Analysis of the Different Heads of Income

Analysis of the Different Heads of Income

INTRODUCTION-

The government levy taxes on citizens to raise revenue for the purpose of performing the undertaken responsibilities of fostering economic growth and enhancing the efficacy in improving the living standards of the people. Thus, taxes are the mandatory capital costs that the government demands and utilizes to carry out beneficial welfare activities viz. national development, improvement of infrastructure, the wellbeing of the population, and many more. Welfare schemes necessitate considerable spending, and thereof government meets such needs with the public finance raised of the tax collections.

It is purported that ancient manuscripts like Manusmrithi and Arthashastra have the endorsement of taxation. Nemine contradicente, the statutes are backed by the constitution; if not, then the same will be revoked qua ultra vires. Correspondingly, the state and the central governments acquire authority from the provisions of the Indian constitution to levy tax on the allocated sectors. It is envisaged that the taxes must not be levied or collected unless and until it is endorsed by the authority of law pursuant to Article 265 of the Constitution.

Furthermore, entry 82 of List I of Seventh schedule empowers the parliament to levy and collect income tax not inclusive of agricultural incomes, which is being collected by the state as per Entry 46 of List II.

As far as India is concerned, given catchall legislation that governs, levy, collect, administer, and recover income tax is Income Tax Act, implemented on 1st April of 1961 (earlier Income Tax Act, 1922). Under this Act, the phraseology income tax comprises both the cess and the surcharge for the assessment year¹. It is pertinent to note that the Act provides provisions for the cess, which includes taxation on income received in advance, and income yet to be received.

HEADS OF INCOME-

A) Salaries-

Essential norms of salary income-

In order to understand the meaning of expression “salary”, one has to keep in mind the following norms-

a) Relationship between payer and payee – Income under the head “Salaries” covers all remuneration due/paid to a person in respect of services rendered by him under an express or implied contract of employment. Charge under this head of income presumes the relationship of an employer and an employee between the payer and payee in contrast to that of a principal and an agent. The distinction between the two types of relationship is vital because income earned by an employee from his employer is chargeable under the head “Salaries”, whereas income earned by an agent is chargeable either under the head “Profits and gains of business or profession” or under the head “Income from other sources.²

b) Salary and Wages – Both are compensation for work done or services rendered, though ordinarily salary is paid in connection with services of non-manual type of work, while wages are paid in connection with manual services.³

c) Salary from more than one source – If an individual receives salary from more than one employer during the same previous year (maybe due to change of employment or due to employment with more than one employer simultaneously), salary from each source is taxable under the head “Salaries”. For instance, if a clerk works with two employers on part-time basis, salary from both the employers will be chargeable to tax under the head “Salaries”.

d) Salary from former employer, present employer or prospective employer – Remuneration received (or due) during the previous year is chargeable to tax under the head “Salaries irrespective of whether it is received from a former, present or prospective employer.

e) Salary income must be real and not fictitious – Amount taxable under the head “Salaries” is real salary and not fictitious salary. There should be an intention to pay and receive salary. Where, for example, there was, merely in order to comply with the requirement of the Board of Education Rules, an agreement between the assessee (a school teacher) and the governing body of the school granting a certain salary to the assessee and simultaneously there was another agreement by which an identical sum was to be returned by the assessee to the governing body as donation, it was held that there was in reality no agreement to pay and receive salary.⁴ Likewise, if there is no intention to render any service and agreement is made to make payment on paper in order to claim the same as business deduction, the amount received by the so-called employee is not chargeable as salary.

f) Foregoing of salary – Section 15 deals with taxes salary on “due” basis, even if it is not received. If, therefore, an employee foregoes his salary, it does not mean that salary so foregone is not taxable. Once salary has accrued to an employee, its subsequent waiver does not make it exempt from tax liability. Such voluntary waiver or foregoing by an employee of salary due to him is merely an application of income and is nonetheless chargeable to tax.

g) Surrender of salary – If an employee opts to surrender his salary to the Central Government under section 2 of the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, the salary so surrendered would be excluded while computing his taxable income. Thus, tax is not payable in respect of salary surrendered, which can be basic salary as well as different allowances. Benefit of tax exemption in respect of salary surrendered is available to all employees whether they are employed in private sector or public sector. In CIT Raghunath Murti⁵, the assessee-managing director revised return because he had to refund certain sum to his employer-company as the same was found in excess of limits prescribed in the Companies Act, 1956. The Delhi High Court held that as the said refund was neither voluntary nor was it for any extraneous consideration, the same could not be held to be the assessee’s income and, therefore, was not assessable”.

h) Salary paid tax-free – If salary is paid tax-free by the employer, the employee must include in his taxable income not only the salary received but also the amount of tax paid by the employer. It does not make any difference whether tax is paid under terms of contract voluntarily Under section 17(2)(iv) such payment is statutorily deemed as “perquisite”.

i) Voluntary payments- Salary, perquisite or allowance may come as a gift to an employee and yet it would be taxable. The Act does not make any distinction between gratuitous payment and contractual payment.

Salary under section 17(1) – Under section 17(1), salary is defined to include the following:

a) Wages

b) any annuity or pension:

c) any gratuity.

d) any fees, commission, perquisite, or profits in lieu of or in addition to any salary or wages;

e) any advance of salary;

f) any payment received in respect of any period of leave not availed by him:

g) the portion of the annual accretion in any previous year to the balance at the credit of an employee participating in Recognised Provident Fund to the extent it is taxable;

h) transferred balance in a Recognised Provident Fund to the extent it is taxable; and

i) the contribution made by the Central Government in the previous year, to the account of an employee under a pension scheme referred to in section 80CCD.

Tax treatment of different forms of salary income

a) Basic salary and dearness pay are charged to tax under section 15.

b) Advance salary [Sec. 17(1)(v)]- Advance salary is taxable on receipt basis, in the year relevant to the previous year in which it is received, irrespective of the incidence of tax hands of the employee. The recipient can, however, claim relief in terms of section 89. A loan taken from employer is not taxable as advance salary.

c) Arrear salary-It is taxable on receipt basis, if the same has not been subjected to tax earlier on due basis. In this case also recipient can claim relief under section 89.

d) Leave Salary -As per service rules, an employee gets different leaves. An employee to earn leave in the first instance and only when he has leave to his credit, he can apply for leave. If a leave (standing to his credit) is not taken within a year, as per the service rules it may lapse it may be encashed or it may be accumulated. The accumulated leaves standing to the credit of an employee may be availed by the employee during his service time or, subject to service rules such leaves may be encashed at the time of retirement or leaving the job. Encashment of leave by surrendering leave standing to one’s credit is known as “leave salary”.

Leave Salary at The Time of Retirement To Central/State Government Employees – In the case of Central/State Government employee, any amount received as cash equivalent of leave salary in respect of period of earned leave at his credit at the time of retirement/superannuation, is exempt from tax [sec. 10 (10AA) (i)]

A professor/teacher of a university established under an Act of Parliament/State legislature (as well as college affiliated to such university or constituent college of such university) is treated as Government employee for this purpose.⁶

OTHER POINTS-

The following other points should also be kept in view:

a) Relief under section 89 – Relief under section 89 would be admissible in respect of encashment of leave salary by an employee when in service⁷ or leave salary paid at the time of retirement or otherwise.

b) Leave salary to legal heirs not taxable – Salary paid to the legal heirs of a deceased employee in respect of privilege leave standing to the credit of such employee at the time of his/her death is not taxable as salary⁸. Sum equivalent of leave salary received by the family of a government servant who died in harness, is not taxable in the hands of the recipient.⁹

c) Retirement or otherwise – Exemption under section 10(10AA) is available in respect of cash equivalent of earned leave at the employee’s credit only at the time of retirement, whether such retirement is on superannuation or otherwise. The word “otherwise covers the case of retirement which takes place not at the time of superannuation but any other time. According to the Madras High Court in CIT RJ. Shahney¹⁰, Allahabad High Court in CIT v. D.p.Vijay Pal Singh¹¹ and the Bombay High Court in CIT v. D.P. Malhotra¹² voluntary retirement from service is one such case which comes within the four corners of the words “otherwise than superannuation”.

The words “or otherwise should not be construed ejusdem generis, but rather as extending the scope of the statute to include the case of retirement which does not take place at the superannuation but some other time. Barring the case of “termination” of service, any other case of leaving service (whether under the Voluntary Retirement Scheme of the employer or by way of resignation by the employee) is covered by section 10(10AA).

d) Salary in lieu of notice-period. It is taxable under section 15 on receipt basis¹³.

e) Salary to a partner – Salary paid to a partner by a firm is an appropriation of profits. It is, therefore, not chargeable under the head “Salaries” but is taxable under the head “Profits and gains of business or profession”. Likewise, interest, bonus, commission, or remuneration, by whatever name called, due to (or received by) a partner of a firm from such firm is not taxable under section 15.

f) Fees and commission – Fees and commission are taxable as salary irrespective of the fact that they are paid in addition to or in lieu of salary. Even where salary and commission are paid to employees under two separate agreements, commission would be taxable as salary when work done under the agreement is performed by the employee for the benefit of his employer.¹⁴ If, however, fees or commission is paid to a person (other than an employee), it is not taxable as salary income. For instance, commission paid to a director (not being an employee) for his giving guarantee for repayment of loan, etc., is taxable under the head “Income from other sources”.

g) Bonus – It is taxable in the year of receipt if it has not been taxed earlier on due basis. While contractual bonus is regarded as salary, gratuitous bonus is taxable as perquisite. If bonus is received in arrears, the assessee can claim relief in terms of section 89.

B) Income from House Property-

Chargeability [Sec. 22]

Income is taxable under the head “Income from house property”, if the following three conditions are satisfied:

a) The assessee should be owner of the property.

b) The property should not be used by the owner for the purpose of any business or profession carried on by him, the profits of which are chargeable to income-tax.

c) The property should consist of any buildings or lands appurtenant thereto.

Unless, therefore, all the aforesaid conditions are satisfied, the property income cannot be charged to tax under the head “Income from house property”.

In other words, if all the aforesaid conditions are satisfied, property income is taxable under section 22 under the head “Income from house property”. It makes no difference if the assessee is a company which has been incorporated with the object of buying and developing landed properties.¹⁵ It equally makes no difference that the property constitutes stock-in-trade of a business or the business of the assessee is to let out house properties.¹⁶

Property consisting of any buildings or land appurtenant thereto – The term “property” is very wide, though under section 22 it is used for a limited purpose, i.e., the property “consisting of any buildings or lands appurtenant thereto”. All other types of properties are, thus, excluded from the scope of section 22. Rental income of a vacant plot (not appurtenant to building) is chargeable to tax under the head “Income from house property”, but is taxable either under the head “Profits and gains of business or profession” or under the head “Income from other sources”, as the case may be.

i) Assessee should be owner of the property – Income is taxable under the head, “Income from house property only if the assessee is the owner of a house property. Income from subletting is not taxable under section 22, but is taxable under section 56 under the head “Income from other sources. It is immaterial whether the owner is in possession and enjoyment of house property or has been let out to third persons.

If person makes gift of rental income to a friend or a relative, without transferring ownership of the, annual value of property is taxable in the hands of the donor, even if rental income is by the done – S. Kartar Singh v. CIT¹⁷. In other words, for the purpose of section 22, the owner must be that person who can exercise the rights of the owner, not on behalf of the owner but in his own right¹⁸.

ii) Property should not be occupied by the owner for his own business or profession – Annual value of a house property is not chargeable to tax under the head “Income from house property” if the following conditions are satisfied-

Condition 1- The owner of the property utilizes the property for the purposes of carrying on his business or profession

Condition 2 Income of the above business or profession is chargeable to tax.

If the above conditions are satisfied, annual value of the property is not taxable under section 22 under the head “Income from house property”. This rule is applicable even if in a particular your income from business or profession is nil or there is loss. The reason of this exclusion seems to be that notional rent of property is not allowable as a permissible deduction while computing business in his own house property.

Property owned by partner and used by firm – For the purpose of section 22, the business carried on by the firm should be regarded as being carried on by all the partners. Thus, annually value of a building belonging to the assessee which is in the occupation of a firm in which is in the occupation of the firm in which the assessee is not the partner, is not includible in income of the assessee under section 22.¹⁹

Where Karta of HUF is partner in firm, in representative capacity and property belonging to HUF occupied by firm for carrying on business, exemption under section 22 will be available to HUF²⁰.

The contrary view expressed by the Karnataka High Court in CIT v. K.N. Guruswamy²¹, it is respectfully submitted, requires reconsideration.

Applicability of Section 22 in Certain Typical Situations –

Apart from the points discussed, the following points are relevant for understanding-

a) House property in a foreign country – A resident assessee is taxable under section 22 in respect of annual value of a property situated in a foreign country. A resident but not ordinarily resident or non-resident is, however, chargeable under section 22 in respect of income of a house property situated abroad, if income is received in India during the previous year. If tax incidence is attracted under section 22 in respect of a house property situated abroad, annual value will be computed as if the property is situated in India. The Madras High Court in CIT R. Venugopala Reddiar²² observed that while computing taxable income, no distinction should be made between a house property situated in India and a house property situated abroad.

b) Disputed ownership – If title of ownership of a house property is under dispute in a court of law, the decision as to who is the owner rests with the Income-tax Department. The department has prima facie the power to decide whether the assessee is the owner and is chargeable to tax under section 22, without waiting for judicial judgment of any suit filed in respect of the property.²³ It was observed in Franklin IRC²⁴ that the recipient of income is taxable though there may be a rival claim as to the title of source of income and he may have to give up and account for what he is taxed upon.

c) Property held as stock-in-trade- As a specific head of charge is provided for income from house property, annual value of house property cannot be brought to tax under any other head of income. It will remain so even if-

– the property is held by the assessee as stock-in-trade of a business; or

– the assessee is engaged in the business of letting out of property on rent, or if the assessee is company which is incorporated for the purpose of owning house property.

House-owning, however profitable, is neither trade nor business for the purpose of the Act. Where income is derived from house property by the exercise of property rights, income falls under the head “Income from house property”²⁵.

Exceptions-

The rule that income from ownership of house property is taxable under the head “Income from house property has the following exceptions:

Exception one-Letting is incidental and subservient to the main business-If the letting is only incidental and subservient to the main business of the assessee, rental income is not taxable under the head “Income from house property” but is chargeable as business income under the head “Profits and gains of business or profession.”

Exception two – Hiring of complex – In some cases, income is received not only for letting out of property but also for incidental services or facilities (e.g., a furnished paying guest accommodation, a well-equipped theatre, a safe deposit vault). In such cases, the subject hired out is a complex one. The income cannot be said to be derived from mere ownership of house property but because of facilities and services rendered. Income in such case may be assessed as income from business.

d) Splitting up of a composite rent – Apart from recovering rent of the building, in some cases the owner gets rent of other assets (like furniture) or he charges for different services provided in the building (for instance, charges for lift, security, air conditioning, etc.). The amount so recovered is known as “composite rent”. The tax treatment of the composite rent is as follows-

• • Where Composite Rent Includes Rent of Building and Charges for Different Services (Like Lift, Air Conditioning) – If the owner of a house property gets a composite rent for the property as well as for services rendered to the tenants, composite rent is to be split up and the sum which is attributable to the use of property is to be assessed in the form of annual value under section 22. The amount which relates to rendition of the services (such as electricity supply, provision of lifts, supply of water, arrangement for scavenging, watch and ward facilities, etc.) is charged to tax under the head “Profits and gains of business or profession” or under the head “Income from other sources”.
  • Where Composite Rent is Rent Of Letting Out Of Building And Letting Out Of Other Assets (Like Furniture) And The Two Lettings Are Not Separable-If there is letting of machinery, plant and furniture and also letting of the building and the two lettings form part and parcel the same transaction or the two lettings are inseparable (in the sense that letting of one is not acceptable to the other part without letting of the other), then such income is taxable either as business income or income from other sources. This rule is applicable even if sum receivable for the two lettings is fixed separately.
  • Where Composite Rent is Rent of Letting out Of Building And Letting Out of Other Assets And The Two Lettings Are Separable- If there is letting out of building and letting of other assets and the two lettings are separable (in the sense that letting of one is acceptable to the other party without letting out of the other for instance letting out of building along with car), then income from letting out of building is taxable under the head “Income from house property and income from letting out of other assets is taxable either as business income or income from other sources. This rule is applicable even if the assessee receives composite rent from his tenant for two lettings.²⁶
    • Property owned by co-owners [Sec. 26]- If a house property is owned by two or more persons, such persons are known as co-owners. Section 26 covers case if a property is owned by co-owners. Section 26 is applicable if the following conditions are satisfied-
      • The property must consist of building or building and land appurtenant thereto.
      • It is owned or deemed to be owned by two or more persons.
      • The respective shares of the co-owners are definite and ascertainable. If these conditions are satisfied, then the share of each co-owner in the income of the property (as computed under the head “Income from house property”) shall be included in the total income of each such person. The following points should be noted-
      • In respect of property income, co-owners shall not be assessed as an association of persons.
      • The concessional tax treatment in respect of self-occupied property is applicable as if each such person is individually entitled to such relief.

Other points- One should also keep in view the following propositions:

a) Transfer by book entries- If a firm transfers its house property to its partners before dissolution, merely by book entries, annual value of the property is taxable in the hands of the firm.²⁷

b) Stalls permanently affixed-Since the words “building” and “house property” are not defined under the Act, annual value of stalls permanently affixed to the ground is taxable under section 22.²⁸

c) Rent of tower/antenna installed on terrace-If an assessee who owns terrace floor of a building. gives the same on licence to a telecom company for installing tower/antenna, the licence fee is taxable as income from house property.²⁹ Where the assessee carries on hotel business in the building and rent is received for letting out of its terrace for installing tower, rental income will be taxable as business income.³⁰

d) Onus of proof – In order to attract taxability, the onus is on the revenue dept. to prove that an assessee is the owner of building in question.³¹

C) Profits and gains of business or profession-

Chargeability [Sec. 28]

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

a) profits and gains of any business or profession

b) any compensation or other payments due to or received by any person specified in section 28 (ii)

c) income derived by a trade, professional or similar association from specific services performed for its members

d) profit on sale of import entitlement licences, incentive by way of cash compensatory support and drawback of duty

e) any profit on transfer of the Duty Entitlement Pass Book (DEPB) Scheme,

f) any profit on the transfer of the Duty-Free Replenishment Certificate.

g) the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession

h) any interest, salary, bonus, commission, or remuneration received by a partner of firm from such firm

i) any sum whether received or receivable, in cash or kind, under an agreement for not carrying out any activity in relation to any business or not to share any know-how, patent, copyright, trademark, licence, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision for service.

j) any sum received under a keyman insurance policy (including bonus).

k) any sum received (or receivable) in cash or kind, on account of any capital asset (other than land or goodwill or financial instrument) being demolished, destroyed, discarded, or transferred, if the whole of the expenditure on such capital asset has been allowed as a deduction under section 35AD; and

l) income from speculative transaction.

Income from the aforesaid activities is computed in accordance with the provisions laid down is sections 29 to 44DB.

♦ Business – Meaning of – In view of section 2(13), business includes any (a) trade, (b) commerce (c) manufacture, or (d) any adventure or concern in trade, commerce, or manufacture.

Definition of “Business” in section 2(13) is not exhaustive – The definition of the term “business” in section 2(13) is not exhaustive, it covers every facet of an occupation carried on by a person with a view to earning profits. Thus, the word “business” under section 28 has a very broad meaning and may be used in many different connotations.

Production of goods from raw material, buying and selling of goods to make profits and providing services to others are different forms of “business”.

Business includes trade – In view of section 2(13) business, inter alia, includes trade. Therefore, it is essential to deal with it separately. Shah, J. observed in State of Punjab v. Bajaj Electricals Ltd³² that trade in its primary meaning is the exchanging of goods for goods or goods for money; in its secondary meaning it is repeated activity in business carried on with a profit motive, the activity being manual or mercantile, as distinguished from the liberal arts or learned professions or agriculture.

♦ Business includes commerce – If a person purchases goods with a view to selling them at a profit, it is an ordinary case of trade. If such transactions are repeated on a large scale, it is called commerce. In determining a case of trade or commerce, in contradiction to investment, one has to take into account the nature of the assets, the occupation of assessee, and the frequency and volume of transactions.³³

♦ Business includes manufacture- The word “manufacture” is defined by the Oxford English Dictionary as making of articles or materials by physical labour or mechanical power.” “The essence of manufacturing is that something is produced or bought into existence which is different from that out of which it is made, in the sense that the thing produced is by itself commercial commodity which is capable as such of being sold or supplied.”

♦ Business includes any adventure in the nature of trade, commerce or manufacture-When section 2(13) refers to an adventure in the nature of trade, it clearly suggests that the transact cannot properly be regarded as trade or business. It is allied to transactions that constitute trade business, but may not be trade or business itself. It is characterised by some of the essential feature that make up trade business but not by all of them.³⁴

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

– Rental income in case of dealer in Property – Rent of house property is taxable under section 22 under the head “Income from house property “, even if property constitutes stock-in-trade of recipient of rent or the recipient of rent is engaged in the business of letting properties on rent.³⁵

– Dividend on shares in the case of a dealer in shares – Dividends on shares are taxable under section 56(2)(i), under the head “Income from other sources” even if they are derived from shares held as stock-in-trade or the recipient of dividends is a dealer in shares. Dividend received from a Indian Company is not a chargeable to tax in the hands of shareholders (this rule is subject to a few exceptions).

– Winning from lotteries, etc – Winnings from lotteries, races, etc., are taxable under the head “Income from other sources” (even if derived as a regular business activity).

– Interest received on Compensation or Enhanced Compensation – Such interest is always taxable in the year of receipt under the head “Income from other sources” (even if it pertains to a regular business activity). A deduction of 50 percent allowed and effectively only 50 per cent of such interest is taxable under the head “lace from other sources”.

Profits derived from the aforesaid business activities are not taxable under section 28, under the head “Profits and gains of business or profession”. Profits and gains of any other business taxable under section 28, unless such profits are exempt under sections 10 to 13A.

♦ Meaning of “profession” and “vocation” – Section 2(36), profession includes the word “profession” implies professed attainments in special knowledge as distinguished from mere skill: “special knowledge” which is “to be acquired only after patient study and application.”³⁶ Many vocations may fall within the ordinary and accepted use of the word “profession: for instance, as those of tax experts, financial accountants, cost accountants, may fall within the ordinary and accepted use of management accountants, architects, engineers, journalists, and so forth. However, whether a person in any given case carries on a profession is a question of degree and always of facts.³⁷.

A company being an artificial person cannot be said to possess any personal skills. A company (being an artificial person) does not have mind and body and, therefore, cannot be engaged in profession. It can neither have an intellectual skill or any manual skill.³⁸

³⁶ United States v. Laws [1896] 163 US 258

³⁷ Robbins Herbal Institute v. Federal Taxation Commissioner [1923] 32 CLR 457

Compensation or other payments due to or received by any person specified in section 28(ii) – Under section 28(ii), compensation or payment due to or received by the following persons, by whatever name called, is chargeable to tax under the head “Profits and gains of business or profession”:

– any person managing the whole (or substantially the whole) of affairs of an Indian company, at (or in connection with) the termination of his management (or the modification of the terms and conditions relating thereto);

– any person managing the whole (or substantially the whole) of the affairs in India of any other company, at or (in connection with) the termination of his office (or the modification of the terms and conditions relating thereto);

– any person, holding an agency in India for any part of the activities relating to the business of any other person, at (or in connection with) the termination of the agency (or the modification of the terms and conditions relating thereto):

– any person, for (or in connection with) the vesting in the Government (or in any corporation owned or controlled by the Government), under any law for the time being in force, of the management of any property or business.

♦ Income of trade or professional associations from specific services [Sec. 28(iii)]-It is a settled principle that excess of income over expenditure accruing to a mutual association is not income and, consequently, it is not liable to tax. The principle is based upon the fact that in the case of surplus, the contributors are to receive back a part of their own contributions; the complete identity between the contributors to common fund and the participants in the surplus negatives the idea of any income, as no one can make a profit out of himself.³⁹

To this rule, an exception is provided in the case of insurance business carried on by a mutual insurance Company or co-operative society under section 2(24) vii). Another exception to the general principle is provided by section 28(iii) which provides that income of a trade, professional or similar association from specific service performed for its members is taxable as business income, even though the association enjoys a mutual character. In order to bring an income within section 28(iii), two essential conditions have to be satisfied, namely, (a) income is derived by a trade, professional or similar association, and (b) income is derived by specific services performed for its members.

D) Capital gains-

Chargeability [Sec. 45(1)]

Any profit or gain arising from the transfer of a capital asset during a previous year is chargeable to tax under the head “Capital gains” in the immediately following assessment year, if it is not eligible for exemption under sections 54, 54B, 54D, 54EC, 54EF, 54F, 54G, 54GA and 54GB. In other words, capital gains tax liability arises only when the following conditions are satisfied:

Condition 1: There should be a capital asset.

Condition 2: The capital asset is transferred by the assessee.

Condition 3: Such transfer takes place during the previous year.

Condition 4: Any profit or gain arises as a result of transfer.

Condition 5: Such profit or gain is not exempt from tax under sections 54, 54B, 54D, 54EC, 54EE, 54F, 54G, 54GA and 54GB.

If the aforesaid conditions are satisfied, then capital gain is taxable in the assessment year relevant to the previous year in which the capital asset is transferred. However, the following points should be considered:

a) In some cases, capital gain is taxable in a year other than the year in which the capital asset is transferred.

b) In some cases, capital gain arises even if there is no “transfer” of capital asset.

a) Meaning of capital asset [Sec. 2(14)]

“Capital asset” is defined to include property of any kind, whether fixed or circulating, movable or immovable, tangible or intangible.

b) Property of any kind is a capital asset – Property of any kind held by an assessee (except some given exceptions) is a capital asset for the purpose of the Income-tax Act. It includes movable assets, immovable assets, tangible/intangible assets, incorporeal rights, and chooses in action. The term “property” is a term of the widest import and subject to any limitation which the context may require, it signifies every possible interest which a person can clearly hold and enjoy.⁴⁰ Property transferred must be a capital asset on the date of transfer. It is not necessary that it should have been capital asset also on the date of its acquisition by the assessee.⁴¹

The Supreme Court in the case of Vodafone International Holdings B.V. v. Union of India⁴² held that influence/persuasion of a parent company over its subsidiary could not be construed as a right in the legal sense. To supersede this ruling, an Explanation is inserted by the Finance Act, 2012 below section 2(14) (with retrospective effect from April 1, 1962) to clarify that “property includes any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.

c) Stock-in-trade, raw material, etc., is not a capital asset [(Sec. 2(14)(1)] – By virtue of section 2(14)(i), any stock-in-trade (not being securities held by a Foreign Institutional Investor), consumable stores or raw material held for the purpose of business or profession is not a capital asset. This is because of the fact that any surplus arising on sale or transfer of stock-in-trade, consumable stores or raw material is chargeable to tax as business income under section 28.

d) Personal effects being movable property are not capital assets [Sec. 2(14)(ii)]-Personal effects are not capital assets under section 2(14)(ii), if the following conditions are satisfied:

– It should be movable property (including wearing apparel and furniture).

– It should be held for personal use by the assessee or any member of his family dependent on him.

– It should not be jewellery, archaeological collections, drawings, paintings, sculptures, or any work of art.

Judicial Rulings – One should also keep in view the following judicial pronouncements:

√ Must be intended for personal and household use – Gold and Silver coins and bars used for puja of deities as a matter of pride or ornamentation and normally not intended for personal or household use are not “personal effects and are, therefore, treated as capital assets⁴³.

A property intended for personal or household use (may be for ceremonial occasions only), is always a “personal effect”. For instance, clothes meant for use at weddings or formal occasions are not used daily. Yet, they are stitched for personal use of the wearer. As such, they would form a part of his personal effects⁴⁴.

Likewise, silver utensils held by an assessee which are not in use ordinarily and normally by the assessee, but only on certain occasions are personal effects.⁴⁵ 1′ Furniture – Furniture can be said to be movables held for personal use⁴⁶.

√ Goats- Where the assessee purchases 1172 goats and holds them mainly for grazing on its lands and for procuring their wastes as natural manure to increase agricultural production, goats held by the assessee cannot be said to be personal effects of the assessee.⁴⁷

e) Agricultural land situated in rural area is not a capital asset- Agricultural land in India is not a capital asset provided it is situated in a rural area. If agricultural land is situated in a village which comes within a municipality, then population of municipality shall be considered (and not of village). In such a case if population of the municipality exceeds 10,000, then agricultural land is a capital asset, even if population of the village less than 10,000.⁴⁸

f) Gold Bonds are not capital assets – 6 ¹/₂ per cent Gold Bonds, 1977;7 per cent Gold Bonds, 1980, and National Defence Gold Bonds, 1980, issued by the Central Government are not capital assets. It is not necessary that the assessee should be the initial subscriber to the Gold Bonds.

g) Special Bearer Bonds, 1991-Special Bearer Bonds, 1991, issued by the Central Government are not capital assets by virtue of section 2(14)(v). In order to avail the benefit of section 2(14)(v), it is not necessary that the assessee should be the initial subscriber of these bonds.

h) Gold Deposit Bonds, 1999-Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999, notified by the Central Government are not capital assets by virtue of section 2(14)(vi) from the assessment year 2000-01.

Capital gains exempt from tax

The Act grants total/partial exemption from capital gains tax in terms of sections 54, 54B, 54D, 54EC, SEE 54F, 54G, 54GA, 54GB and 54H. It is possible to avail of multiple exemptions under these sections. However, the aggregate amount of exemption cannot exceed the quantum of capital gain amount of capital gain.

E) Income from Other Sources-

Basis of charge [Sec. 56]

Income from other sources is the last and residual head of income. Sub-section (1) of section 56 covers any income which does not fall under any other head of income. However, sub-section of section 56 specifies nine incomes which are always taxable under the head “Income from other sources”

Special provisions – The following ten incomes are always taxable under the head “Income from other sources”-

a) Dividend – Dividend is defined by section 2(22). Dividend received from an Indian company is not chargeable to tax in the hands of shareholders (this rule is subject to a few exceptions)

b) Winning from lotteries, etc – It includes any winnings from lotteries, crossword puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature whatsoever. These receipts are chargeable to tax under the head “Income from other sources”.

c) Employees contribution towards staff welfare scheme – Any sum received by the assessee from his employees as contributions to any staff welfare scheme is taxable in the hands of the employer under the head “Income from other sources”.⁴⁹

d) Rental income of letting out of plant, machinery or furniture along with letting out of building and the two lettings are not separable – Such rental income is taxable under the head “Income from other sources (if the same is not taxed as business income under section 28).

e) Interest on Securities – Interest on debentures, Government securities/bonds is taxable under the head “Income from other sources” (if the same is not taxed as business income under section 28).

f) Rental Income of Machinery, Plant or Furniture – Rental income from machinery, plant or furniture let on hire is taxable as income from other sources (if the same is not taxed as business income under section 28).

g) Sum received under Keyman Insurance Policy – Any sum received under a Keyman insurance policy (including bonus) is taxable as income from other sources (if the same is not taxable as salary income or business income).

h) Gift – If any sum of money or property is received during a previous year without consideration by an individual or a Hindu undivided family from any person or persons exceeds Rs. 50,000, the whole of such amount is taxable in the hands of the recipient as income from other sources.

i) Interest on Compensation or Enhanced Compensation – Clause (vii) has been inserted in section 56(2) by the Finance (No. 2) Act, 2009 to provide that income by way of interest received on compensation or on enhanced compensation shall be assessed under the head “Income from other sources” in the year in which it is received.

j) Advance money received during negotiations for transfer of a capital asset – Where any sum of money, received as an advance or otherwise in the course of negotiations for course of the negotiations for transfer of a capital asset, is forfeited and the transfer of a capital asset negotiations do not result in transfer of such capital asset, then, such sum shall be chargeable to income-tax under the head “Income from other source” (applicable from the assessment year 2015-16).

General provisions [Sec. 56(1)]- “Income from other sources” is the last and residual head of income. A source of income which does not specifically fall under any one of the other four heads of income (viz., “Salaries”, “Income from house property”, “Profits and gains of business or profession” or “Capital gains”) is to be computed and brought to charge under section 56 under the head “Income from other sources”. In other words, it can be said that the residuary head of income can be resorted to only if none of the specific heads is applicable to the income in question and that it comes into the operation only if the preceding heads are excluded.

Proposition On The Basis Of Judicial Pronouncements – The House of Lords in Salisbury House Estate Ltd. v. Fry⁵⁰ had laid the following propositions regarding the scope of Schedule D (i.e.., the residuary Schedule under the English income-tax law) which are equally applicable to the scope of the head “Income from other sources”, as has been affirmed by the Supreme Court in Nalinikant Ambalal Mody v. CIT⁵¹

An income can be charged to tax under the residuary head only if none of the specific heads is applicable to the income in question.

Where an item of income is taxable under one of the specific heads of income and charge under that head of income exhausts the chargeability of income to tax, no part of such income can be charged to tax under the residuary head.

The residuary head of income can be resorted to only if none of the specific heads is applicable to the income in question and it comes into operation only after the preceding heads are excluded.⁵² The character or the nature of income does not cease to be income from property because of its non-chargeability under the relevant computing sections. What is crucial is the classification. Once the income is classified under a particular head, then only one has to look to the corresponding computing section for the purpose of chargeability to tax.

Broad Conclusions-

To sum up, it can be said that the residuary head of income can be invoked only if all the following conditions are satisfied:

– Income-There is an “income” [sec. 2(24), read with sections 4 and 5].

– Income should not be exempt– That income is not exempt from tax under sections 10 to 13A.

– Not covered by other heads-That income is neither salary income, nor rental income from house property, nor income from business/profession, nor capital gains. These four categories of incomes are not chargeable to tax under the head “Income from other sources”, even if such incomes, or a part thereof, cannot be brought to tax under their respective heads.

Judicial Pronouncements

The following judicial pronouncements will give a clear idea about the scope of section 56(1):

Discontinuance of business – Money received by an assessee from a business/profession, discontinued prior to the commencement of the previous year, is chargeable to tax under section 56.⁵³

Liquidator – Where the liquidator of a banking company is engaged in realising business asset, interest received on fixed deposits is chargeable under the head “Income from other sources”, as the liquidator under these circumstances cannot be said to carry on the business of the banking company.⁵⁴

Interest on unrecognised provident fund – Interest received by an employee at the time of retirement on his contribution to an unrecognized provident fund is taxable as income from other sources.⁵⁵

Interest earned before commencement of business – Interest earned on short-term investment of funds, borrowed for setting up of factory, during construction of factory before commencement of business has to be assessed as income from other sources and it cannot be held to be non-taxable ground that it would go to reduce interest liability on borrowed amount which would be capitalised.⁵⁶

Tax on salary – Tax on salary of the assessee borne by payer, for whom the assessee was working under a contract, under a legal obligation, was assessable as income of payee under the head “Income from other sources”.⁵⁷

Income from let out go-down– Where the assessee-company let out go-down to its subsidiary Company at Rs. 37,902 per month whereas subsidiary let it out to another party at Rs. 44,794 per month, the Tribunal was justified in holding that the difference was assessable as the assessee’s income from other sources.⁵⁸

Broad principles regarding interest on deposit of surplus money. The following principles are applicable in assessing interest income under the provisions of the Income-tax Act-

a) Interest on fixed deposits and other deposits before the commencement of the business is income from other sources.

b) Income from interest on deposits of surplus money during the construction period is also to be considered/treated as income from other sources.

c) Interest income in respect of surplus money, not required for business and deposited in bank or with persons, as idle money, for safe keeping, would be assessable as income from other sources If the income from interest is from a fund which has been brought as surplus capital, it would be assessable as income from other sources.

d) In respect of investment of surplus funds there is divergence of opinion between different High Courts and the Rajasthan High Court in the case of Murli Investments Co. held that if the surplus funds are invested instead of keeping them idle, the income by way of interest should be treated as income from other sources.⁵⁹

Although there is only one tax on the income calculated under various heads, but there are different rules of computation of income under each head and income has to be computed under that head after applying such rules only.

F) Some Common Judicial Pronouncements –

1. Income under each head has to be determined in the manner provided by the appropriate sections mentioned against each head above. [CIT v Ramesh Lal Pahwa⁶⁰]

2. If there is an income which cannot be brought to tax by computation under the above heads, it would not be included in the total income for the purpose of taxability. [CIT v Justice R.M. Datta⁶¹]

3. The computation of income under each of the above 5 heads of income will have to be made independently and separately. There are specific rules of deduction and allowance under each head. No deduction or adjustment on account of any expenditure can be made except as provided by the act. [Tuticorin Akali Chemical and Fertilizers Ltd v CIT⁶²]

4. The above mentioned 5 heads of income are mutually exclusive of each other. Thus, where an item of income falls specifically under one head, it must be charged under that head only and not under any other head.⁶³ [United Commercial Bank v CIT⁶⁴]

7. Conclusion –

Five types of Income have been discussed in the project. There are certain types of income which are taxed in different heads of income and certain incomes which are not taxed anywhere, sometimes the judicial activism is also showed in income tax rulings like in case of Vodafone Holdings Ltd. Moreover, there are certain incomes needed to not be taxed but are taxed there our Parliament need to do serious amendment in Income Tax Act 1961 so that the items could be elaborated in a more detailed manner and Judiciary needs to play a more active role also more judges who are from finance/ commerce background needed to be recruited in judge system.

BIBLIOGRAPHY-

A) BOOKS-

a) Dr. S.R Myneni, Law of Taxation (Allahabad Law Agency, Plot No. 33, 16/5, Faridabad-121002, 2017)

b) Dr Vinod K Singhania, Taxmann’s Direct Taxes Law & Practice (Tan Prints, Rohtak Road, Jhajjar, Haryana-124001, 59^th, 2019)

B) WEBSITES-

a) 5 Heads of Income for Computation of Income Tax available at: (https://www.charteredclub.com/5-heads-of-income/, last visited, 20th May 2023)

C) ACTS/STATUTES-

a) The Constitution of India, 1950

b) Income Tax Act (43 of 1961)

c) Income Tax Act (011 of 1922)

Notes:-

¹ Section 2(9) of Income Tax Act, 1961

² Cowan v. Seymour (1920) 1 KB 500 (CA)

³ Gestetner Duplicators (P) Ltd. v. CIT (1979) 117 ITR 1 (SC)

⁴ Reade v. Brearley (1933) 17 TC 687

⁵ (2009) 178 Taxman 144 (Delhi)

⁶ Ram Kanwar Rana v. ITO (2016) 71 taxmann.com 54 (Delhi- Trib.)

⁷ Circular No. 431, dated September 12,1985

⁸ Circular Letter No. F. 35/1/65-IT(B), dated November 5, 1965

⁹ Circular No. 309, dated July 3, 1981.

¹⁰ [1986] 159 ITR 160

¹¹ [2005] 144 Taxman 504

¹² [1998] 229 ITR 394

¹³ V.D Talwar. v. CIT [1963] 49 ITR 122 (SC)

¹⁴ CIT v. T. Abdul Wahid and Co (2000) 243 ITR 467 Mad.

¹⁵ S Mercantile Corpn. (P) Ltd. v. CIT (1972) 83 ITR 700 (SC).

¹⁶ O.R.M.SP.S.V. Firm v. CIT [1960] 39 ITR 327 (Mad.)

¹⁷ [1969] 73 ITR 438 (Delhi).

¹⁸ R.B Jodha Mal Kuthiala v. CIT [1971] 82 ITR 570 (SC)

¹⁹ CIT v. K.M Jagannathan [1989] 180 ITR 191 (Mad.)

²⁰ CIT v. Shri Champalal Jivraj 1995 215 ITR 289 (Mad.).

²¹ [1984] 146 ITR 34

²² [1965] 58 ITR 439

²³ Re. Keshardeo Chamaria [1937] 5 ITR 246 (Cal.)

²⁴ 15 TC 464

²⁵ CIT v. National Storage (P) Ltd. [1963] 48 ITR 577 (Bom.)

²⁶ Dr. S.R Myneni, Law of Taxation (Allahabad Law Agency, Plot No. 33, 16/5, Faridabad-121002, 2017)

²⁷ Inder Narain Har Narain v. CIT [1980] 3 Taxman 365 (Delhi).

²⁸ CIT v. Kanaiyalal Nimani [1979] 120 ITR 892 (Cal.).

²⁹ Niagara Hotels & Builders (P) Ltd. v. CIT [2015] 233 Taxman 183 (Delhi)

³⁰ New Kenilworth Hotel (P.) Ltd. v. CIT [2016] 387 TTR 201 (Cal.).

³¹ CIT v. Fazalbhoy Investment Co. (P) Ltd [1977] 109 ITR 802 (Bom.)

³² [1968] 70 ITR 730 (SC)

³³ W.L. Knopp v. CIT [1948] 16 ITR 398 (Mad.).

³⁴ G. Venkata Swami Naidu & Co. v. CIT [1959] 35 ITR 594 (SC).

³⁵ Salisbury House Estate ltd v. Fry [1930] AC 432 (HL)

³⁶ United States v. Laws [1896] 163 US 258

³⁷ Robbins Herbal Institute v. Federal Taxation Commissioner [1923] 32 CLR 457

³⁸ ITO v. Ashalok Nursing Home (P) Ltd. (2006) 9 SOT 61 (Delhi) (URO)

³⁹ Harris v. Corporation of Burgh of Irvine 4 TC 221.

⁴⁰ Ahmed G.H. Ariff v. CWT [1970] 176 TTR 471 (SC)

⁴¹ Arun Sunny v. CIT [2009] 184 Taxman 498 (Ker.)

⁴² (2012) 204 Taxman 408

⁴³ Maharaja Rana Hemant Singhji v. CIT [1976] 103 ITR 61 (SC)

⁴⁴ CIT v. HH Maharani Usha Devi [1998] 98 Taxman 309 (SC)

⁴⁵ Jayantilal A. Shah v. K.N. Anantharama Aiyar, CIT [1985] 23 Taxman 14 (Bom.)

⁴⁶ CIT v. Sitadevi N. Poddar [1984] 17 Taxman 345 (Bom.)

⁴⁷ V. Kali Rajan v. ITO [2001] 77 ITD 31 (Mad.).

⁴⁸ Omer Khan v. CIT [1992] 63 Taxman 533 (SC).

⁴⁹ Dr Vinod K Singhania, Taxmann’s Direct Taxes Law & Practice (Tan Prints, Rohtak Road, Jhajjar, Haryana-124001, 59^th ed., 2019)

⁵⁰ [1930] AC 432

⁵¹ [1966] 61 ITR 428

⁵² G. Mercantile Corpn. (P.) Ltd. v. CIT [1972] 83 ITR 700 (SC)

⁵³ Roma Bose v. ITO [1974] 95 ITR 299 (Cal).

⁵⁴ Morvi Mercantile Bank Ltd. v. CIT [1976] 104 ITR 568 (Guj.)

⁵⁵ CIT v. G. Hyatt [1971] 80 ITR 177 (SC).

⁵⁶ Tuticorin Alkali Chemicals & Fertilizers Ltd. v. CIT [1997] 93 Taxman 502/227 ITR 172

⁵⁷ Emil Webber v. CIT [1993] 200 ITR 483 (SC)

⁵⁸ CIT v. Shriram Jute Products Ltd. [1993] 71 Taxman 293 (Cal)

⁵⁹ CIT v. Rajasthan Land Development Corpn. [1995] 211 ITR 597 (Raj.)

⁶⁰ (1980) 123 ITR 86 (Cal)

⁶¹ (1989) 180 ITR 86 (Cal)

⁶² (1997) 227 ITR 172 (SC)

⁶³ 5 Heads of Income for Computation of Income Tax available at: (https://www.charteredclub.com/5-heads-of-income/, last visited, 20^th May 2023)

⁶⁴ (1957) 32 ITR 688 (SC)