domestic servant like Watchman, Sweeper,Gardener, etc. are employed by employer and are provided to employee free of

charge, then salary paid/payable by employer to such domestic servant is taxable in

the hands of specified employee as a perquisite. Instead of this if domestic servant

is employed by employee himself and salary of such servant is either directly paid by employer or is paid by employee and then employer reimburses employee for

such salary, then salary of such servant is taxable in the hands of all employees(and not only in the hands of specified employees) as ‘an obligation of employee

met by employer’. Taxable value of this perquisite = salary of such domestic

servant paid/payable by employer.

2) Transport Facility provided to employees, other than employees of Transport

Undertaking: is taxable as a perquisite in the hands of specified employees only.

Taxable value of this perquisite = Value at which such transport facility is offered

by employer to general public or if it is not being offered by employer to general public, then cost to the employer less any amount recovered from the employee.

3) Supply of Gas, Electricity, Water : provided by employer to employee is taxableas a perquisite in the hands of specified employees only. Taxable value of this perquisite = cost to the employer less any amount recovered from the employee. If

connection of Gas, Electricity, Water is in the name of employee and either

employer makes a direct payment of bill or employee makes the payment andemployer reimburses the employee for such expenses, then it is ‘an obligation of

employee met by employer’ and is therefore, taxable in the hands of all employees.

4) Provision of Medical Facilities : (a.) If a fixed medical allowance is given, then it

is fully taxable in the hands of all employees. (b.) If Mediclaim Insurance Premiumon health of employee is paid by employer; it is not taxable in case of any

employee. (c.) But if medical facility is provided to an employee, then taxable value

of such perquisite shall be determined as follows (whether Medical Bill is issued inthe name of employer or is issued in the name of employee makes no difference)

(whether employer makes the direct payment of Medical Bill or it is first paid by

employee and then employer reimburses the bill amount to the employee, makes nodifference):-

(A.) If Medical Facility is provided in India : If an employee or any of his family

member is medically treated in –

38




A Hospital maintained or owned by employer, or

A Hospital maintained by Central/Sate Government, or

A Hospital maintained by Local Authority, or

A Hospital approved by Chief Commissioner of Income Tax

(CCIT)

and medical bill is paid by or reimbursed by the employer, thennothing shall be taxable in the hands of any employee. It will be fully

exempt.

But if an employee or any of his family member is medically treatedin any other hospital other than the above four and medical bill is paid by

or is reimbursed by the employer, then it is a taxable perquisite, taxable

only in the hands of specified employees and is exempt upto Rs. 15,000/- per annum. (Amount of this perquisite in excess of Rs. 15,000/- only shall

be taxable)

Here, the term ‘Family’ means spouse, children, brothers, sisters,

whether dependant on employee or not and the term ‘Hospital’ includes

Dispensary, Nursing Home, Clinic, etc. also.

(B.) If Medical Facility is provided outside India : If an employee or his familymember is provided with a ‘medical facility’ outside India by employer,

then it shall be a taxable as a perquisite, taxable in the hands of only

specified employees. Taxability shall be as follows:-

Types of Costs incurred Taxability/Exemption

(1.) Cost of Medical Treatment of

Patient (Employee or his

Family Member) outside India.

Exempt to the extent of an amount

permitted by Reserve Bank of India

(R.B.I.).

(2.) Cost of Travel of patient andone attendant accompanyingthe patient outside India.

Fully exempt if GROSS TOTAL INCOME of that employee, does not exceed Rs.2,00,000/-, otherwise fully taxable.

(3.) Cost of stay abroad of patientand 1 attendant accompanying

the patient outside India.

Exempt to the extent of an amount permitted by Reserve Bank of India

(R.B.I.).

5.) Free Education Facility: (a.) If training is provided to an employee by employer,

whether at place of work or at the Training Center, then it is fully exempt in case of allemployees. (b.) If Fixed Education Allowance for Children of employee is given, then it is

exempt upto Rs. 100/- per month per child subject to a maximum of two children. Balanceis taxable in case of all employees. (c.) Actual Reimbursement or Direct payment of School Fees of employee’s children, is fully taxable in case of all employees as ‘an obligation of

employee met by employer’. (d.) If ‘Scholarship’ is given by employer to employee’s

children on merit basis, then it is fully exempt in case of all employees. (e.) If Education Facility is provided by employer free of cost in an Institute owned/maintained by

39




employer, then it shall amount to a perquisite and shall be taxable in the hands of only

specified employees. The taxability of this perquisite is explained as follows:-

If provided to children of employee : Taxable value = Cost of such education in a

similar educational institute in a nearby locality less any amount recovered from the

employee. This perquisite is exempt upto Rs. 1,000/- per month per child, without

any restriction on number of children. If provided to any other family member of employee (other than children of

employee): Taxability shall be as above only but without any exemption i.e.

Taxable value = Cost of such education in a similar educational institute in a nearbylocality less any amount recovered from the employee. No exemption is allowed in

this case. (Even Grand Children or Great Grand Children of employee are included

in this category).

However, educational facility provided to Govt. employees by Govt. shall not be

taxable.

Permissible Deductions from Gross Salary under Section 16: After taking total of allthe above, i.e. total of Basic Salary + Dearness Allowance + Dearness Pay + Bonus +

Commission + All Taxable Allowances + All Taxable Perquisites, whether Monetary or Non-Monetary, what we get is known as “GROSS SALARY”. From ‘Gross Salary’ so

computed, the following amounts can be claimed as deduction under section 16:-

(1.) Standard Deduction: [Section 16(i)]: No more available with effect from A.Y. 2006-

2007.

(2.) Entertainment Allowance (E.A.): [Section 16(ii)]: Entertainment Allowance (E.A.)is an allowance which is exempt to the extent spent by the employee for official purposes,

in other words, it is taxable to the extent not spent for the official purposes. The taxableamount of E.A. is taxable in case of all employees, whether ‘Specified Employee’ or not.Deduction under section 16 (ii) is available against such allowance, but is available only to

Government employees. No deduction under this section is available Non-Government

Employees. Under section 16 (ii), Deduction shall be available to the extent of least of thefollowing three:-

1/5th or 20 % of the ‘Basic Salary’, OR

Amount notified for this purpose – Rs. 5,000/- maximum, OR

Actual amount of Entertainment Allowance (E.A.) received

(3.) Professional Tax or Employment Tax: [Section 16(iii)]: If Professional Tax or

Employment Tax is paid by the employer out of his pocket, then it is treated as ‘anobligation of employee met by employer’ and is added in the salary as a taxable perquisite,

taxable in case of all employees. But if it is either paid by employee himself or it is paid byemployer on behalf of employee, then nothing shall be added in the salary, as no benefit is

derived by the employee in addition to his/her salary. In both the above cases Professional

Tax paid, is fully allowed to be deducted, without any ceiling limits from salary under

40




section 16 (iii). (Allowed to be deducted only to the extent Professional Tax or

Employment Tax actually paid).

FORMAT OF COMPUTATION OF INCOME FROM ‘SALARIES’:

CH-6

INCOME FROM HOUSE PROPERTY (H.P.)

41

PARTICULARS AMOUNT

Basic Salary (whether received or receivable) XXX

Dearness Allowance / Dearness Pay XXXAdvance Salary / Arrears of Salary XXX

Bonus XXX

Commission XXXAll Taxable Allowances XXX

All Taxable Perquisites (Whether Monetary or Non-Monetary) XXX

GROSS SALARY XXX

LESS: Deductions Under Section 16:

(1.) Entertainment Allowance under section 16(ii)

(Only in case of Government Employees) XXX

(2.) Professional Tax/Employment Tax under section 16(iii) XXX (XXX)

NET TAXABLE SALARY XXX





An income is chargeable to tax under this head U/S 22, only if the following three

conditions are satisfied, namely,

1.) As a House Property, there should be either a ‘house’ or ‘a house and land adjoining the house’ and not only the ‘land’ or ‘vacant plot of land without a house/building’,

2.) The Assessee should be the owner that house property, whether a Legal owner or a

Deemed owner . (If the Assessee has transferred the property to his/her spouse or aMinor child, without adequate consideration, then he still continues to be the deemed

owner of that property.) If the assessee is in receipt of rent from H.P. but he is not the

owner, but is a tenant, then that rent will be charged to tax as income from other sources (as a rent from sublet property) and not as income from H.P.,

3.) The property should not be used by the assessee for his Business/Profession , like

used as Office, shop, godown, etc.

Points to be noted:-

1.) Income from vacant plot of land would be chargeable to tax as ‘income from other

sources’ or as ‘income from Business/Profession’ and not under this head of income.

2.) Unrealized rent of property will become taxable in the year of receipt of such rent, evenif the assessee is no more the owner of the said H.P. i.e. if he has sold off the H.P.

3.) If the assessee receives a composite rent, by letting out H.P. together with some other

assets like Furniture, Air conditioner, Refrigerator, etc. then that part of the rent, which is

attributable to H.P. will be charged under this head, whereas that part of the rent, which isattributable to the other assets will be chargeable to tax as ‘Income from other sources’.

4.) In case of composite rent if, ‘letting out H.P.’ only, without letting out of the other assets, is not acceptable to the other party, then the entire composite rent will be chargeableto tax either as ‘income from Business/Profession’ or as ‘income from other sources’ as the

case may be and not as ‘income from H.P.’, even if it is possible to bifurcate the composite

rent into ‘rent from H.P.’ and ‘rent from other assets’.

There are mainly two possibilities in case of a H.P. either (i.)the property isgiven by the owner on hire to somebody for rent, whether for residential purpose or for

commercial purpose (such properties are called Let out properties- L.O.P.) or (ii.)the

property is used by the owner for his own residence or for the residence of his family

members (such properties are called Self Occupied Properties – S.O.P.).A Self occupied property could be used either for residential purpose or for

commercial purpose i.e. either as a residence or as an office. If S.O.P. is used for

commercial purposes i.e. as an office, shop or godown, then it is not to be considered inthis chapter. In this chapter we shall consider only those S.O.P. which are used for

residential purpose.

42




What is taxable as an income from H.P. is not the ‘actual rent received minus

actual expenditure incurred’, but the taxable income is to be calculated in the following

way :-

[A.] CALCULATION OF INCOME FROM LET OUT HOUSE PROPERTY:

# Calculation of Gross Annual Value (G.A.V.) for a Let Out Property (L.O.P):-

(a.) Municipal Valuation *(b.) Fair Rent **

(c.) = Higher of (a.) and (b.)

(d.) Standard Rent (If Rent Control Act is applicable) ***

(e.) Expected Rent = Lower of (c.) and (d.)(f.) = Expected Rent minus loss due to vacancy of property,# if any

(g.) Actual Rent receivable for the whole year minus Unrealized Rent ## minus

Loss due to vacancy of property,# if any

(h.) Gross Annual Value (G.A.V.) = Higher of (f.) and (g.)

*Municipal Valuation: is the value of a H.P.determined by the Local Municipality.

**Fair Rent: is an annual rent that a similar property in a similar locality fetches.

***Standard Rent: is a maximum rent that a landlord can demand for a property, towhich ‘Rent Control Act’ is applicable.

#Loss due to vacancy of property: is the actual Rent of those months during which

the property could not be let out or property was vacant. It is also known as

‘Vacancy Allowance’ or ‘Vacancy Loss’.##Unrealized Rent: is that part of the receivable rent of the property, which could not

be realized by the landlord from his tenant, due to any reason.

Note: Municipal Valuation, Fair Rent and Standard Rent (If Rent Control Act is

applicable) will be readily given in the question, if not given then shall not be assumed

to be NIL, but shall be completely ignored, assuming, that particular item to be notapplicable for the valuation.

Illustration 1. Mr. X owns four houses at different parts of India with following

details. Compute the Gross Annual Value (GAV) of the house properties.

PARTICULARS House I House II House III House IV(a) (i) Municipal valuation(ii) Fair rent

(iii) Standard rent under

rent control Act.(b) Rent received/receivable

40,00056,000

52,00048,000

40,00056,000

52,00060,000

40,00056,000

N.A.48,000

44,00052,000

N.A.58,000

43




Solution : Applying the above formula to details of all the four houses as given in the

above table, we get the following Gross Annual Values:-

House I: Rs. 52,000/- or Rs. 48,000/- whichever higher. Hence, GAV is Rs. 52,000/-.

House II: Rs. 52,000/- or Rs. 60,000/- whichever higher. Hence, GAV is Rs. 60,000/-.

House III: Rs. 56,000/- or Rs. 48,000/- whichever higher. Hence, GAV is Rs. 56,000/-.House IV: Rs. 52,000/- or Rs. 58,000/- whichever higher. Hence, GAV is Rs. 58,000/-.

# Calculation of Income from House property from a Let Out Property (L.O.P):-

Particulars Amount

GROSS ANNUAL VALUE as calculated above XXX

LESS: Municipal Taxes, actually paid by the assessee/owner of

the H.P. (Only if, actually paid during the relevant PreviousYear) (XXX)

NET ANNUAL VALUE (N.A.V.) XXXLESS: Deductions U/S 24:

1.) Standard Deduction u/s 24(a)

(30 % of NAV) XX2.) Interest on Borrowed Capital u/s 24(b) whether

paid or not paid i.e. deduction available on due

basis (Borrowal/Loan should be for the purpose of

Purchase, Construction, Reconstruction, Renewal,or Repair of the H.P.) XX (XXX)

INCOME FROM LET OUT HOUSE PROPERTY XXX

Points to be noted:

(a.) If Municipal Taxes are paid by the Tenant, then that part of the taxes, which is paid

by the Tenant will not be allowed to be deducted.

(b.) Those Municipal Taxes are allowed to be deducted, which are actually being paid

by the assessee being the owner of the H.P., even if taxes paid are not for therelevant Previous Year i.e. if the taxes of P.Y. 2008-2009 are paid in 2009-2010,

then will be allowed to be deducted in P.Y. 2009-2010.

(c.) If the H.P. is located outside India, then Municipal Taxes levied by the Governmentof that country will be allowed to be deducted.

(d.) Interest on borrowed capital is allowed to be deducted on accrual basis, even if it is

not paid during the year.(e.) If the capital is borrowed for purposes other than those mentioned above, then

interest will not be allowed to be deducted. For e.g.: Interest on loan taken for

marriage of assessee’s daughter by mortgaging house property – will not be

allowed as a deduction u/s 24(b).

44




(f.) Only interest on loan is allowed to be deducted, i.e. interest on interest, or interest

on delayed repayment of loan is not allowed to be deducted.

(g.) Interest on ‘new loan’ taken for discharging the ‘old loan’ is allowed to beclaimed.

(h.) No other expenses, except of those mentioned above will be allowed to be

deducted. For e.g.: Insurance charges of H.P., Rent collection charges, Societymaintenance charges of H.P., etc. will not be allowed to be deducted.

Illustration 2. Mrs. X is the owner of four houses. She pays local taxes @ 10 % of their

Municipal Valuation. Houses I and III are covered by Rent Control Act. Determine

their Net Annual Value (N.A.V.):

Houses No. I II III IV

Municipal valuation

Fair RentActual Rent received

Standard Rent

Rs.

24,000

28,00026,000

28,000

Rs.

24,000

26,00032,000

-----

Rs.

24,000

32,00034,000

32,000

Rs.

24,000

34,00032,000

----

Solution:

Mrs. X

[A.] Annual Value of Houses not Covered by Rent Control Act.

Detail / Houses No. II IV

(a.) Municipal Value or Fair Rent(whichever is higher)

(b.) Actual rent or (a.) above, (whichever is higher)

will be G.A.V. of the House

Less: Local taxes @ 10 % of Municipal valuation(10 % of Rs. 24,000/-)

Rs.

26,000

32,000

(2,400)

Rs.

34,000

34,000

(2,400)

Net Annual Value (N.A.V.) 29,600 31,600

[B.] Annual Value of Houses Covered by Rent Control Act.

Detail / Houses No. I III

(a.) Higher of Municipal Value or Fair Rent(b.) Lower of Standard Rent under Rent Control

Act or (a.) above.

Rs.

28,000

28,000

Rs.

32,000

32,000

45




(c.) Higher of Actual Rent and (b.) above

will be G.A.V. of the HouseLess: Local taxes @ 10 % of Municipal valuation

(10 % of Rs. 24,000/-)

28,000

(2,400)

34,000

(2,400)

Net Annual Value (N.A.V.) 25,600 31,600

[B.] CALCULATION OF INCOME FROM SELF OCCUPIED HOUSE

PROPERTY (S.O.P.):

# Calculation of Income from House property for a Self Occupied Property (S.O.P):-

Particulars Amount

GROSS ANNUAL VALUE NIL

LESS: Municipal Taxes (Whether paid or not paid) NIL NETANNUAL VALUE (N.A.V.) NIL

LESS: Deductions U/S 24:1.) Standard Deduction U/S 24 (a) NIL

2.) Interest on Borrowed Capital U/S 24 (b) whether

paid or not paid i.e. deduction available on due

basis (Borrowal/Loan should be for the purpose of Purchase, Construction, Reconstruction, Renewal,

or Repair of the H.P.) (Max. Rs. 30,000/- or Rs.

1,50,000/-) XX (XXX)

INCOME FROM SELF OCCUPIED HOUSE PROPERTY XXX

Points to be noted:

(a.) Only those Self Occupied Properties are considered which are self occupied for the

purpose of residence of assessee or assessee’s family members. Those S.O.P. whichare used for commercial purposes by assesee are not to be considered here.

(b.) In case of S.O.P. Gross Annual value of the property is always to be taken as NIL.

No deduction is allowable towards Municipal Taxes, whether paid or not paid.Hence, NAV of such property will always be NIL.

(c.) Since, NAV of such property is NIL, Standard Deduction U/S 24 (a) will also be

NIL.(d.) If the capital is borrowed for purposes other than those mentioned above, then

interest will not be allowed to be deducted. For e.g.: Interest on loan taken for

marriage of assessee’s daughter by mortgaging house property – will not beallowed as a deduction U/S 24 (b).

(e.) Interest on capital borrowed is allowed subject to maximum of Rs. 30,000/- for

S.O.P. that means deduction will be the actual amount of interest for the year or Rs.

30,000/- whichever is lower. (Such limit is applicable only to S.O.P and not to

46




L.O.P.- For L.O.P. actual interest is allowed to be deducted, without any maximum

ceiling limit).

(f.) Only interest on loan is allowed to be deducted, i.e. interest on interest, or intereston delayed repayment of loan is not allowed to be deducted.

(g.) Instead of Rs. 30,000/- as explained in (e.) above, a higher limit of Rs. 1,50,000/-

is available, if all the three following conditions are satisfied :-(1.) Capital is borrowed or Loan is taken on or after 01st April, 1999.

(2.) Capital is borrowed only for the purpose of purchase or construction of

house property and for no other purpose. (Even if capital is borrowed for the purpose of repair, renewal or reconstruction of H.P., then benefit of

higher limit of Rs. 1,50,000/- will not be available and therefore, limit of

Rs. 30,000/- will be applicable)

(3.) Borrower must purchase the H.P. or construct the H.P. within three years

from the end of the financial year in which the capital was borrowed or loan

was taken. For e.g.: If the loan was taken on 27th June, 2006 then the

financial year in which loan is taken expires on 31st March, 2007 and period

of three years from the end of financial year in which loan was taken,expires on 31st March, 2010. Therefore, purchase or construction of H.P.

shall be completed by 31st March, 2010 in this example, in order to claimhigher deduction.

All the three conditions must be satisfied. Even if two conditions are

satisfied, but anyone condition is not satisfied, then higher deduction limitof Rs. 1,50,000/- will not be available.

(h.) In case of S.O.P., due to GAV/NAV being NIL and interest on borrowed capital

allowed to be claimed as a deduction, there may be a negative income from S.O.P.

(i.) Interest on ‘new loan’ taken for discharging the ‘old loan’ is allowed to be claimed.(j.) No other expenses, except of those mentioned above will be allowed to be

deducted. For e.g.: Insurance charges of H.P., Rent collection charges, Societymaintenance charges of H.P., etc. will not be allowed to be deducted.

INTEREST DURING PRE-CONSTRUCTION PERIOD:

Whether, property is S.O.P. or L.O.P. it can be put to use for the purpose of

residence or for letting out, only if the construction of the property is completed. It may

so happen that the loan is taken, but the construction of the property is completed onlyafter few years from the date of the loan. Interest on loan is allowed to be deducted

from H.P. income only when the property is put to use which is possible only when the

construction of the property completed. What will happen to the interest on loan for the period between the date of the loan and the date on which it’s construction is completed

(such period is known as pre-construction period)? Will it lapse? Answer is No! It will

be allowed to be claimed as a deduction U/S 24 (b) in the following way :-

(a.) Pre-construction period begins on the date on which the loan is taken.

47




(b.) Pre-construction period ends, either on the date on which the loan is fully repaid or

on 31st March, immediately preceding the date of completion of construction,

whichever date is earlier.(c.) For e.g.: (1.) If loan is taken on 25 th April, 2006 and (2.) Construction of the

property is completed on 28th March, 2009 and (3.) Loan is fully repaid on 13th

May, 2008. ⇒Pre-construction period in this case would begin on 25th

April, 2006and end either on (i.) the date of repayment of loan i.e. on 13th May, 2008 , or (ii.)

on 31st March, immediately preceding the date of completion of construction i.e. on

31st March, immediately preceding 28th March, 2009 = 31st March, 2008 . Therefore,the date on which the pre-construction period expires will be either 13 th May, 2008

or 31st March, 2008, whichever is earlier i.e. 31st March, 2008 (As it comes before

13th May, 2008).(d.) Now find out the total interest paid/payable during the pre-construction period as

above, for the entire pre-construction period.

(e.) 1/5th of the Total pre-construction period interest is allowed to be deducted everyyear, during the post-construction period for five years.

(f.) In case of S.O.P., Pre-construction period interest is also subject to ceiling limit of Rs. 30,000/- or Rs. 1,50,000/- as the case may be.

[C.] DEEMED LET OUT PROPERTY (D.L.O.P.): If the assessee has more than one property, which are not let out by him, then as per the provisions of the act, any one of such

properties, at the option of the assessee can be treated by him as a Self Occupied Property

and all such other properties, though not let out, will be considered as let out. Such S.O.P.swhich are even though not let out but are considered to have been let out are called

‘DEEMED LET OUT PROPERTIES’ (D.L.O.P.) and are treated at par with Let out

properties. All the provisions of the act that are applicable to a let out property are equallyapplicable to such D.L.O.P. properties.

Illustration 3. Mr. Rajesh Ganatra has two houses, both of which are Self-Occupied.

The Particulars of the houses are as under:

PARTICULARS House I

(Rs.)

House II

(Rs.)

Municipal Value

Fair Rental Value

Standard RentMunicipal Taxes

7,50,000

8,78,000

N.A.24,000

(due but not paid)

10,80,000

14,44,000

20,00,00029,000

(paid during the year)

Mr. Rajesh Ganatra has opted to treat the second house as Self-Occupied. Compute the

Net Annual Value of the two houses for the Assessment Year 2009-2010.

Solution:

48




Mr. Rajesh Ganatra

Computation of Net Annual Value

Particulars Amount (in Rs.)

HOUSE I (Deemed to be let out)

Gross Annual Value 8,78,000Less: Municipal Taxes, due but not paid NIL

Net Annual Value (NAV) 8,78,000

HOUSE II (Self Occupied)

Gross Annual Value NIL

Less: Municipal Taxes NIL

Net Annual Value (NAV) NIL

[D.] PARTLY LET OUT AND PARTLY SELF OCCUPIED PROPERTY: It may sohappen that a property is divisible into two parts. One part of the property is let out by the

assessee, whereas the other part is self occupied by the assessee. In such cases, the entire

property will be treated as comprising of two properties. That part of the property which islet out, will be treated as an independently ‘Let Out property’, whereas that part of the

property, which is self occupied, will be treated as an independently ‘Self Occupied

property’ and all the provisions of the act, that are applicable to L.O.P./S.O.P. shall beapplicable to both such independent parts respectively as if they are two different

properties. For e.g.: If one property is divisible into two parts, as Part A and Part B and Part

A is let out, whereas, Part B is used by the assessee for his own residence, then both Part A

and B will be treated as two separate properties. Part A will be treated as 100 % L.O.Pwhereas Part B will be treated as 100 % S.O.P. and all the provisions of the act regarding

L.O.P will be applicable to Part A and all the provisions of the act regarding S.O.P. will be

applicable to Part B.

[E.] PROPERTY LET OUT FOR PART OF THE YEAR AND SELF OCCUPIED

DURING THE REMAINING PART OF THE YEAR: It may so happen that one single property is used by the assessee for his residence for a part of the year say for 9 months and

the same property is let out by him for the remaining part of the year say for 3 months. In

such cases, the entire property will be treated as having been let out all throughout the year and all the provisions of the act regarding L.O.P. will be applicable to such property. Rent

for three months i.e. the rent for the period during which the property was self occupiedwill be allowed to deducted [In Step no. (f.) and (g.) of Calculation of GAV of a L.O.P] as

a loss due to vacancy which is popularly known as ‘vacancy loss’ or ‘vacancy allowance’.(Such Property will be treated as L.O.P., even if it was let out only for a single day during

the entire relevant Previous Year)

49




[F.] PROPERTY JOINTLY OWNED BY TWO OR MORE PERSONS: (CO-

OWNERSHIP) (Section 26): If any property (whether SOP or LOP), is jointly owned by

two or more persons, then income from such property shall be computed in a normal way,as if the property is owned by one person only. And then the income so computed shall be

divided amongst each such co-owner in the ratio in which they had agreed to share such

H.P. income amongst themselves. (if no such ratio is given in the question, then it should be assumed to be ‘equal ratio’)

.

TREATMENT OF UNREALIZED RENT RECOVERED IN THE CURRENT

PREVIOUS YEAR :- It may so happen that the assessee receives in the current Previous

Year, the rent of H.P. pertaining to some earlier Previous Year, which could not be realized

in that year, due to some reasons. Such unrealized rent of earlier year, becomes taxable inthe year of its receipt and becomes taxable under this head only even if assesse is not the

owner of the said H.P. in the year of its receipt i.e. when second condition enumerated at

the beginning of this chapter is violated. The taxability of such unrealized rent can be

explained as follows:-

Amount of Unrealized Rent now recovered XXX

LESS: Amount of Unrealized Rent not allowed as a deduction in that year (XXX)

Amount chargeable to tax in the year of receipt of Unrealized Rent XXX

Note: No further deduction for any expenses will be allowed from the taxable amount

calculated as above. For e.g.: Deduction towards legal charges to recover such rent,

collection charges, etc.

TREATMENT OF ARREARS OF RENT RECEIVED IN THE CURRENT

PREVIOUS YEAR :- For e.g.: Due to High Court judgement, rent of property per month

is increased from Rs. 10,000/- p.m. to Rs. 12,000/- p.m. with retrospective effect from 1 st

April, 2007. Increased rent of Rs. 2,000/- p.m. from 01st April, 2007 till today is known as

Arrears of rent and not unrealized rent. That rent which was due but not received due to

some reasons is called ‘Unrealized Rent’ whereas that rent which was not due, but has now

become due, is called ‘Arrears of Rent’ or ‘Rent in Arrear’. Such Arrears of Rent aretaxable in the year of their receipt, irrespective of whether the assessee is the owner of that

H.P. in the year of receipt or not and is taxable under this head of income only, just like

Unrealized Rent. But the amount taxable will be as follows, irrespective of the year towhich such arrear of rent pertains :-

Arrears of Rent received XXXLESS: Standard Deduction U/S 24 (a) @ 30 % of Arrears of Rent (XXX)

Amount chargeable to tax in the year of receipt of Arrears of Rent XXX

50




Note: No further deduction for any expenses will be allowed from the taxable amount

calculated as above. For e.g.: Deduction towards legal charges to recover such rent,

collection charges, etc. No actual expenditure incurred will be allowed to be deducted, asStandard Deduction @ 30 % is allowed to be claimed there from.

Exercise:

Illustration 4. Mr. John Abraham owns two houses, one of which is Let Out to ABC

Ltd. and the other one is Let Out to Mr. A for Business purposes.

Determine the taxable income of Mr. John Abraham, under the head Income

from House Property for the Assessment Year 2009-2010, after taking into account

the following information relating to the property income:

Particulars House – 1 House – 2

Fair rent (Rent Control Act is not applicable)

Actual RentMunicipal Valuation – Annual Value

Municipal Taxes paid

RepairsInsurances Premium on Building

Land revenue

Ground rent

Interest on Capital borrowed by mortgaging House-1(funds are used for construction of House –2)

Nature of occupation

Date of completion of Construction

Amount

1,20,000

1,26,0001,22,000

28,000

7,0006,000

15,000

8,000

36,000

Let-out to ABC

Ltd.

March, 1996

Amount

3,64,000

3,68,0003,70,000

80,000

15,40066,000

48,000

15,600

------

Let-out to

Mr.A for

BusinessApril, 1998

Solution:

MR. JOHN ABRAHAM

Computation of Taxable Income from House Property

Status: Individual Res. Status: R & OR

Previous Year: 2009-10 Assessment Year: 2010-2011

P.A.No.: ___________

Particulars Amount Amount Amount

51




Income from House property:

House – 1 (Let-out for residence):

Gross Annual Value (being maximum of Municipal

Valuation, Fair Rent and Actual Rent)

Less: Municipal Taxes Net annual value

Less : (i) Statutory Deduction @ 30 % of NAV U/S24 (1)

(ii) Interest u/s 24 (2): (as the funds are

utilized for House –2, it is not deductible

from House – 1

House –2 (Let-out business):

Gross Annual Value (being maximum of MunicipalValuation, Fair Rent and Actual Rent)

Less: Municipal tax Net Annual ValueLess: (i) Deductions U/S 24(1) Standard Deduction

(30 % of N.A.V. of Rs. 2,90,000/-)

(ii) Interest on funds borrowed U/S 24(2) – (asthe amount is borrowed for construction of

House -2, it is deductible even if House-1 is

mortgaged]

Net Taxable Income from House Property.

29,400

NIL

87,000

36,000

1,26,000

(28,000)98,000

(29,400)

3,70,000

(80,000)2,90,000

(1,23,000)

68,600

1,67,000

2,35,600

52




CH-7

PROFITS AND GAINS OF BUSINESS/PROFESSION

(SECTION 28 TO SECTION 44D)

In all, there are three concepts, namely, (i.) Business, (ii.) Profession and (iii.)Vocation. There’s no need to explain the term ‘Business’, as it is very much self-

explanatory. According to section 2(13), the term ‘Business’ is defined to include any

Trade, Commerce or Manufacture or any Adventure or Concern in the nature of Trade,Commerce or Manufacture. The term ‘Profession’ has been defined in a very narrow

manner. According to section 2(36), the term ‘Profession’ has been defined to include any

‘Vocation”. The terms ‘Profession’ and ‘Vocation’ are very similar to each other; the onlydifference is that ‘Vocation’ requires ‘natural abilities’, whereas ‘Profession’ requires some

kind of ‘educational qualification’. Chartered Accountant, Doctor, Lawyer are examples of

profession, whereas examples of vocation would include, Carpenter, Cobbler, Plumber,Barber, etc. Income Tax Act, does not recognize any difference between Profession and

Vocation, according to it both vocation and profession are one and the same, but it doesrecognize the difference between ‘Business’ and ‘Profession’. Though, act recognizes the

difference between the two, income from both are taxed at the same rates and in a similar way.

As per Section 28 of the Income Tax Act, the following conditions are required

to be satisfied in order to charge an income under this head:-

(1.) There should be either Business or Profession ( Profession includes Vocation)

(2.) Business or Profession should be carried on by the assessee.

(3.) Business or Profession should be carried on during the previous year.

Even if all the above conditions are satisfied, the following incomes are notchargeable to tax under this head (they may be chargeable under some different head of income):-

(1.) Rent from House Property, even though it is a business of the assessee. It isalways chargeable to tax as income from House Property.

(2.) Winnings from Lotteries, Puzzles, Crossword, Card Game or any other game of

any sort or nature, Races including Horse Races, Gambling or Betting of any sort,etc. Such incomes are always taxable as income from other sources.

(3.) Dividend income. Dividend income is always taxable as Income from Other

Sources.

Note:- Income from ‘Illegal business’ is also chargeable to tax and is chargeable under this

head only.

# Following Incomes are chargeable to tax under this head:-

53




(1.) Profits and Gains of Business or Profession carried on by the assessee,

(2.) Compensation received for terminating ‘Agency’ continued by the assessee or

compensation received for modification of any agreement,(3.) Sale proceeds of an Import License or an Export License,

(4.) Cash assistance received from Government. For e.g.: Subsidy received from

Government,(5.) Duty Drawback of excise duty upon exporting goods,

(6.) Salary, Bonus, Commission, Interest on Capital or any other remuneration received

by a partner from partnership firm, provided such payment was allowed to the firmas a deduction from its income,

(7.) Gift received by the assessee, whether in cash or in kind, related to his Business or

Profession (if gift is in the nature of a ‘Personal gift’, then it is not chargeable to

tax as an income under any head),(8.) Maturity proceeds of a Key-man Insurance Policy (K.I.P.), including bonus therein,

if any (for meaning of ‘Key-man Insurance Policy’ refer to Chapter- I of this

book),

(9.) Income from Speculative business.

# Following Losses are allowed to be deducted from above incomes under this

head:- (Generally allowable Losses)

(1.) Loss of Stock due to Tsunami, Fire, Flood, Accident, etc. or any other Natural

Calamities,

(2.) Fall in the value of stock-in-trade due to devaluation in the market price of stock-in-

trade,(3.) Loss of Cash by theft,

(4.) Loss due to negligence or dishonesty of employees,(5.) Loss due to insolvency of a Banker or a Banking Company, with whom assessee hasan account,

(6.) Apart from the above any other loss will be allowed to be deducted from the above

income, if following conditions are satisfied:-(a.) Loss should be in the nature of a ‘Revenue Loss’ and not in the nature of a

‘Capital Loss’.

(b.) Loss should have been incurred during the Previous Year.

(c.) Loss should be incidental to or related to the Business or Profession of theassessee.

# Following Losses are not allowed to be deducted :- (Generally disallowable Losses)

(1.) Loss not related to Business or Profession,(2.) Loss in the nature of ‘Capital Loss’ or a loss due to damage or destruction of a

capital asset,

54




(3.) Expenditure incurred to set up a new Business or Profession, which ultimately could

not be set up, For e.g.: Expenditure on conducting research or a survey before setting

up a new business,(4.) Anticipated future losses. For e.g.: Provision for Bad Debts or Doubtful Debts, as

such losses are not actual loses but are all future anticipated or expected losses.

# Expenses Expressly allowed to be deducted :- (Expressly allowable Expenses ):

(1.) Section 30 : Rent, Rates, Taxes, Repairs of a Building,

(2.) Section 31 : Repairs and Insurance of Plant, Machinery and Furniture,

(3.) Section 32 : Depreciation on assets – if following conditions are satisfied:-

Conditions:-

(a.) Assessee should be the owner of the asset, either entirely on his own or

jointly with others.

(b.) Asset must be used in the Business or Profession of the assessee.(c.) Asset must have been used during the Previous Year. (not necessarily for

the whole year, but at least for one single day)Depreciation is not charged on an individual asset, but is charged on a “Block of

Assets”, as defined by section 2 (11) and is computed as follows:-

BLOCK OF ASSET WITH DEPRECIATION @ 10 % AMOUNT

Opening W.D.V. of the block XXX

(+) Cost of any new asset within the same block purchased during the year XXX(-) Selling Price of any asset of the block sold during the year (XXX)

Balance W.D.V. available for charging depreciation XXX(-) Depreciation at the rate applicable to the block i.e. 10 % in this case(10 % of balance W.D.V. as calculated above) (XXX)

Closing W.D.V. of the block XXX

Points to be noted about Depreciation:-

No depreciation is allowed when W.D.V. of block of assets become zero or

negative. (It is possible only when any of the asset/s within the same block is sold

during the year and its/their selling price is equal to or more than the Opening

W.D.V. of the block (+) Cost of any new asset within the same block purchasedduring the year).

No depreciation is allowed when block become empty i.e. when all the assets

belonging to the block are sold off. (This is applicable mainly, where all the assetsof the block are sold off but still some balance W.D.V. is left out in the block,

where selling price of all the assets of the block is less than the opening W.D.V. (+)

cost of new addition to the block)

55




Depreciation is allowable at the rates prescribed by the Income Tax Act and not at

the rates prescribed by the Companies Act or as per wear and tear of the asset or as per normal practice followed by the assessee. Depreciation is always to be charged

as per provisions of the Income tax Act, 1961 and the rates of depreciation are

provided by Appendix – I and II of Income Tax Rules.

If an asset is newly purchased during the Previous Year and is used for less than180 days (its 180 days and not 182 days as in case of ‘Residential Status’) then

only half year’s depreciation is allowed.

Charge of Depreciation is mandatory. In other words, Assessee has to charge thedepreciation year after another, whether he wants to claim depreciation or not, as

charging of depreciation is not optional to the assessee.

As per provisions of the Income Tax Act, 1961, Depreciation is always chargeable,applying “Written Down Value Method”, except in case of an assessee being a

Power Generating or Distributing Unit/Company, who are allowed to follow

“Straight Line Method” for charging depreciation

Depreciation on ‘Imported Cars’: No Depreciation is allowable on imported cars

purchased between 01st March, 1975 and 31st March, 2001.But depreciation on imported cars will be allowed (even if imported car was

purchased during the above period), in the following exceptional cases:-

Imported car is used in India for ‘Tourism Business’.

Imported car is used outside India for Business or Profession in foreign

country.

Illustration 1. From the following particulars, ascertain the depreciation admissible

under section 32 of the Income Tax Act, 1961 and other liabilities, if any, in respect to

the Previous Year relevant to the Assessment Year 2010-2011.

Building Plant

Rs. Rs.

W.D.V. at the beginning of the year

Additions during the year

Sales during the year

2,50,000

3,00,000

6,00,000

10,00,000

NIL

2,00,000

Solution:

Computation of Depreciation Allowable under section 32 of the act.

Particulars Building

Rs.

Plant

Rs.

Opening W.D.V.

Addition during the year

Less: Sales during the year

Short term Capital Gains

2,50,000

3,00,000

5,50,000

(6,00,000)

50,000

10,00,000

NIL

10,00,000

(2,00,000)

NIL

56




Balance W.D.V. of the Assets

Less: Depreciation for the year @ 10%

8,00,000

(80,000)

Closing W.D.V. NIL 7,20,000

Therefore, Depreciation admissible under section 32 of the Income Tax Act, 1961

for the Previous Year, relevant to Assessment Year 2010-2011 is Rs. 80,000/-.

(4.) Section 36(1)(i) : Insurance Premium paid/payable on Stock-in-trade.

(5.) Section 36(1)(ii) : Insurance Premium paid/payable on health (health and not onlife) of employees, provided it is paid by Cheque, otherwise deduction will not be

allowed.

(6.) Section 36(1)(iii) : Bonus, Commission, etc. paid to employees or to partners,subject to maximum limit specified by section 40(b).

(7.) Section 36(1)(iv) : Interest on loan taken or capital borrowed for Business purpose,

subject to provisions of section 43B.

(8.) Section 36(1)(v) : Contribution by employer to Employees’ Provident Fund

(E.P.F.), Recognized Provident Fund (R.P.F.), Super-annuation Fund (S.A.F.) onlyif paid within the due date for such payment.

(9.) Section 36(1)(vi) : Employer’s contribution to an approved Gratuity Fund.(10.) Section 36 (1)(vii): Write Off allowance for animals/cattle used as stock-in-trade

for business or profession carried on by assessee.

(11.) Section 36(1)(viii): Actual Bad Debts (and not provision for bad debts).(12.) Section 36(1)(ix): Revenue expenditure on promoting Family Planning

amongst employees is fully allowed, but if it is a Capital expenditure then 1/5 th of such

capital expenditure will be allowed as a deduction every year for five years. (However,this deduction on account of promoting Family Planning amongst employees, whether

revenue or capital is allowable only to ‘Companies’ and not to any other assessee)

(13.) Section 36(1)(xv): Securities Transaction Tax (STT) paid in the business of dealing in Securities.(14.) Section 36(1)(xvi): Commodities Transaction Tax (CTT) paid in the business of

dealing in Commodities.

# Expenses generally allowed to be deducted :- (Generally allowable Expenses ):

As per Section 37(1), apart from expressly allowed deductions, other general

expenses are also allowed to be deducted subject to followings:-

It should not be a Capital expenditure.

It should not be a Personal expenditure.

It should have been incurred during the Previous Year.

It should be in respect of Business or Profession carried on by the assessee.

It should not have been incurred for any purpose, which is an ‘offence’ .

‘Wealth Tax’ and ‘Income Tax’ ‘Fringe Benefit Tax’ are not allowed to bededucted. (But ‘Sales Tax’, ‘Service Tax’, ‘Excise Duty’, ‘Customs Duty’,

‘Value Added Tax – VAT’ ‘Professional Tax’, ‘Octroi Duty’, ‘Entertainment

Tax’ ‘Securities Transaction Tax (STT)’ are allowed to be deducted)

57




# Expenses Expressly disallowed to be deducted :- (Expressly disallowable

Expenses):

1) Section 37(2)(b) : Advertisement given in ‘Political Souvenirs’ : Any

expenditure incurred by assessee on advertisement in any souvenir, brochures,

pamphlets, tracts of any political party whether directly or indirectly is entirelydisallowed.

2) Section 40(a) : Payment outside India without T.D.S.: Any Royalty, Intr est,

fees for technical service paid/payable outside India whether to a residentIndian or non-resident Indian or to any other person, without deducting tax at

source (T.D.S.) is not allowed as deduction. If the T.D.S. is deducted in

subsequent year and deposited with the Central Government, then deduction

can be claimed in that subsequent year in which T.D.S. is deducted anddeposited with the Central Government.

3) Section 40(a)(ia) : Payments in India without T.D.S.: Certain payments made

to any person in India, like Royalty, Interest, Commission, Professional Fees,

Fees foe technical Services, etc without deducting tax at source (T.D.S.) is notallowed as deduction. If the T.D.S. is deducted in subsequent year and

deposited with the Central Government, then deduction can be claimed in thatsubsequent year in which T.D.S. is deducted and deposited with the Central

Government.

4) Section 40(a)(3) : Salary payable outside India without T.D.S.:If any salary is paid or is payable outside India without deducting T.D.S. there from, without

deducting tax at source (T.D.S.) is not allowed as deduction. If T.D.S. is

deducted in subsequent year and deposited with the Central Government, then

deduction can be claimed in that subsequent year in which T.D.S. is deductedand deposited with the Central Government.

5) Section 40(a)(5) : Tax on non-monetary perquisites given by employer toemployee: If employer provides any tax-free non-monetary perquisite to anyemployee, then tax paid by employer on such perquisite is not allowed as a

deduction to employer from his taxable income.

6) Section 40A(2) : ‘ Excessive’ payments to ‘Relative’ : An payment made by anassessee relative or any person having a ‘substantial interest’ in the business of

the assessee, if found to be excessive or unreasonable according to assessing

officer, having regard to ‘ fair market value’ or ‘legitimate needs’ of the

business of the assessee, will not be allowed as a deduction to the assessee.(only that part of the expenditure will be disallowed as a deduction, which is

found to be unreasonable or excessive) (excessive payment to a non-related

person or to a person not having any substantial interest will not be disallowed)(substantial interest means holding of 20 % or more of voting rights or equity

shares or profit sharing rights).

7) Section 40A(3) : Cash payment in excess of Rs. 20,000/-: If any ‘ Revenueexpenditure’ paid by the assessee during the Previous Year is in excess of Rs.

20,000/- by any mode other than by way of a ‘ crossed cheque’, then the entire

amount of such expenditure will be disallowed.

Points to be noted:-

58




o Section 40A(3) is applicable only to ‘ Revenue expenditures’ and not to

‘Capital expenditures’.

o The ‘entire’ expenditure will be disallowed and not the amount in excess of Rs.

20,000/-

o Section 40A(3) is applicable only to deductible expenditures and not to thoseexpenditures which are not deductible only.

o Section 40A(3) is subject to exceptions enumerated under Rule 6DD of the

Income Tax Act.

o Limit of Rs. 20,000/- prescribed above is applicable to payment made to any

single person in any one day and is not a ‘yearly’ limit.

8.) Section 40A(7) : Provision for Gratuity on retirement: Any amount debited to P

& L A/C as a ‘Provision for Gratuity on retirement’, payable to employees on their retirement, is not allowed as a deduction. (Because provision for gratuity on

retirement is not an actual liability of the assessee, it’s just a contingent liability)9.) Section 40A(9) : Contribution by employer to a Non-Statutory Fund is not allowed

as a deduction to the employer.10.) Section 43B: Unpaid Statutory Liability: Certain expenses are allowed to be

deducted only on actual payment basis, i.e. they are deductible only if they are

actually paid during the year. Following is the list of such expenditures:-

Any Tax, Duty, Cess, Fees payable under any law. (Fees here would mean

legal fees in the form of tax)

Contribution to any Recognized Provident Fund (R.P.F.), Superanuation Fund

(S.A.F.) or ay other Employees’ Welfare Fund.

Bonus or Commission to ‘employees’ . (Bonus/Commission does not includeany other incentives given to employees. Here, the act has specified only

bonus/commission. So any incentive other than bonus/commission is not

subject to any restriction imposed by section 43B) (Here, we are talking about bonus/commission to ‘employees’ only and not to any other person, e.g. we are

not concerned with bonus/commission paid/payable to an agent)

Any sum payable as an interest on loan from any ‘Public Financial

Institution’ like ICICI, HDFC, IDBI, IFCI, etc.

Interest on any term loan or an advance taken from any ‘Scheduled bank’.

‘Leave Salary’ paid to an employee either during his service or at the time of

his retirement.

All the above expenses will be allowed to be deducted only if actually paid either during

the Previous Year or at any time after the end of the financial year but on or before the duedate for filing of the Income Tax Return for that Previous Year, otherwise it will not be

allowed to be deducted in the year in which such expenditure was due. Such expenditure

can then be claimed only in that year in which its actual payment is being made.

# FORMAT OF COMPUTATION OF PROFITS AND GAINS OF BUSINESS OR

59




PROFESSION:

[I] WHEN INCOME AND EXPENDITURE ACCOUNT OR RECEIPTS AND

PAYMENTS ACCOUNT IS GIVEN (NORMALLY IN CASE OFPROFESSIONAL INCOMES):

PARTICULARS AMOUNT AMOUNT

A.] PROFESSIONAL INCOMES:

1.)……………………………...2.)……………………………...

3.)……………………………...

4.)……………………………...

XXX

XXXXXX

XXX XXX

LESS: B.] PROFESSIONAL EXPENDITURES:

1.)……………………………..

2.)……………………………..

3.)……………………………..4.)……………………………..

XXX

XXX

XXX

XXX (XXX)

TAXABLE INCOME UNDER THE HEAD PROFITS

AND GAINS OF BUSINESS OR PROFESSION

______

XXXX

[II] WHEN PROFIT AND LOSS ACCOUNT IS GIVEN (NORMALLY IN CASE

OF BUSINESS INCOME):


NET PROFIT OR LOSS AS GIVEN

ADD:EXPENSES DISALLOWED BUT DEBITED TO

PROFIT AND LOSS ACCOUNT:

1.)……………………………...2.)……………………………...

3.)……………………………...

4.)……………………………... LESS:EXPENSES ALLOWED BUT NOT YET

DEBITED TO PROFIT AND LOSS A/C:

1.)…………………………….

XXXXXX

XXX

XXX

XXX

XXX

XXX

60




2.)…………………………….

3.)……………………………4.)……………………………

XXX

XXXXXX (XXX)

LESS: INCOME NOT CHARGEABLE BUT STILLCREDITED TO PROFIT & LOSS A/C:

1.)……………………………..

2.)……………………………..

3.)……………………………..

4.)……………………………..

ADD: INCOME CHARGEABLE BUT NOT YET

CREDITED TO PROFIT AND LOSS A/C:

1.)…………………………….

2.)…………………………….

3.)…………………………….4.)…………………………….

XXX

XXX

XXX

XXX

XXX

XXX

XXXXXX

(XXX)

XXX

TAXABLE INCOME UNDER THE HEAD PROFITS

AND GAINS OF BUSINESS OR PROFESSION

______

XXXX

CH - 8

61




INCOME FROM CAPITAL GAINS


Under Section 45 (1), Profits and Gains arising on transfer of a Capital Asset is

chargeable to tax under this head of income. An income is chargeable to tax under this head of income, only if all the following five conditions are satisfied:-

(1.) There must be a ‘Capital Asset’,

(2.) The capital asset must be ‘Transferred’,

(3.) Such Capital Asset must be transferred during the Previous Year,

(4.) As a result of transfer of capital asset, there should be a ‘Profit’ or ‘Gain’ arising

thereon,

(5.) Such Profit or Gain arising on transfer of capital asset, should not be exempt from tax

under section 54 of the act.

If all the above five conditions are satisfied, then such profit or gain arising on transfer

of a capital asset is chargeable to tax under this head. It would be worthwhile to note here, that

these conditions are subject to certain exceptions, which will be dealt with as and when we comeacross such exceptional cases. Let us now try and understand all the five conditions mentioned

above.

(1.) There must be a ‘Capital Asset’: The term ‘Capital Asset’, has been defined by Section 2

(14) as ‘A Property of any kind, held by the assessee, whether connected with his Business or

Profession or not, whether tangible or intangible, moveable or immoveable, fixed or circulating’

For e.g.: Land, Building, Plant, Machinery, Vehicles, etc. are examples of tangible capital assets,

whereas, Goodwill, Patent, Copy Right, Trade Mark, etc. are examples of intangible capital

assets. But section 2 (14) excludes, the following Capital Assets from its purview. In other words,

though the following six assets are capital assets, they are specifically being excluded from the

definition of ‘Capital Assets’:-

(a.) Any Stock-in-trade, Consumables Stores, Raw Materials held for Business or Profession

of the assessee. Profit on sale of such stock-in-trade will be chargeable as Profits and

Gains of Business or Profession of the assessee. Whether a particular asset is stock-in-

trade or not depends on the business of the assessee, for example a ‘car’ may be a capital

asset for others, but for an assessee who is a dealer of cars, car is certainly, stock-in-trade.

(b.) Any ‘Personal effects’ (excluding jewellery, gold, etc.) of the assessee, i.e. any moveable

property of the assessee, including any wearing apparel or furniture held for personal use

of the assessee or for use of any of his family members who are dependent on him. Any

Jewellery, Gold, Ornaments, Precious or Semi-Precious Stones (Stones – whether sewn

into any wearing apparel or studded in any furniture or otherwise), Precious or Semi-

Precious Metal or any Alloy of such Metal are considered to be Capital Asset, even

though these are asseessee’s personal effect. Even any Immoveable Property held by

assessee is capital asset even if held for personal use, for e.g.: Assessee’s own personal

Residential House, though used by him for his personal residence, is not considered as a

part of his ‘personal effect’ and is therefore, considered as a ‘capital asset’ and any gain

arising on transfer of a such residential house is chargeable to tax as capital gain.

However, Drawings, Paintings, Archaeological Collections, Sculptures, though meant

for ‘personal purpose’, they are not to be considered as ‘Personal Effect’, therefore, such

assets will be considered as capital assets.

62




(c.) Any Rural ‘ Agricultural Land ’ situated in India.: If ‘Agricultural Land’ is situated in

rural area in India, then that agricultural land is excluded from the purview of ‘capital

assets’. But if agricultural land is situated ‘outside India’ or is situated in ‘an urban area

in India’ or ‘outside India’, then such land shall be treated as capital asset, even if it is

used for agricultural purposes.

(d.) 6 ½ % Gold Bonds, 1977 , 7 % Gold Bonds, 1980, National Defence Bonds, issued by

Central Government.

(e.) Special Bearer Bonds, 1991.

(f.) Gold Deposit Bonds, issued under Gold Deposit Scheme, 1999.

(g.) Goodwill of a Profession (and not Goodwill of a Business)

(2.) The capital asset must be ‘Transferred’: Such capital asset must be transferred. As defined

by section 2(47) the term transfer includes the followings:-

(a.) Sale of a Capital Asset,

(b.) Exchange of a Capital Asset. For e.g.: when Mr. A, exchanges his old car for a new one,

it amounts to transfer of his old car.

(c.) Relinquishment of a Capital Asset. In other words, withdrawing the ownership in an assetor surrendering an asset, whether for cash or otherwise. For e.g.: Mr. X relinquishes his

50 % right in a joint property, in favour of his brother Mr. Y, without any cash

consideration, then it amounts to transfer of Mr. X’s 50 % right in joint property.

(d.) Extinguishment of a Capital Asset. When an asset ceases to exist, it is called

extinguishment of that asset. For e.g.: If some Machinery being a capital asset, belonging

to Mr. X, was completely destroyed by fire and that machine was fully insured and

insurance claim was being lodged by Mr. X, it amounts to transfer of that machinery by

Mr. X in favour of insurance company.

(e.) Compulsory Acquisition of a Capital Asset, under any law.

(f.) Transfer of property under section 53A of the Transfer of Property Act, i.e. transfer of

physical possession of the property in part performance of contract of selling the

property.(g.) Any other transaction, which has an effect of transferring the immoveable property

belonging to the assessee.

(h.) Conversion of a Capital Asset in to ‘Stock-in-Trade’.

(i.) Introduction of a Capital Asset by a partner in his partnership firm, as his capital

contribution.

There are however, few exceptions to the definition of ‘Transfer’, i.e. some transactions

are not regarded as transfer. The following transactions are not regarded as ‘Transfer’, hence no

capital gain tax liability will arise in case of following transactions:-

(a.) An asset transferred or given to somebody by way of ‘Gift’,

(b.) An asset transferred by way of ‘Will’, upon death of assessee,

(c.) Conversion of Debentures into Equity or Preference Shares,

(d.) Transfer of Goodwill of ‘Profession’ (only of a Profession and not of Business)

(3.) Such Capital Asset must be transferred during the Previous Year: Capital Gains are

chargeable to tax on accrual basis, i.e. to say that capital gains are chargeable to tax in the year in

which the asset is transferred, whether selling price is received in that year or not. In other words,

the year of transfer of the capital asset is the year in which the capital gain arising thereon ischargeable to tax, irrespective of the date of receipt of the sale consideration. Even method of

accounting followed by the assessee is irrelevant. There are two exceptions to this general

63




condition (i.) A case of transfer, where a capital asset of an assessee is compulsorily acquired by

Government under ‘Compulsory Acquisition’ under any law. In such a case capital gain arising

on transfer of such asset is not chargeable to tax in the year of transfer of the asset, but is taxable

in that year in which the assessee receives the compensation (sale consideration) from the

Government. If compensation is received from Government in part or in installment, then capitalgain will be taxable in that year in which the first installment is received by the assessee. (ii.) In a

case, where a Capital Asset of the assessee is converted by assessee into ‘Stock-in-Trade’. In sucha case, the capital gain will be taxable in that year in which the converted asset is finally sold as

stock-in-trade and not in the year in which it is converted into stock.

TYPES OF CAPITAL ASSETS: From students’ point of view, a Capital Asset may either be

Tangible or Intangible, Fixed or Circulating, or Moveable or Immoveable. But from Income Tax

Act point of view, Capital Assets are of two types, namely, Short Term or Long Term. Short

Term and Long Term Assets are not two separate assets. An asset, which is a short term capital

asset, can become long term capital asset, if held by assessee for some more period of time. In

other words, character of an asset is dependent on the period of holding (P.o.H.) of that asset by

the assessee. Let us now understand these two types of Capital Assets.

(a.) SHORT TERM CAPITAL ASSET: If a Capital Asset is held by the assessee for a period

not exceeding 36 months (3 Years) is called ‘Short Term Capital Asset’. In other words, if a

capital asset is held for a period upto 36 months, then it is called ‘Short Term Capital Asset’.

(b.) LONG TERM CAPITAL ASSET: If a Capital Asset is held by the assessee for a period of

more than 36 months, then it is called ‘Long Term Capital Asset’.

CAPITAL ASSET

SHORT TERM LONG TERM

If PoH < 36 Months If PoH > 36 Months

In other words, a capital asset is called as short term upto first 36 months of its period

of holding, then from the very next day after completion of 36 months’ period, the same asset will

be called as long term capital asset.

EXCEPTION TO THE ABOVE RULE: In the following three cases, for determining whether

the asset is short term or long term, the period of holding of 36 months, as discussed above, shall be substituted by 12 months.

i.) Equity or Preference Shares, whether listed on any recognized Stock

Exchange or not.

ii.) Listed Debentures or Government Securities, only if listed on any

recognized Stock Exchange.

64




iii.) Units of a Mutual Fund or units of UTI (UNIT TRUST OF INDIA),

whether listed on any recognized Stock Exchange or not, whether such units

are quoted or not.

In all the three cases above, if they are held by the assessee for a period upto 12

months, then they are called short term capital asset, whereas, if they are held for a period of

more than 12 months, then they shall be called as long term capital asset.

Now a question that arises, is why such bifurcation of capital assets into short term andlong term? We need to bifurcate all capital assets into short term and long term, because of

difference in the chargeability of gain on transfer of these capital assets to tax. Gain arising on

transfer of a Short Term Capital Asset is added to other normal incomes and chargeable to tax at

normal rates of tax, whereas, gain arising on transfer of a Long Term Capital Asset is chargeable

to tax at a flat rate of tax of 20 % under section 112.

PERIOD OF HOLDING: Period of holding means, the period starting from the date on which

the asset was acquired by the assessee and ending on the date of transfer of the asset by the

assessee or the date on which the calculation of such period is made, whichever is earlier. Period

of holding plays an important role, as it can change the character of the asset from short term to

long term and can thereby change the taxability of the gain arising on its transfer. The following

points shall be borne in mind while calculating the period of holding of an asset:-

(a.) Liquidation of a Company : Where equity or preference shares are held in a company

and that company goes into Liquidation, the period of holding of these shares shall come

to an end, immediately on the date on which that company goes into liquidation. In other

words period subsequent to the date of liquidation of the company shall be ignored while

computing the period of holding of shares.

(b.) Amalgamation [Section 49(2) ]: If two or more companies amalgamate and form a new

company, under a scheme of Amalgamation and a shareholder (assessee) of an

amalgamating company is issued new shares in amalgamated company in lieu of his/her

shares in amalgamating company. The period of holding of these new shares in the

amalgamated company shall include the period of holding of old shares in amalgamatingcompany, provided that the amalgamated company is an Indian company (As if no new

shares were allotted and assessee continued holding old shares in that amalgamating

company and calculation is being made for those old shares only).

(c.) Demerger : In a similar way, when an assessee is being issued with shares in a resulting

company in lieu of his/her shares in a demerging company, under a scheme of Demerger,

the period of holding of these new shares in resulting company shall include period of

holding of shares in demerging company, provided that the resulting company is anIndian company.

(d.) Issue of Bonus Shares : When an assessee is being issued Bonus Shares as a result of

his/her holding original shares, the period of holding of Bonus Shares shall be calculated

from the date of issue of such bonus shares. The period of holding of original shares,

shall not be included in period of holding of bonus shares.

(e.) Conversion of Debentures : When Debentures or Debenture Stock or such Deposits held

by assessee are converted into Equity Shares, the period of holding of such equity shares

shall be calculated from the date of their conversion from debenture and shall not include

the period of holding of those debenture or debenture stock.

(f.) Right Shares : When an offer is made by a company to its existing shareholders to

subscribe for right shares, which is known as ‘Right Entitlement’ and shareholder

subscribes for shares offered under right offer and such right shares are allotted to

65




him/her, the period of holding of such right shares shall be calculated from the date of

allotment of such right shares and not from the date on which the right offer is made by

the company. The period of holding of original shares shall not be added in the period of

holding of right shares.

(g.) Right Entitlement : When a ‘Right’ offer is made by a company to its existing

shareholders, it is known as ‘Right Entitlement’. Such entitlement is also a capital asset.

A Shareholder may either subscribe to such right shares offered or he may sell off thatright entitlement in the market. If he/she sells off such right entitlement, it is known as

‘Renouncement of Right Entitlement’ and one will have to calculate the profit or gain

arising on transfer of such right entitlement. The Cost of acquisition of right entitlement

shall be NIL. Period of holding of such right entitlement shall be calculated from the date

on which the company made such offer to subscribe for right shares.

(h.) Section 49(1) Transactions : Transactions, which are covered by section 49 (1) i.e.

transactions where a capital asset becomes the property of the assessee otherwise than by

way of purchase, the period of holding of the current owner (Assessee) shall include the

period for which the asset was held by its previous owner.

FORMAT OF COMPUTATION OF SHORT TERM CAPITAL GAINS:


Full Value of Sale Consideration (Received + Receiveable)

Less: Transfer Expenses, like Brokerage, Commission, etc.

(Wholly and exclusively in connection with transfer)

Net Sale Consideration

Less: (1.) Cost of Acquisition (C.O.A.) (Whether Actual or

Notional)

(2.) Cost of Improvement (C.O.I.)

(Additions/Alterations to the Asset)

SHORT TERM CAPITAL GAIN / (LOSS)

XXX

XXX

XXX

(XXX)

XXX

(XXX)

XXX

Now let us try to understand the various terminologies used in the above format.

(1.) Full Value of Sale Consideration : means what one receives when an asset is being

transferred, whether received immediately or receivable after some time. For Income Tax

purpose Capital Gains are chargeable to tax on accrual basis, irrespective of the method

of accounting followed by the assessee. It does not mean the market value of the asset

transferred. It may be received in cash or in kind. If it is received in kind, then market

value of what is received in kind shall be treated as a full value of sale consideration,

Book entries are irrelevant for the purpose. Adequacy or inadequacy of the consideration

is also irrelevant.

(2.) Transfer Expenses : Tansfer Expenses incurred by an assessee wholly and exclusively in

connection with the transfer of the capital asset, are allowed to be deducted from the full

value of consideration, provided such expenses are not deductible under any other head

of income, i.e. no double deduction of any expense is allowed. For e.g.: Commission,

Brokerage, Stamp Charges, Registration Charges, Travelling and Conveyance Charges,

etc. incurred in connection with the transfer of the asset. Expenses shall be real ones,

Notional Expenses are not allowed to be deducted.

(3.) Cost of Acquisition : is the price for which a capital asset is acquired by the assessee. It

even includes expenses of a capital nature for completing or acquiring a title or ownership of a property. For e.g.: Stamp Duty, Brokerage, Commission, etc. paid while

66




acquiring a house property, or interest on capital borrowed for acquiring a property (only

interest incurred upto the date of acquiring the property) are all part of actual cost of

acquisition of that property. Legal expenses incurred in connection with acquisition of an

immoveable property is allowed to be capitalized. The following additional points

regarding cost of acquisition shall be worth noting:-

Cost of Acquisition of an ‘Intangible Asset’: [like Patent, Goodwill of a Business

(of Business only and not a Goodwill of a Profession) or Copyright, Trademark,

Brand Name, Tenancy Rights, Loom Hours, Right to Carry on Business, Right to

Manufacture any Article or a Thing, etc.] As per section 55(2a), if such

intangible asset is Self-Generated (Self-Developed) then the cost of acquisition is

always to be taken as NIL or ZERO. But if these assets are not self-generated and

are purchased by the assessee from somebody, then cost of acquisition of such

asset in the hands of the assessee shall be the actual amount paid by the assessee

towards acquiring it.

In case of transactions covered by section 49(1 ), i.e. a case where capital asset is

received by assessee free of cost by way of Gift, Will, Inheritance, the Cost of

Acquisition in the hands of the current owner of the asset i.e. in the hands of the

assessee, shall be the cost of acquisition to the previous owner of that asset. In

case where, the previous owner acquired such asset before 01st April, 1981, thencost of acquisition in the hands of the current owner shall be either the cost of

acquisition of that asset in the hands of the previous owner of that asset or Fair

Market Value (F.M.V.) of such asset as on 01st April, 1981, whichever is higher.

As per section 49(2), the Cost of acquisition of shares in an Amalgamated

Company (New Company) received by the assessee in lieu of his shares in

Amalgamating Company (Old Company) under a scheme of amalgamation, shall

be same as the cost of acquisition of shares of amalgamated company (old

company). For e.g.: If assessee acquired 1,000 shares in ABC Ltd. @ Rs. 10/- per

share (i.e. Rs. 10,000/- total investment made). ABC Ltd. amalgamated with

XYZ Ltd. and 500 shares of XYZ Ltd. were issued to the assessee in exchange of

1,000 shares in ABC Ltd. The cost of acquisition of 500 shares in XYZ Ltd. shall be Rs. 10,000/- only or Rs. 20/- per share of XYZ Ltd., irrespective of the market

price of shares of XYZ Ltd.

Cost of Acquisition of shares received upon conversion of Debentures : As

per section 49(2), where Debentures, Debenture Stock or any Deposit

Certificates are converted into Equity or Preference Share s , the cost of

acquisition of these new shares shall be same as the cost of acquisition of

Debentures, Debenture Stock or Deposit Certificates. If these Debentures,Debenture Stock or Deposit Certificates are partly converted into Equity or

Preference Shares and balance part is redeemed for cash, then cost of acquisition

of new shares shall be the proportionate cost of acquiring Debentures, Debenture

Stock or Deposit Certificates. For e.g.: If 60 % of a 100/- Rs. Debenture is

converted into 5 equity shares and balance 40 % is redeemed for cash, then costof acquisition of these 5 shares shall be Rs.60/- in total or Rs. 12/- per share, i.e.

60 % of the cost of acquisition of one debenture.

As per section 55(2aa), the Cost of Acquisition of Bonus shares , allotted before

01 st April, 1981 shall be the Fair Market Value of such shares as on 01st April,

1981. But if Bonus Shares are being allotted on or after 01 st April, 1981, then the

cost of acquisition of such Bonus shares shall always be taken as NIL.

67




As per section 55(2aa), the Cost of Acquisition of Right Entitlement shall be

NIL.

As per section 55(2aa), the Cost of Acquisition of Right Shares in the hands of

the assessee, shall be the amount actually paid by him/her to the company for

acquiring such right shares. But if such right shares are not being subscribed for, but are renounced by the assessee in favour of another person and when such

other person i.e. transferee of the right entitlement, subscribes for right shares,

then the cost of acquisition of right shares in the hands of such person shall be the

amount actually paid him/her to the company towards right shares plus amount

paid by him/her to the transferor of right entitlement towards right entitlement.

As per section 55(2b), the Cost of acquisition of a Capital Asset acquired

before 01st April, 1981 shall be either the actual cost of acquisition or its Fair

Market Value as on 01st April, 1981 , whichever is higher. This option of

substituting original cost by Fair Market Value as on 01st April, 1981, is however

not applicable in case of Depreciable Assets (u/s 50A), or any intangible asset

like Goodwill of Business, Trademark, Brand-name, Tenancy Rights, Loom

Hours, Stage Carriage permit, Route permit.

(2.) Cost of Improvement [C.O.I.] [Section 55(1)]: C.O.I in relation to any tangible asset

means all expenses of a capital nature, incurred in connection with an Addition,

Alteration, Modification, or Rectification to the tangible asset . For e.g.: A Building

consisting of three floors was acquired by an assessee for Rs. 50 Lacs in 1992. In 1995

assessee spent Rs. 8 Lacs and constructed the fourth floor. In this case Rs. 50 Lacs is the

cost of acquisition of the building, whereas Rs. 8 Lacs is the cost of improvement.

Cost of Improvement is allowed to be deducted only if it is not deductible

under any other head of income. In other words, no double deduction is allowed.

C.O.I. of two Intangible Assets viz. (i.) Goodwill of a Business (and not a

Goodwill of a Profession) whether self-generated or not and (ii.) Right to carry onany business, or a Right to Manufacture or Produce any Article or a Thing, is

always to be taken as NIL or ZERO. Whereas, C.O.I. of any other intangible assetslike Patent, Copyright, Brand Name, Trademark, Tenancy Rights, Loom Hours,

Stage/Carriage Permit, Route Permit, shall be the actual cost of improvement

incurred on such assets.

However, Cost of Improvement for any asset incurred before 01st April,

1981, shall always be taken as NIL. This can be better explained with the help

of the following chart:-

SECTION 55(1)

COST OF IMPROVEMENT

IN CASE OF GOODWILL OF A BUSINESS/ IN ANY OTHER CASE

RIGHT TO CARRY ON BUSINESS, MFG./

PRODUCE ANY ARTICLE OR A THING

ALWAYS NIL INCURRED BEFORE INCURRED ON OR AFTER

68




1ST APRIL, 1981 1ST APRIL, 1981

ALWAYS NIL ACTUAL COST

OF IMPROVEMENT

FORMAT OF COMPUTATION OF LONG TERM CAPITAL GAINS:


Full Value of Sale Consideration (Received + Receivable)


(Wholly and exclusively in connection with the transfer)

Net Sale Consideration

Less: (1.) Indexed Cost of Acquisition (I.C.O.A.) (Whether

Actual or Notional)

(2.) Indexed Cost of Improvement (I.C.O.I.)

(Additions/Alterations to the Asset)LONG TERM CAPITAL GAIN / (LOSS)

XXX

XXX

XXX

(XXX)

XXX

(XXX)XXX

INDEXATION: Indexation is only for the purpose of calculating Long Term Capital Gain/Loss

and shall not be used for calculating Short Term Capital Gain/Loss. In case of a Long Term

Capital Asset, the Cost of Acquisition or Cost of Improvement is required to be indexed. In other

words, the original Cost of Acquisition or original Cost of Improvement of a Long Term Capital

Asset shall not be taken at their respective original values, but shall be adjusted for rise in the rate

of inflation in the country from the year of incurring the cost of acquisition or cost of

improvement till the year of transfer of such Long Term Capital Asset, as per the Index numbers

for each such relevant Previous Years, issued by the Central Government in this behalf by way of

a notification in the Official Gazette. Such Index numbers are called “Cost Inflation Index”(C.I.I.) numbers. Such Cost Inflation Index numbers are issued by Central Government, having

regard to 75 % of average rise in the consumer price index of urban non-manual employees for

the immediately preceding Previous Year. Concept of Indexation was introduced by the Central

Government for the first time with effect from Assessment Year 1993-1994, by considering

Previous Year 1981-1982 as the Base Year. Such Cost Inflation Index numbers are issued for

Previous Years or Financial Years and not for Assessment Years. The Cost Inflation Index (CII)

numbers issued up till now are as follows:-

Previous Year Cost Inflation Index (C.I.I.) Number

1981-1982

1982-1983

1983-1984

1984-1985

1985-1986

100

109

116

125

133

69




1986-1987

1987-1988

1988-1989

1989-1990

1990-1991

1991-1992

1992-1993

1993-1994

1994-1995

1995-1996

1996-1997

1997-1998

1998-1999

1999-2000

2000-2001

2001-2002

2002-2003

2003-2004

2004-2005

2005-2006

2006-2007

2007-2008

2008-2009

2009-2010

140

150

161

172

182

199

223

244

259

281

305

331

351

389

406

426

447

463

480

497

519

551

582

632

Note: Such C.I.I. numbers are issued for Previous Years or Financial Years, starting form the

Year 1981-1982, which is the Base Year. Students are expected to remember the C.I.I. number

70




only for the years 1981-1982 and for the year 2009-2010 i.e. for the first and the last year and not

for any other year. For any other year C.I.I. number would be provided in the examination. Cost

Inflation Index numbers are generally notified by the central government within few months from

the declaration of the Financial Budget of the relevant financial year.

Cost Inflation Index numbers are applicable to the whole financial year, irrespective of thedate of acquisition or transfer of the asset.

As an impact of allowing indexation, the cost of acquisition or cost of improvementincreases as compared to its original value and thereby it reduces the Long Term Capital Gain and

as a result of this the tax on Long Term Capital Gain also gets reduced. Therefore ‘Indexation’ is

considered to be a benefit given to the assesees by the Income Tax Act, 1961.

Formula for finding out Indexed Cost of Acquisition or Indexed Cost of Improvement:

Indexed Cost of Acquisition of a Long Term Capital Asset or its Indexed Cost of Improvement,

can be found out by applying the following formula:-

CII of the year of transfer of

the assetIndexed Cost of Acquisition = Cost of Acquisition X

CII of the year of acquisition of the asset

Indexed Cost of Improvement can also be found out by applying the same formula, where the

term ‘Cost of Acquisition’ used in the above formula will be replaced by the term ‘Cost of

Improvement’, while finding out Indexed Cost of Improvement.

Example of Indexation: Mr. X had acquired a House Property in the year1984-1985, for Rs.

1,00,000/- and sold it off in the year 2003-2004 for Rs. 5,00,000/-. Calculate the Capital

Gain/Loss for Mr. X if CII for 1984-85 is 125 and for 2003-2004 is 463.

Answer: In this example the original cost of acquisition of the asset is Rs. 1,00,000/- which is

required to be indexed as the period of holding of the house property is more than 36 months and

the asset is a Long Term Capital Asset. This cost of acquisition will be indexed by applying the

above formula. Therefore the Indexed cost of acquisition will be Rs. 1,00,000/- X 463/125 = Rs.

3,70,400/-And Long Term Capital Gain will be the difference between the Sale Proceeds and the Indexed

Cost of Acquisition i.e. Rs. 5,00,000/- less Rs. 3,70,400/- = Rs. 1,29,600/-.

Students shall note the fact that if the benefit of indexation was not available, then Long Term

Capital Gain in this case would have been the difference between the Sale Proceeds and the

original coat of acquisition of the asset i.e. Rs. 5,00,000/- less Rs. 1,00,000/- = Rs. 4,00,000/-

as compared to Rs. 1,29,600/- as computed above.

Exceptions to the concept of Indexation: In the case of following Long Term Capital Assets,

the benefit of Indexation shall not be available. In other words, though the asset is a Long Term

Capital Asset, the calculation of any gain/loss thereon will be computed just like the way it would

be computed had it been a Short Term Capital Asset, without indexing the Cost of Acquisition or

Cost of Improvement:-

(1.) Any Bonds or Debentures, whether listed on any recognized Stock exchange or not,

except of Capital Indexed Bonds, issued by Central Government.

71




(2.) Depreciable Assets as are governed by Section 50A of the act. (to be dealt with

separately)

(3.) Transfer of entire Undertaking or an entire Division of the assessee by way of “Slump

Sale” as governed by Section 50B.

Except of the above three exceptions, the benefit of Indexation will be available in case allthe Long Term Capital Assets.

Different Formulas for Indexation: An asseessee may have acquired a capital asset under

following five different situations. Depending upon the situation, the formula for indexing the

cost of acquisition would differ:-

(A.) Capital Asset acquired by assessee himself/herself before 01 st April, 1981.

(B.) Capital Asset acquired by assessee himself/herself on or after 01 st April, 1981.

(C.) Capital Asset is acquired by assessee from its previous owner under transactions

covered by section 49 (1), where asset was acquired by its previous owner before

01st April, 1981 and assessee also acquired from previous owner before 01st April,

1981.(D.) Capital Asset is acquired by assessee from its previous owner under transactions

covered by section 49 (1), where asset was acquired by its previous owner before

01st April, 1981 but assessee acquired from previous owner on or after 01st April,

1981.

(E.) Capital Asset is acquired by assessee from its previous owner under transactions

covered by section 49 (1), where asset was acquired by its previous owner after

01st April, 1981 and assessee also acquired from previous owner after 01st April,

1981.

The basic formula of indexation remains the same, but the numerator and

denominator for CII would differ under all the five situations mentioned as above. Thiscan be better explained with the help of the following table:-

SR. No.

SITUATION INDEXED COST OF ACQUITION INDEXED COST OF IMPROVEM

(A)

Capital Asset acquired

by the assessee before

01st April, 1981

F.M.V. of theAsset as on

01/04/1981OR

Cost of CII of theacquisition year of

of the asset X _ transfer___

whichever CII of is higher 1981-1982

Actual Cost of

Improvement

(ignoring

any cost of X

improvement

incurred before

01/04/1981)

72

CII of the ye

__of Trans

CII of theyear

of improveme




(B)


by the assessee on or

after 01/04/1981

Actual Costof X

Acquisition

Actual Cost of

Improvement X

(C)


by Previous Owner as

well as by Assessee

both before 01/04/1981

F.M.V. of theAsset as on

01/04/1981OR

Cost of CII of the

acquisition year of

to the Previous X _ transfer _

Owner whichever CII of is higher 1981-1982

Actual Cost of

Improvement

(ignoring

any cost of X

improvement

incurred before

01/04/1981)

(D)


by Previous Owner before 01/04/1981, but

acquired by assessee

after 01/04/1981

F.M.V. of the

Asset as on01/04/1981

OR

Cost of its X

acquisition

to the Previous

Owner, which-

-ever is higher

Actual Cost of Improvement

(ignoring

any cost of X

improvement

incurred before

01/04/1981)

(E)


by Previous Owner as

well as by Assessee

both on or after 01/04/1981

Cost of acquisition

to the X

Previous

Owner of

The Asset

Actual Cost of

Improvement

incurred by the

Assessee as well Xincurred by its

Previous Owner

Exemptions applicable in case of Capital Gains: The following exemptions are available in

respect of Capital Gains Income:-

[1.] Section 10 (37): Income from Capital Gain on Transfer of Agricultural Land: Only in

the case of an assessee being an Individual or a Hindu Undivided Family, any Capital Gain

arising on transfer of an Agricultural Land situated in a specified area (Urban Area) and used by

that individual or his/her parents or by HUF for agricultural purposes, shall be exempt from its

chargeability to Income Tax under section 10 (37), provided impugned Agricultural Land was

73

CII of th

year of

__Transfe

_

CII of th

year of

improvem

t

CII of the

year of

__Transfer_

_

CII of the

year of

improvemen

t

CII of the ye

__of Trans

CII of theyear

of

improveme

CII of the year

__of Transfer_

CII of the

year

in which theAsset was

acquired by

the Assessee

CII of the ye

__of Trans

CII of the

year

of

improveme

CII of the year

__of Transfer_

CII of theyear in which

the Asset was

acquired by

the Assessee

CII of the ye

__of Transf

CII of the

year

of

improveme




compulsorily acquired by Government under any Law in force or sale consideration of such

Agricultural Land was determined by Reserve Bank of India (RBI) or by Central Government.

This exemption was being introduced with effect from Assessment Year 2005-2006 and exempts

only those Capital Gains, which have arisen on sale consideration received on or after 01 st April,

2004.

[2.] Section 10(38): Long Term Capital Gain on transfer of Listed Securities: Any LongTerm Capital Gain (Only Long Term Capital Gains and not Short Term Capital Gains) arising on

transfer of Equity Shares of a Company listed on a Recognized Stock Exchange in India or Units

of Equity Oriented Mutual Fund, shall be exempt by virtue of Section 10(38), provided transfer

has taken place through a Recognized Stock Exchange and such transaction of sale attracts

Securities Transaction Tax (S.T.T.). Section 10(38) has been introduced with effect from

01/10/2004.

CALCULATION OF CAPITAL GAIN IN SOME SPECIAL SITUATIONS:

[A.]Computation of Capital Gain/Loss in case of Depreciable Assets: [Section 50A]: Capital

Gain/Loss on transfer of a Capital Asset, which is a Depreciable Asset, shall be calculated not for

an individual asset transferred, but for the whole Block of Assets to which, such transferred asset belongs, the way Depreciation under section 32 is charged not on an individual asset, but on the

entire block of assets. The Capital Gain/Loss so arising on transfer of any Depreciable Asset,

whether Long Term or a Short Term Capital Asset shall always be treated as a Short Term

Capital Gain/Loss. The Cost of Acquisition of a Depreciable Asset shall not be the actual cost of acquisition of the transferred asset but it shall be determined as follows:-

PARTICULARS AMOUNT

Opening Written Down Value (WDV) of the entire Block of Asset

ADD: Actual Cost of acquisition of any new asset, falling within

The same Block, acquired during the relevant Previous Year

Closing Written Down Value / Cost of Acquisition of the Block

XXX

XXX

XXX

The only thing that is different here is the cost of acquisition of the asset (asset here

would mean the entire Block and not only that individual asset that is being transferred). The cost

of acquisition here will be the cost of acquisition of the entire Block as shown above. The Gain or

Loss arising on transfer of a Depreciable asset shall always be Short Term Capital Gain/Loss

irrespective of whether the asset or the Block was held for a period of 36 months or less before it

was being transferred. The Capital Gain/Loss will be computed as shown below:-


Full Value of Sale Consideration (Received + Receiveable)


(Wholly and exclusively in connection with transfer)Net Sale Consideration

Less: (1.) Cost of Acquisition (C.O.A.) (As computed in the

Above table = W.D.V. of the Block of Assets)

(But restricted to the maximum of the amt. of Net

Sale Consideration, unless all the assets of the

Block are sold off)

(2.) Cost of Improvement (C.O.I.)

XXX

XXX

(XXX)XXX

74




(Additions/Alterations to Asset)

SHORT TERM CAPITAL GAIN / (LOSS)

NIL (XXX)

XXX

In simple words, the following points shall be kept in mind, while calculating Capital Gain in

case of Depreciable Assets:-

(1.) No Indexation Benefit will be available,

(2.) No distinction to be made between Short Term and Long Term. Both to be treated at par.

The Gain or Loss from transfer of a depreciable asset will always be called as Short

Term.

(3.) Gain or Loss to be computed not for the asset sold, but for the entire ‘Block of Assets’ to

which such asset belongs.

(4.) The Cost of Acquisition will not be the actual cost of acquisition of the block, but will

be equal to the ‘Written Down Value (W.D.V.)’ of the entire block

[B.] Stamp Duty Valuation: [Section 50C]: This section applies only to transfer of ‘Land’,

‘Building’ or both and not to any other asset transferred. Many assesses were found to beevading Income Tax, by declaring lower ‘sale consideration’ on sale of their House Property,

in their Income Tax Return and thereby reducing their Capital Gain and Income Tax on such

Capital Gains. For e.g.: An assessee sold his House Property for Rs. 50 Lacs but entered into

agreement with the buyer of the property for an amount of Rs. 20 Lacs only. He accepted the

cheque for Rs. 20 Lacs and balance Rs. 30 Lacs was accepted by him by way of cash which

was not declared by him. In this case he suppressed his sale consideration from Rs. 50 Lacs to

Rs. 20 Lacs. Assuming the Indexed cost of acquisition of the said property to be Rs. 13 Lacs,

the assessee is liable to pay tax on Capital Gain of Rs. 37 Lacs (Rs. 50 Lacs less Rs. 13 Lacs)

but he would compute his Long Term Capital Gain as Rs. 7 Lacs only (Rs. 20 Lacs less Rs.

13 Lacs) and thereby he would evade tax on capital gain of Rs. 30 Lacs (Rs. 37 Lacs less Rs.

7 Lacs). In order to curb such tax evasion practices followed by assesses, section 50 C was

introduced to standardize the amount of sale consideration in case of transfer of Land or

Building or both.Section 50 C is the deeming provision of the act. According to section 50 C, the

value of sale consideration of an asset being Land, building or Land plus Building shall be

deemed to be the value of that asset adopted for the purpose of payment of Stamp Duty on

that asset, irrespective of the actual amount of sale consideration of that asset. (Stamp Duty is

required to be paid as a percentage on a predetermined value of the property, determined by

the Stamp Value Authorities, irrespective of the market value of that property). This is

applicable, whether the asset is a Long Term Asset or a Short Term Asset. In the above

example, if the value of the House Property adopted by Stamp Value Authority is Rs. 51

Lacs, then assessee will have to calculate Capital Gain/Loss, considering Rs. 51 Lacs to be

the sale consideration of the property, irrespective of the fact that he actually sold the

property for Rs. 50 Lacs only. This section has a very harsh implication on genuine

taxpayers. Valuation done by Stamp Value Authorities is not updated on a time-to-time basis.

Eventually in a Bullish Economic Trend, the value adopted by Stamp Value Authority will be

higher than the actual market value of the property. In such a situation if an assessee sells

his/her property at market price, which will be lower than the Stamp Duty Value, then also

he/she will have to end up paying income tax on a higher capital gain, which would be

calculated applying Stamp Duty Value. Assessee will have to pay tax even on an amount,

which was never received by him/her.

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But Income Tax Act has taken care of such situations also. In a case, where an

assessee claims that the sale consideration received by him/her or the market value of the

asset is less than the value adopted by Stamp Value Authorities, then based on the claim of

the assessee, the Assessing Officer may refer the entire valuation to an Officer of the

Department called “Valuation Officer”, who shall investigate in the matter and submit hisvaluation report to the assessing officer. In such a case where, the matter is being referred to

the valuation officer, the value reported by such officer in his report or the Stamp DutyValue, whichever is less, shall be adopted as the value of the property.

[C.] CONVERSION OF A CAPITAL ASSET INTO STOCK-IN-TRADE: Whenever a

Capital Asset is converted into Stock-in-Trade, it amounts to transfer of that asset. Capital Gain

on the same will have to be computed having regard to the following points:-

(1) Capital Gain is to be computed in the year of its conversion into stock, even if the asset has

not yet been sold.

(2) The ‘Sale Consideration’ will be deemed to be equal to the amount of ‘Fair Market Value

(FMV)’ of such asset as on the date of its conversion into stock. (Generally, the sale consideration

should have been ‘NIL’ as the asset has not yet been sold, but then also it will be assumed to be

equal to the FMV as on the date of conversion)

(3) The period of Holding of such asset will begin from the date of its acquisition and will end onthe date of it’s conversion into stock.

(4) For the purpose of Indexation, the year of conversion will be considered as the year of

transfer.

(5) However, the Capital Gain (whether Long Term or Short Term) so computed shall bechargeable to tax in the year in which such asset is ultimately sold as Stock and not in the year in

which it is converted into stock.

(6) When such converted asset is ultimately being sold in the form of stock, there would be some

business income generated. Such business income will be = Actual Sale Consideration less FMV

of the asset as on the date of its conversion into stock.

[D.] TRANSFER OF A CAPITAL ASSET BETWEEN FIRM AND PARTNER:

(a.) When a Partner transfers a Capital Asset to the Firm as his capital contribution :

[Section 45(3)]:

♦ Introducing a Capital Asset by a partner to the firm, as his capital contributionamounts to transfer of that asset. Capital Gain will have to be computed in the

hands of the partner.

♦ The Capital Gain will be computed in a normal way only, as would have

otherwise been computed.

♦ Since, partner is transferring his asset to the firm free of cost as his capital

contribution, i.e. the partner is not receiving anything from the firm for

transferring the asset, the ‘Sale Consideration’ will be missing.

♦The Amount recorded by the firm in its Books of Accounts will be assumed to be the Sale Consideration of such Asset.

(b.) When a Firm transfers or distributes a Capital Asset to Partner, upon its Dissolution or

otherwise: [Section 45(4)]:

♦ It amounts to transfer of Capital Asset for the Firm Capital Gain will have to be

computed in the hands of the Firm.

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♦ Since, the firm is transferring the asset to its partners free of cost, i.e. the firm is

not receiving anything from the partner for transferring the asset, the ‘Sale

Consideration’ will be missing.

♦ The FMV of the asset as on the date of its transfer will be deemed to be the

‘Sale Consideration’ in the hands of the Firm.

[E.] COMPENSATION ON COPULSORY ACQUISITION: These provisions shall applyonly in a case where there’s compulsory acquisition of a Capital Asset by Government under any

Law in force.

(a.) For Initial Compensation :

♦ Capital Gains are normally taxed in the year in which the asset is ‘transferred’.

However, in case of compulsory acquisition the Capital Gains will be taxable in

the year in which the compensation (or a part of compensation) is received and

not the year in which the asset was transferred.

♦ The period of Holding will be calculated from the date of its acquisition till the

date of its compulsory acquisition by Government, i.e. till the year of transfer,

though the capital gain is taxable in the year of receipt of compensation and notin the year of transfer.

♦ However, for the purpose of indexation, the year of compulsory acquisition is to

be taken into account as the year of transfer.

(b.) For Enhanced Compensation : If the Original amount of compensation increased /

enhanced by any Court or any Higher Authority, then such enhanced compensation will

be taxable as follows:

♦ Such Enhanced Compensation will be taxable in the year of its actual receipt.

♦ If assessee is not alive to receive it, then it will be taxed in the hands of his Legal

Heirs or Successors.

♦ The Cost of Acquisition and the Cost of Improvement will be taken as NIL, as

these costs were already allowed as a deduction from the initial compensation.♦ However, litigation / legal expenses incurred to get the compensation enhanced

will be allowed as a deduction in the form of ‘Transfer Expenses’.

♦ Such Capital Gain will be Short Term or Long Term depending upon whether the

original capital gain was short term or long term.

[F.] RECEIPT OF INSURANCE CLAIM: When an Insurance Claim is received or

compensation is received from the Insurance Company for ‘Damage’ or ‘Destruction’ to any

Capital Asset, then such compensation so received shall be taxable under the head Capital Gains.

♦ The Capital Gain shall be computed in a normal way.

♦ The amount of compensation received from the Insurance Company shall be

considered as ‘Sale Consideration’.

♦ If the compensation is not in cash, but is in kind, then the FMV of the asset or a thing

received as compensation (FMV as on the date of its receipt) shall be deemed to be

the sale consideration.

♦ The Capital Asset may have damaged due to Fire, Flood, Typhoon, Hurricane,

Tsunami, Earthquake or any other Natural Calamity or Riot, Civil Disturbance, War,

Action of enemy whether with or without declaring a War, or an action taken in

combating with an enemy.

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[G.] CAPITAL GAINS IN THE HANDS OF NON-RESIDENT: Whenever, a Non-Resident

assessee brings foreign currency into India, acquires an asset out of that and sells that asset and

derives capital gains, then the capital shall be computed in the following manner (only for Non-

Residents):-

(a.) In case of Shares and Debentures of Indian Companies :

♦ The Capital Gain or Loss will have to be computed in foreign currency.

♦ Convert the ‘Sale Consideration in Indian Currency’ into ‘Sale Consideration in

Foreign Currency’ applying the Average of ‘Buying’ and ‘Selling’ Telegraphic

Transfer Rate (T/T Rate) offered by State Bank of India as on the date of transfer

of such asset. We will get Sale Consideration in foreign currency.

♦ Similarly convert the ‘Transfer Expenses’ also in foreign currency, applying

Average of ‘Buying’ and ‘Selling’ T/T Rate of SBI, prevailing as on the date of

transfer .

♦ Similarly, convert the ‘Cost of Acquisition in Indian Currency’ into the ‘Cost of

Acquisition in Foreign Currency’, but by applying Average of ‘Buying’ and

‘Selling’ T/T Rate of SBI prevailing as on the date of acquisition.♦ No Indexation Benefit will be available in such scenario.

♦ Calculate the Capital Gain / (Loss) in a normal way, but without availing the

benefit of Indexation.

♦ Such Capital Gain, whether Long Term or Short Term, will be in terms of foreign

currency.

♦ Reconvert such ‘Capital Gain in Foreign Currency’ into the ‘Capital Gain in

Indian Currency’, by applying the ‘Buying’ T/T Rate of SBI as on the date of

transfer .

(b.) In case of any other Asset other than Shares and Debentures of Indian Company acquired

by Non-Resident: In case of any other Asset other than Shares and Debentures of Indian

Company acquired by Non-Resident, the above-mentioned procedure mentioned in pointno. (a.) above, shall not apply, the Capital Gains shall be computed in an absolutely

normal way, the way it would have been calculated otherwise for a resident assessee. The

benefit of Indexation will be available for other assets. There shall be no requirement to

convert the Sale Consideration or the Cost of Acquisition from Indian Currency to

Foreign Currency. The Capital Gain or Loss shall be computed in Indian Currency only.

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CH-9

INCOME FROM OTHER SOURCES

(SEC 56 AND 57)

Any income which is not chargeable to tax under Section 15, 22, 28, or 45, will

be chargeable to tax as Income from Other Sources (IFOS) i.e. any income not taxableunder the head Income from Salary, House Property, Business/Profession or Capital Gains,

is chargeable to tax as Income from Other Sources. Thus, it is a ‘Residual’ head of income.

Section 56 (2): Under Section 56 (2), the items that are mentioned as taxable under thishead are as follows:-

1. Interest on Securities , provided Securities are held as Investment and not as Stock-in-

trade. (If they are held as Stock-in-Trade, then interest therefrom will be chargeable to tax

as income from Business or Profession and not as income from Other Sources).

2. Rent from Letting out of Plant & Machinery, Furniture .

3. Composite Rent (Combined Rent) from Letting out of Building, along with Plant &

Machinery or other assets. For e.g.: Composite rent from letting out of a Cinema Building

together with chairs, projectors and other furniture will be entirely chargeable as income

from Other Sources.

4. Dividend from shares of a Foreign Company or from shares of a Co-Operative Society.[Dividend from shares of an Indian Company is exempt from tax by virtue of section 10

(34), if it was not exempt, then it would have been chargeable to tax as income from

Other Sources.]

5. Any sum received as contribution by assessee from his employee towards any Staff

Welfare Scheme. Initially when an employer receives any contribution from his

employees towards any Staff Welfare Scheme, it becomes an income in his hand andlater on when he deposits such sum in the respective fund, it is allowed as a deduction to

him from his income as an allowable business expenditure, subject to the provisions of

section 43B.

6. Any sum received under a ‘Keyman Insurance Policy (KIP)’ including any Bonus

therein.

7. Winnings from Lotteries, Puzzles, Crosswords, Card games , any other game of any sort,Races including Horse Races or from Betting or Gambling. (Only Winnings from such

activities and not business income generated out such activities. For e.g.: Income from

Agency Commission on selling of Lottery Tickets will not be taxable as IFOS, but will be

separately taxable as income from Business /Profession).

8. Any Gift in cash (only cash and no other asset whether moveable or immoveable)

exceeding Rs. 50,000/- received by an Individual or a Hindu Undivided Family on or

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after 01-09-2004, without any consideration from any person. However, following

receipts of cash shall not be regarded as an income:

(a.) Cash received from any person on occasion of Marriage (only Marriage and no other

function like Birthday Party or Engagement),

(b.) Cash received in contemplation death of the donor,

(c.) Cash received under a Will or Inheritance,

(d.) Cash received from a Relative, where the term ‘Relative’ would mean:

Θ Spouse of the Individual,

Θ Brother or Sister of the Individual,

Θ Brother or Sister of the Spouse of the Individual,

Θ Spouse of Brother or Sister of the Individual,

Θ Spouse of Brother or Sister of the Spouse of the Individual,

Θ Parents of the Individual,

Θ Brother or Sister of the Parents of the Individual, or their spouse,

Θ Any lineal ascendant or descendant of the individual,

Θ Spouse of any lineal ascendant or descendant of the individual

For e.g.: Mr. A received Rs. 17,000/- each from his three friends Mr. X, Yand Z on 12/09/2009, then entire amount of Rs. 51,000/- (and not only the

amount in excess Rs. 50,000/-) will be chargeable to tax in the hands of Mr.A, under the head Income from Other Sources.

For e.g.: Mr. A received Rs. 51,000/- from his friend Mr. X on 12/09/2006, then entire amount of

Rs. 51,000/- (and not only the amount in excess Rs. 50,000/-) will be chargeable to tax in thehands of Mr. A, under the head Income from Other Sources.

Anything which is received in kind having ‘money’s worth’ i.e. Property was outside the

purview of the existing provisions. Therefore Section 56 was amended w.e.f. 01/10/2009, to provide that the value of any property received without consideration or for inadequte

consideration will also be included in the computation of total income of the recipient as

follows:- [Such properties will include immovable property being Land or Building or both,

Shares and Securities, Jewellery, Archaeological Collections, Drawings, Paintings,

Sculptures or any Work of Art.]

[A.] In case of an Immovable Property: (i.) In a case where an immovable property is received

without consideration and the stamp duty value of such property exceeds Rs. 50,000/-, the whole

of the stamp duty value of such property shall be taxed as the income of the recipient.

(ii.) If an immovable property is received for a consideration which is less than the

stamp duty value of such property and the difference between the two, exceeds Rs. 50,000/- (an

inadequate consideration), then the excess of stamp duty value of such property over such

consideration shall be taxed as the income of the recipient.

(If the stamp duty value of immovable property is disputed by the assessee, the Assessing Officer may refer the valuation of such property to a Valuation Officer. In such cases, the provisions of

existing section 50C and sub-section (15) of section 155 of the Income Tax Act shall, as far as

may be, apply for determining the value of such property.)

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[B.] In case of a Movable Property: (i.) In a case where movable property is received without

consideration and the aggregate fair market value (FMV) of such property

exceeds Rs. 50,00/-, the whole of the FMV of such property shall be taxed as the income of the

recipient.

(ii.) If a movable property is received for a consideration which is less than the FMV of such property and the difference between the two exceeds Rs. 50,000/- (i.e. for an inadequate

consideration), then the excess of the FMV of such property over such consideration shall betaxed as the income of the recipient.

It is also proposed to provide that,—

(i) the value of movable property shall be the fair market value as on the date of receipt in

accordance with the method prescribed; and

(ii) in the case of an immovable property, the value of the property shall be the ‘stamp duty value’

of the property.

This amendment will take effect from 1st October, 2009 and will accordingly apply for

transactions undertaken on or after such date.

NOTE:

(1.) One shall borne in mind that all the incomes discussed above, will be taken as

income from other sources only when the same is not taxable under any of theother four heads of income, except of Dividend income and Winnings from

Lotteries, Puzzles, Card Games, Gambling, Betting, etc. Dividend and Winnings

are always taxable as Income from Other Sources, irrespective of the business of the assessee.

(2.) All those incomes, which are chargeable to tax as income from Other Sources, are

chargeable to tax either on ‘Due’ basis or on ‘Receipt’ basis, depending upon themethod of accounting regularly followed by the assessee, except of ‘Dividend’

income. Dividend income is always chargeable to tax on ‘Due’ basis, irrespective

of the method of accounting followed by the assessee.

OTHER INCOMES CHARGEABLE UNDER THIS HEAD:

1. Interest on Bank Fixed Deposits and Loans given.2. Royalty income. For e.g.: Royalty received for writing Books.

3. Director’s Sitting fees (Directorship Fees).

4. Commission received by a Director from his/her Employer Company for standingas Guarantor of a loan taken by his/her Employer Company.

5. Gratuity received by a Director from the Company provided he/she is not an

employee of that company. (If he/she were an employee Director, then such

Gratuity would be chargeable to tax as Salary and not as income from Other Sources).

6. Rent from Letting out of a vacant Plot of Land. (Only from a vacant Plot of Land

without having any Building constructed thereon, if Building is also present, thensuch rent would be chargeable to tax as income from House Property and not as

income from Other Sources)

7. Ground Rent.8. Compensation received on business asset.

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9. Agricultural income received from a Land situated outside India.

10. Commission received by a Director from his/her Employer Company for

underwriting the Shares of that Employer Company.11. Annuity (Annual Receipt) received under a Will or a Trust deed.

12. Amount received under Family Pension. (Subject to Standard Deduction u/s 57 (2)

(a), which will be lower of 1/3rd

of such Family Pension or Rs.15,000/-) (‘FamilyPension’ is an un-commuted monthly/periodical pension received by Family

Members or Legal Heirs of a deceased Employee after his/her death)

13. Income from Subletting of a House Property. (Rent received from Letting out of aHouse Property is chargeable to tax as income from House Property, whereas rent

received from Subletting of a House Property is chargeable to tax as income from

Other Sources) (‘Subletting’ means letting out of a property by Tenant of that

property or by a person who is not an owner of that property)14. Salary received by Members of Parliament. (Though it is called as ‘Salary’, such

remuneration is not chargeable to tax as ‘Salary’ because Members of Parliament

are not treated as Government Servant. They do not have any employer and due to

lack of employer-employee relationship, their remuneration can not be charged totax as ‘Salary’)

15. Income from an Undisclosed Source.16. Income on any Investment.

17. Casual and Non-Recurring Incomes other than Capital Gains.

18. Any Income received by an assessee, who is engaged in ‘Owning & Maintaining’Horse Race.

19. Interest on Refund of Income Tax, received from Income Tax Department.

(However, the Principal amount of Income Tax Refund is not taxable – only

interest on such refund is taxable)

PERMISSIBLE DEDUCTIONS FROM INCOME FROM OTHER SOURCES:

Section 57: The following Deductions are permissible under the head Income from Other

Sources (IFOS):

(1.) Section 57(1) : Commission or Remuneration paid for realizing Dividend or

Interest on Securities.

(2.) Section 57(1)(a ): Deduction in respect of Employees’ Contribution towardsStaff/Employees’ Welfare Scheme, provided that the contribution is credited to the

fund before the due date of filing the Income Tax Return by Employer.

(3.) Section 57(2) : Repairs and Depreciation in case of letting out of the Plant andMachinery, Furniture, Building. Current repairs in respect of Building as per

Section 30, Insurance Premium on the Premises, for the risk of Damage or

Destruction. Repairs on the Plant and Machinery and on the Furniture along withthe Insurance Premium as per Section 31, are all allowed to be deducted.

(4.) Depreciation as per Section 32 : Depreciation as per section 32 of the Act, is

allowed to be deducted from Income from Other Sources, provided income

generated out of that asset is chargeable to tax as Income from Other Sources.

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(5.) Section 57(2)(a) : Standard Deduction in case of Family Pension allowed to be

deducted at either Rs. 15,000/- or 1/3rd of Family Pension received, whichever is

less, in the hands of the person who is in receipt of the amount under FamilyPension.

(6.) Section 57(3) : Any other expenses for earning income from Other Sources is

allowed to be claimed as deduction if, such:(a.) Expense is incurred wholly and exclusively for earning the income.

(b.) Expense is not a Capital Expenditure.

(c.) Expense is not a Personal expenditure.

(d.) Expense is incurred in the Previous Year.

# List of incomes exempted from tax under section 10 from this head:

1. Section 10(1): Agricultural income from Agricultural Land in India.

2. Section 10(11): Interest or any Amount due from Public Provident Fund.

3. Section 10(12): Any amount due from Provident Fund A/C.4. Section 10(13): Any amount due from an Approved Superannuation Fund.

5. Section 10(15): Any Interest on Post Office Saving A/c or from notifiedSecurities.

6. Section 10(16): Any Educational Scholarship received.

7. Section 10(17): Allowances to MLA or MP.8. Section 10(17A): Any Award received from Central/State Government.

9. Section 10(34): Any Dividend received from an Indian Domestic Company.

10. Section 10(35): Any income from units of UTI or from units of a Mutual

Fund.11. Section 10(10D): An amount received from Life Insurance Policy including

any Bonus therein, issued by any Insurance Company in India, providedannual premium payable on such policy, does not exceed 20 % of the SumAssured of such Policy.

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CH-10

DEDUCTIONS UNDER CHAPTER VI A

(SECTION 80C TO SECTION 80U)

Apart from specific deductions available under each respective head of income

(just like Standard Deduction available under the head income from ‘Salary’), there are few

more deductions available from Gross Total Income i.e. from total of income of all the fiveheads of income. These deductions are called ‘general deductions’, whereas, deductions

available from each individual head of income are called ‘specific deductions’. These‘general deductions’ are governed by Chapter VI-A of the act, which are popularly known

as deductions from Section 80C to section 80U. In all there are many deductions available

under this Chapter, but we have only five deductions applicable for our syllabus, namely,(1) u/s 80C, (2) u/s 80CCC, (3) u/s 80D, (4) u/s 80DD, (5) u/s 80E and (6) u/s 80U.

While dealing with any of the above five deductions, one must mainly observe

the following points regarding each deduction, so that one can easily remember all of

them:-

What should be the Residential Status of the Assessee in order to be eligible for the

deduction, i.e. whether the deduction is available to ‘Resident and OrdinarilyResidents (R.O.R.)’ only or is it available to ‘Resident but not Ordinarily Resident(R.N.O.R.)’ and ‘Non-Residents (N.R.)’ also?

What is the quantum of the deduction i.e. what is the maximum deductible amount

under each section?

Any other specific condition attached to each section subject to fulfillment of which

deduction shall be available.

The total of all the deductions under this chapter shall be restricted to the

maximum of ‘Adjusted Gross Total Income’, where ‘Adjusted Gross Total Income’

would mean [Gross Total Income i.e. G.T.I.] less [‘Long Term Capital Gains’ and‘Winnings from Lotteries, Puzzles, Crossword, Betting, Gambling, etc.’]. In other words,

total of deductions shall not exceed the Adjusted Gross Total Income and Gross Total

Income shall not become negative due to deductions. There shall be no ‘Refund of Tax’arising due to deductions.

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Certain deductions are based on ‘Incomes’ whereas, few are based on

‘Expenses’. Let us now consider all the six deductions separately to have a better

understanding of all of them.

(1.) Under Section 80C: Deduction on account of payment / deposit / investment, etc..

in any of the followings:-

Θ Any amount paid towards Premium of Life Insurance Policy of an Insurance

Company, where annual premium of the policy does not exceed 20 % of the SumAssured (Sum Assured is nothing but the amount for which the policy is taken out).

If the annual premium exceeds 20% limit, then amount of premium in excess of

20% shall be ignored for the purpose of deduction under this section. For e.g.: For aLife Insurance Policy of Rs. 1,00,000/- if the annual premium is Rs. 23,000/-, then

deduction under this section will be available for only Rs. 20,000/- and balance Rs.

3,000/- shall lapse.Such premium may be paid by the assessee on the life of Self or Spouse or

Children, whether dependent on the assessee or not. There is no limit on the number of children and a child may be minor or major, male or female, married or unmarried.

Θ Amount deposited in a Pension Plan or an Annuity Plan of an InsuranceCompany in India. It would be worth noting here that the same Pension Plan or

Annuity Plan may be eligible for Deduction under section 80CCC, but an assessee

may either claim deduction under section 80CCC or may claim deduction under this section, but not both. No Double Deduction is allowed under the act.

Θ Amount contributed by an employee to a Statutory Provident Fund.

Θ Amount contributed by an employee to a Recognized Provident Fund.

Θ Amount contributed by an employee to an Approved Superannuation Fund.

Θ Amount contributed by an assessee to a Public Provident Fund for an amount not

exceeding Rs. 70,000/- per annum.Θ Investments in National Savings Certificates (N.S.C.) VI, VII and VIII Series.

Θ Accrued Interest on National Savings Certificates (N.S.C.) VI, VII and VIII

Series.

Θ Investments in National Savings Scheme (N.S.S.).

Θ Unit Linked Insurance Plan (U.L.I.P.) of Unit Trust of India (U.T.I.) or Life

Insurance Corporation of India (L.I.C.) or any other Mutual Fund.

Θ Contribution to 5 Years, 10 Years or 15 Years Cumulative Time Deposit (C.T.D.)

Scheme of Post Office.

Θ 5 Years’ Term Deposit with any Scheduled Bank ,

ΘInvestment in units of a notified Mutual Fund, for an amount not exceeding Rs.10,000/- per annum.

Θ Contribution to Equity Linked Savings Scheme (E.L.S.S.) of a notified Mutual

Fund, for an amount not exceeding Rs. 10,000/- per annum.

Θ Contribution to a Fund set up by National Housing Bank (NHB).

Θ Any Payment towards Cost of Purchase or Construction of a Residential

Property (It even includes any payment made for Stamp Duty or Registration

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charges to register the Property) including any Repayment of any Loan (only

Loan and not Interest), taken from Government or any Bank or Life Insurance

Corporation (L.I.C.) or National Housing Bank or from an Employer whereEmployer is a Public Company or a Public Sector Company or University or a Co.-

Operative Society

Θ Payment of Tuition Fees of children, (other than any Donation or DevelopmentFees, Gymkhana Fees, Library fees, Bus Fees or any such payment of a similar

nature) to any University, School, College or an Educational Institution in India

(but not to any Coaching Class or to any Private Tutor) , for a Full Time

Educational Course, for a maximum of two children.

Θ Investments in Debenture, Bonds or Equity Shares of an approved Public Sector

Company or a Public Financial Institution engaged in providing InfrastructureFacilities in India.

Θ Investments in units of an approved Mutual Fund engaged in providing

Infrastructure Facilities in India.

Θ Senior Citizen’s Savings Scheme, 2004

Θ Bonds of National Bank for Agricultural and Rural Development (NABARD)

The amount of deduction under this section shall be the lower of the following two:-

• The total of the amount actually Paid / Deposited / Invested in all or any of the

above, or

• Rs. 1,00,000/-

(2.) Under Section 80CCC: Deduction on account of payment of Pension plan

Premium: This Deduction is available upon depositing a sum under an ‘Annuity Plan’

or a ‘Pension Plan’ of Insurance Company in India. Amount of deduction shall be the

lower of the following two:-• The amount deposited under such plan, or

• Rs. 1,00,000/-

In other words, this deduction is restricted to maximum of Rs. 1,00,000/-. Thisdeduction is available to ‘Individuals’ only. Eligible assessee may be Resident

in India or may be a Non-Resident, whether he/she is a Citizen of India or not.

‘Pension’ or ‘Annuity’ received at the time of maturity of such policy, shall betaxable as income from Other Sources.

Note: Contribution to Pension Plan is covered by section 80C as well as by section 80CCC

also. However, as per section 80CCE, the maximum amount of deduction permissibleunder section 80C + 80CCC combined shall not exceed Rs. 1,00,000/- per annum. In

simple words, though ‘Contribution to Pension Plan’ is covered twice with Rs. 1 Lac of

ceiling limit under both the sections, the deductible amount shall not be Rs. 2 Lacs (i.e. Rs.1 Lac + Rs. 1 Lac), but shall be Rs. 1 Lac only.

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(3) Under Section 80D: Deduction on account of payment of Mediclaim Premium:

This deduction is available upon payment of ‘Mediclaim Insurance Premium’, by

assessee on the health of self and/or family members. The amount of deduction shall bethe lower of the following two:-

• The actual amount of mediclaim premium paid, or

• Rs. 15,000/-

This deduction is available to ‘Individuals’ as well as to “Hindu Undivided

Families’ but not to any other assessee. Individuals or Hindu Undivided Familymay be Resident or Non-resident.

Individuals can pay mediclaim premium on the health of

• Self or

• Spouse, whether Spouse is dependent upon the asseessee or not,

• Parents whether dependent upon the asseessee or not or

• dependent Children.

If mediclaim premium is paid by assessee on the health of any other familymember or persons, other than those mentioned above whether dependent upon the

assessee or not, shall not be eligible for deduction under this section. For e.g.: If mediclaim premium is paid by the assessee on the health of his dependent brother ,

then such amount shall not be eligible for the deduction.

If a person on whose health the mediclaim premium is being paid is a

Resident Senior Citizen, then the quantum of deduction under this section shall be the

amount of mediclaim premium paid or Rs. 20,000/- whichever is less. In such a case,

the assessee himself/herself need not be a senior citizen or a resident, only the personon whose health the medicalim premium is being paid shall be a resident senior citizen.

(‘Senior Citizen’ means, a person who is at least of 65 years of age, at anytime during

the Previous Year)The following further points shall be noted in this regard:-

• Mediclaim Premium should have been paid out of taxable income of the

assessee, whether out of taxable income of the current year or out of the taxableincome of any other year.

• Mediclaim Premium should have been paid by way of any mode other than by

way of Cash. If it is paid out of cash, then no deduction under this section shall

be available.

• W.e.f. A.Y. 2009-10, if assessee pays Mediclaim Premium for his parents,

(whether dependent upon him or not), then he will get an additional deduction

of Rs. 15,000/- u/s 80D. If parents are Senior Citizen, then the amount of additional deduction will be Rs. 20,000/- instead of Rs. 15,000/-. (Naturally,

this additional deduction will be either Rs. 15,000/- or Rs. 20,000/- as the case

may be or the actual amount of Mediclaim Premium paid for parents, whichever is less)

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(4.) Under Section 80DD: Deduction on account of maintenance of a dependant

relative suffering from a disability:

(a.) This deduction is available only to a Resident Individual or HUF.(b.) This deduction is available for expenditure incurred on Medical Treatment and

Maintenance charges, incurred by assessee for his relative who is dependant on him and is

suffering from a specified disability.(c.) The dependant relative should be suffering from any of the following:

-- Blindness,

-- Physical Handicappness,-- Low Vision,

-- Cerebral Palsy,

-- Autism,

-- Leprosy(d.) The disability should be at least 40% or more, as certified by a Medical Practitioner

working with any Government Hospital.

(e.) The amount of deduction will be Rs. 50,000/- flat, irrespective of any expenditure

actually incurred on maintenance of such dependant relative.(f.) If the disability is more than 80% (popularly called as ‘Severe Disability’) (as

certified by a Medical Practitioner working with any Government Hospital), then theamount of deduction will be Rs. 1,00,000/- flat (Rs. 75,000/- upto A.Y. 2009-10).(g.) If the percentage of disability has not been specified in the question, then it shall be

assumed to be more than 40% but less than 80%. And accordingly, a deduction of Rs.50,000/- shall be allowed.

(5.) Under Section 80E: Deduction on account payment of Interest on Loan taken for

Higher Education:

(a.) This deduction is available only to ‘Individuals’ whether Resident or Non-Resident.(b.) This deduction is available on account of payment of interest on Loan taken for Higher Education. (only for payment of ‘interest’ and not for repayment of ‘Principal’ amount of

loan).

(c.) There’s no upper limit on the amount of deduction. Therefore, unlimited amount of deduction can be claimed.

(d.) However, the deduction is allowable only for a period of eight consecutive

(continuous) years starting from the year in which assessee starts paying interest for the

first time.(e.) The Loan should have been taken for ‘Higher Education’, whether in India or outside

India.

(f.) ‘Higher Education’ means any full time educational course after HSC (XIIth), whether it leads to any degree or not. (Even any ‘vocational course’ or a ‘Diploma course’ will also

be eligible). It should be in the field of Engineering, Medicine, Applied/Pure Science,

Management, Mathematics, Statistics, Information Technology.(g.) The Loan should have been taken by assessee:-

-- for Self , or

-- for his/her spouse, or

-- for children

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(h.) The loan should have been taken from any Bank or a notified Financial Institution or

any approved Charitable Institution.

(i.) This deduction is allowable on payment basis only. In simple words, no deduction will be allowed if interest on educational loan has just accrued, but has not yet been paid. It will

be allowed as a deduction only if it has been paid during the given year. If interest for the

current year amounts to Rs. 82,000/-, out of which only Rs. 50,000/- has been paid, thendeduction under this section will be only for Rs. 50,000/-.

(6.) Under Section 80U: Deduction on account of Specified Disability: Deduction under this section is available on expenditure incurred on Medical Treatment and Maintenance

charges, incurred by assessee for himself or herself. This deduction is available only to

Resident ‘Individuals’, it is not available to any other assessee. Assessee should be

suffering from any of the following specified disability by at least 40% :-

• Blindness,

• Low Vision,

• Physically or Orthopaedical Handicappness,

• Mental Retardedness,• Cerebral Palsy,

• Autism,

• Leprosy

If the disability is less than 40 %, then no deduction under this section shall beavailable. The amount of deduction available under this section is Rs. 50,000/- flat

irrespective of the amount of expenditure incurred by assesssee. If the disability

specified above is more than 80 % (Severe Disability), then the amount of deduction

available under this section shall be Rs. 1,00,000/- flat, (Rs. 75,000/- upto A.Y. 2009-10) irrespective of the amount of expenditure incurred by the asseseee.

The following further points shall be noted in this regard:-

• A Certificate from Medical Authority shall have to be obtained by the assessee,certifying the fact that he/she is either Blind or Physically Handicapped and such

Certificate shall be attached with the Return of Income of the assessee.

• If the percentage of disability has not been specified in the question, then it shall beassumed to be more than 40% but less than 80%. And accordingly, a deduction of

Rs. 50,000/- shall be allowed.

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42 Tybcom Five Heads Theory 89 Pgs(1)