Dibrugarh University B.Com 3rd Semester Income Tax Law and Practice Notes Unit – 3

Unit – 3
Computation of Income under different heads - 2

Profits and gains of business or profession; Capital gains; Income from other sources.

Meaning of Business and Profession

The tax payable by an assessee on his income under the head “Profits and Gains of Business and Profession” carried on by him or on his behalf during the previous year.

Business: The term ‘Business’ has been defined in section 2(13) to “include any trade, commerce or manufacturer or any adventure or concern in the nature of trade, commerce or manufacture”.

Profession: The term “Profession” has not been defined in the Act. It means an occupation requiring some degree of learning. The term ‘profession’ includes vocation as well. [Section 2(36)]

Chargeability of income under the head Profits and Gains of Business and Profession [section 28]

The various items of income chargeable to tax as income under the head Profits and Gains of Business and Profession are as under:

i. The profits and gains of any business which was carried on by the assessee at any time during the previous year;

ii. Any compensation or other payment due to or received by –

(a) Any person, by whatever name called, managing the whole or substantially the whole of –

(i) the affairs of an Indian company; or

(ii) the affairs in India of any other company at or in connection with the termination of his          management or office or the modification of any of the terms and conditions relating thereto;

(b) Any person, by whatever name called, 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 any of the terms and conditions relating thereto;

(c) Any person, for or in connection with the vesting in the Government or 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.

iii. Income derived by a trade, professional or similar association from specific services performed for its members. This is an exception to the general principle that a surplus arising to mutual association cannot be regarded as income chargeable to tax;

iv. Incentives received or receivable by assessee carrying on export business:

(a) Profits on sales of import licenses granted under Imports (control) order on account of exports,

(b) Cash assistances, by whatever name called, received or receivable against export,

(c) Duty drawbacks of Customs and Central Excise duties,

(d) Any profit on the transfer of the Duty Entitlement Pass Book Scheme,

(e) Any profit on the transfer of the Duty Free Replenishment certificate;

v. The value of any benefit or perquisite whether convertible into money or not, arising from business or the exercise of any profession.

vi. Any interest, salary, bonus, commission or remuneration, by whatever name called, due to or received by a partner of a firm from such firm will be deemed to be income from business. However, where any interest, salary, bonus, commission or remuneration by whatever name called, or any part thereof has not been allowed to be deducted under section 40(b), in the computation of the income of the firm the income to be taxed shall be adjusted to the extent of the amount disallowed.

vii. Any sum whether received or receivable in cash or in kind under an agreement for:-

(a) not carrying out activity in relation to any business; or

(b) not sharing any know-how, patent, copyright, trade-mark, 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 services.

viii. Any sum received under a key man Insurance Policy including the sum allocated by way of bonus on such policy;

ix. Any sum, whether received or receivable, in cash or in kind, on account of any capital asset being demolished, destroyed, discarded or transferred, if the whole of the expenditure on such capital assest has been allowed as a deduction under section 35AD.

Depreciation [section 32]

Depreciation on business assets is fully allowed under Income tax Act.

Depreciation is decrease in the value of on asset due to its wear and tear caused by its use and passage of time. It is debited to profits and loss account. It is calculated on block of assets basis.

Block of assets [section 2(11)] : Block of assets means a group of assets falling within a class of assets comprising Tangible assets being building, machinery, plants etc. Intangible assets being know-how, patents, copyrights, trademarks, licenses, franchisees or any other business or commercial rights of similar nature.

The word know-how means any industrial information or technique likely to assist in the manufacture or processing of goods or in the working of mines, oil well or other sources of mineral deposits (including searching for discovery or testing of deposits for winning access thereto. [section 32 (1)].

Rules / Conditions regarding the claim of deduction of depreciation:

1. Depreciation is allowed on all tangible and intangible assets except land, animals and goodwill.

2. Assets must be owned by the assessee. No depreciation on any hired assets but if any capital expenditure is incurred on a hired building then depreciation can be claimed on such capital expenditure.

3. Depreciation is calculated on the last day of accounting year and only on those assets which are in use on that day.

4. It is calculated at prescribed rate.

5. Depreciation is calculated on diminishing value method i.e. (WDV basis) but in case of assets used in an undertaking engaged in generation or generation and distribution of power, the assessee may opt to choose the actual cost basis (straight line method).

6. Total depreciation in the life of an asset cannot exceed its actual cost.

7. Assets must be used in assessee business or profession.

8. In case of stand by asset like generator, depreciation will be allowed even if it is not used during the year.

9. In case of newly acquired asset during the relevant previous year, full years depreciation is allowed if asset is installed and used for 180 or more than 180 day’s and half year’s depreciation is allowed if installed and used for less than 180 day’s, If asset was acquired in any earlier previous year but is put to use during the relevant previous year, the condition of 180 days shall not be applicable.

10. No depreciation is allowed in the year in which the asset is sold, demolished, discarded or destroyed.

11. No depreciation is allowed on cars manufactured outside India and acquired after 1.3.1975 but before 1.4.2001. But now depreciation is allowed in same manner as for Indian cars.

12. The word plant includes in itself Plant and Machinery, Air conditioners, office equipment, surgical equipment, electrical fittings and utensils of a hotel etc. The plant shall not include tae bushes, livestock or furniture and fittings.

13. The term “Commercial vehicle” includes heavy passenger motor vehicle, light motor vehicle, medium goods vehicle, medium passenger motor vehicle but does not include maxi cab, motor cab, tractor and road roller. These vehicles shall same meaning as is assigned to them in section 2 of Motor Vehicle Act 1998.

Capital Gain

What is a Capital Asset [section 2(14)]:

“Capital asset” means –

(a) property of any kind held by an assessee, whether or not connected with his business or profession;

(b) any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the SEBI regulations.

However, it does not include –

(i) Stock-in-trade: Any stock-in-trade [other than securities referred to in (b) above], consumable stores or raw materials held for the purpose of the business or profession of the assessee,

(ii) Personal effects: personal effects, that is to say, movable property (including wearing apparel and furniture), held for personal use by the assessee or any member of his family dependent on him. However, the following assets shall not be treated as personal effects though these assets are moveable and may be held for personal use:

a. jewellery;

b. archaeological collections;

c. drawings;

d. paintings;

e sculptures;

f. any work of art.

(iii) Agricultural land in India, which is not an urban agricultural land. In other words, it must be a rural agricultural land;

(iv) Gold Deposit Bonds issued under the Gold Deposit Scheme 1999.

Short-term capital asset [section 2(42A)]: A capital asset held by an assessee for not more than 36 months immediately preceding the date of its transfer is known as a short term capital asset.

However, the following assets shall be treated as short-term capital assets if they are held for not more than 12 months (instead of 36 months mentioned above) immediately preceding the date of its transfer:

(a) a security including shares (other than unit) listed in a recognized stock exchange in India

(b) a unit of an equity oriented fund

(c) a zero coupon bond

Further, a share of a company (not being a share listed in a recognized stock exchange in India) would be treated as a short-term capital asset if it was held by the assessee for not more than 24 months immediately preceding the date of its transfer.

Further, an immovable property, being land or building or both, would be treated as a short-term capital asset if it was held by an assessee for not more than 24 months immediately preceding the date of its transfer.

Long-term capital asset [section 2(29A)]: It means a capital asset which is not a short-term capital asset. In other words, if the asset is held by the assessee for more than 36 months or 12 months, as the case may be, such an asset will be treated as a long-term capital asset. The following assets are, therefore long-term capital assets:

i. a security (other than a unit) listed in a recognized stock exchange in India, a unit of UTI or a unit of an equity oriented fund or a zero coupon bond held for more than 12 months;

ii. unlisted shares or an immovable property, being land or building or both, held for more than 24 months immediately preceding the date of its transfer; and

iii. any other capital asset held for more than 36 months.

What is Transfer [section 2(47)]: Transfer, in relation to capital asset, includes:

(i) the sale, exchange or relinquishment of the asset; or

(ii) the extinguishment of any rights therein; or

(iii) the compulsory acquisition thereof under any law; or

(iv) in a case where the asset is converted by the owner thereof into, or is treated by him, as stock-in-trade of a business carried on by him, such conversion or treatment; or

(v) the maturity or redemption of zero coupon bonds; or

(vi) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of the Transfer of Property Act, 1882; or

(vii) any transaction (whether by way of becoming a member of, or acquiring shares in a co-operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of any immovable property.

Computation of capital gains [section 48]

Capital gains are of two types:

(i) Short-term capital gain which arises on the transfer of a short-term capital asset; and

(ii) Long-term capital gain which arises on the transfer of a long-term capital asset

Short-term capital gain is the excess of the full value of consideration over the aggregate of the following three:

a. cost of improvement;

b. expenses of transfer;

c. cost of acquisition of the asset.

Whereas in the case of long-term capital gain, the capital gain shall be the excess of the full value of consideration over the aggregate of the following three amounts:

a. expenses of transfer;

b. indexed cost of acquisition of the asset;

c. indexed cost of improvement.

From capital gain, computed as above, certain exemptions are available u/s 54/54B/54D/54EC/54F/54G/54GA/54GB. The capital gain after claiming the said exemption(s) is known as taxable long-term or short-term capital gain. A format to compute the capital gain is given below:

Computation of short-term capital gain:

Computation of Long-term capital gain:

Transactions not regarded as transfer [section 46 and 47]:

The meaning of transfer is given in section 2(47), whereas transactions not regarded as transfer are covered u/s 46 and 47. In the following transactions although there is a transfer, but these are not considered to be transfer for purpose of capital gains: Some examples are as follows –

i. Any distribution of capital assets on the total or partial partition of a HUF;

ii. Any transfer of capital asset under a gift or will or an irrevocable trust;

iii. Any transfer of capital asset by a holding company to its 100% subsidiary Indian company or by a subsidiary company to its 100% holding Indian company;

iv. Any transfer or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company;

v. Any transfer by a shareholder in a scheme of amalgamation of shares held by him in the amalgamating company;

vi. Any transfer, made outside India, of a capital asset being rupee denominated bond of an Indian company issued outside India, by a non-resident to another non-resident;

vii. Any transfer of a capital asset, being a Government security carrying a periodic payment of interest, made outside India through an intermediary dealing in settlement of securities, by a non-resident to another non-resident;

viii. Any transfer by an individual of sovereign gold bonds issued by RBI by way of redemption;

ix. Any transfer by way of conversion of bonds, debentures, debenture, stock, deposit certificates of a company, into shares or debentures of that company;

x. Any transfer by way of conversion of preference shares of a company into equity shares of that company;

xi. Any transfer of a capital asset in a transaction of reverse mortgage under a scheme made and notified by the Central Government.

Exemption of Capital Gain under section 54/54B/54D/54EC/54EE/54F

(i) Capital Gains on sale of residential house [section 54]:

Eligible assessee – Individual & HUF

Conditions to be fulfilled

a. There should be a transfer of residential house (building or lands appurtenant thereto)

b. It must be a long-term capital asset

c. Income from such house should be chargeable under the head “Income from such house property”

d. One residential house in India should be –

   * purchased within 1 year before or 2 years after the date of transfer (or)

   * constructed within a period of 3 years after the date of transfer.

Quantum of Exemption

1. If cost of new residential house is higher than capital gains, entire capital gain is exempt.

2. If cost of new residential house is lower than capital gains, capital gains to the extent of cost of new residential house is exempt.

(ii) Capital Gains on transfer of agricultural land [section 54B]:

Eligible assessee – Individual & HUF

Conditions to be fulfilled

a. There should be a transfer of urban agricultural land.

b. Such land must have been used for agricultural purposes by the assessee, being an individual or his parent, or a HUF in the 2 immediately preceding years.

c. He should purchase another agricultural land (urban or rural) within 2 years from the date of transfer.

Quantum of Exemption

1. If cost of new agricultural land is higher than capital gains, entire capital gain is exempt.

2. If cost of new agricultural land is lower than capital gains, capital gains to the extent of cost of new agricultural land is exempt.

(iii) Capital Gains on transfer by way of compulsory acquisition of land and building of an industrial undertaking [section 54D]:

Eligible assessee – Any assessee

Conditions to be fulfilled

a. There must be compulsory acquisition of land and building forming part of an industrial undertaking.

b. The land and building should have been used by the assessee for purposes of the business of the industrial undertaking in the 2 years immediately preceding the date of transfer.

c. The assessee must purchase any other land or building or construct any building (for shifting or re-establishing the existing undertaking or setting up a new industrial undertaking) within 3 years from the date of transfer.

Quantum of Exemption

1. If cost of new asset is higher than capital gains, entire capital gain is exempt.

2. If cost of new asset is lower than capital gains, capital gain to the extent of cost of new asset is exempt.

(iv) Capital Gains not chargeable on investment in certain bonds [section 54EC]:

Eligible assessee – Any assessee

Conditions to be fulfilled

a. There should be transfer of a long-term capital asset.

b. Such asset can also be a depreciable asset held for more than 36 months.

c. The capital gains arising from such transfer should be invested in a long-term specified asset within 6 months from the date of transfer.

d. Long-term specified asset means specified bonds, redeemable after 3 years, issued by the National Highway Authority of India (NHAI) or the Rural Electrification Corporation Limited (RECL) or any other bond notified by the Central Government in this behalf.

e. The assessee should not transfer or convert or avail loan or advance on the security of such bonds for a period of 3 years from the date of acquisition of such bonds.

 Quantum of Exemption

1. Capital gains or amount invested in specified bonds, whichever is lower.

2. The maximum investment which can be made in notified bonds or bonds of NHAI and RECL, out of capital gains arising from transfer of one or more assets, during the previous year in which the original asset is transferred and in the subsequent financial year cannot exceed Rs. 50 lakhs.

(v) Exemption of long-term capital gains on investment in notified units of specified fund [New section 54EE]:

Objective:

For incentivizing the start –up ecosystem in India, the ‘start-up India Action plan’ envisages establishment of a fund of funds which intends to raise Rs 2500 crores annually for four years to finance the start-ups.

Exemption of LTCG invested in units of specified fund:

In order to achieve this objective, new section 54EE has been inserted to provide exemption from capital gains tax if the long-term capital gains proceeds are invested by an assessee in units issued before 1st April, 2019 of such fund, as may be notified by the Central Government in this behalf. The lower of the capital gains or the amount so invested would be exempt under section 54EE.

Quantum of Exemption

1. If amount invested in notified units of specified fund is higher than capital gains, entire capital gain is exempt.

2. If amount invested in notified units of specified fund is lower than capital gains, capital gains to the extent of cost of amount invested in notified units is exempt.

Time limit for investment: The investment has to be made within 6 months after the date of transfer.

vi. Capital gains in cases of investment in residential house [section 54F]:

Eligible assessee – Individual & HUF

Conditions to be fulfilled

a. There must be transfer of a long-term capital asset, not being a residential house.

b. Transfer of plot of land is also eligible for exemption

c. The assessee should –

   * Purchase one residential house situated in India within a period of 1 year before or 2 years      after the date of transfer; or

    * Construct one residential house in India within 3 years from the date of transfer.

d. The assessee should not own more than one residential house on the date of transfer.

e. The assessee should not –

    * Purchase any other residential house within a period of 2 years; or

    * Construct any other residential house within a period of 3 years from the date of transfer of   the original asset.

Quantum of Exemption

1. If cost of new residential house is higher than net sale consideration of original asset, entire capital gains is exempt.

2. If cost of new residential house is lower than net sale consideration of original asset, only proportionate capital gains is exempt, i.e.,

Cost of acquisition [section 55(2)]:

Cost of acquisition is the price which the assessee has paid, or the amount which the assessee has incurred, for acquisition of the asset. Expenses incurred for completing the title are a part of the cost of acquisition.

Interest on money borrowed for acquiring capital assets will form part of the cost of asset:

1. Interest on loan taken for acquiring a capital asset (other than house property) will become part of the cost of acquisition.

2. Interest paid by the firm to its partner on capital contribution for the purchase of capital asset cannot be treated as part of cost of acquisition.

3. Interest on the asset acquired by the assessee carrying on business or profession till such asset is put to use, shall form part of the cost of acquisition but any interest paid for the period after the asset is put to use shall be treated as revenue expenses and hence will not form part of cost of acquisition.

Sum paid for discharge of mortgage: Where the property has been mortgaged by the previous owner during his lifetime and the assessee, after inheriting the same, has discharged the mortgage debt, the amount paid by him for the purpose of clearing off the mortgage shall be regarded as cost of acquisition under section 48 read with section 55(2) of the Act.

Cost of improvement [section 55]:

(i) In relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing, or right to carry on any business or profession, the cost of improvement shall be taken to be nil.

(ii) In relation to any other assets –

(a) Where the capital asset became the property of the previous owner or the assessee before 1.4.2001, cost of improvement means all expenditure of a capital nature incurred in making any addition or alteration to the capital asset on or after the said date by the previous owner or the assessee.

(b) In any other case, cost of improvement means all expenditure of a capital nature incurred in making any additions or alterations to the capital assets by the assessee after it became his property. However, there are cases where the capital asset might become the property of the assessee by any of the modes specified in section 49(1). In that case, cost of improvement means capital expenditure in making any addition or alterations to the capital assets incurred by the previous owner.

 

Income from other sources

Chargeability

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

In other words, the following conditions must be satisfied before an income can be taxed under the head “Income from other source”:

(i) there must be an income;

(ii) such income is not exempt under the provisions of this Act;

(iii) such income is not chargeable to tax under any first four heads viz., “Income from Salary”, “Income from House Property”, “Profits and Gains of Business or Profession” and “Income from capital gains”.

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

Incomes included under “Income from other sources” [section 56(2)]:

There are many incomes which are taxable under the head ‘Income from other source’. However, section 56(2) enlists certain specific incomes which shall be chargeable to Income-tax under the head ‘Income from other source’. These are:

(i) dividends, other than the dividends referred to in section 115-Q;

(ii) 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;

(iii) any sum received by the assessee from his employees as contribution to any provident fund, or any other welfare fund for the employees provided it is not taxable under the head ‘profits and gains of business or profession’;

(iv) income by way of interest on securities provided the income is not chargeable to Income-tax under the head profits and gains of business or profession;

(v) income from machinery, plant or furniture belonging to the assessee and let on hire, provided the income is not chargeable to Income-tax under the head profits and gains of business or profession;

(vi) where the assessee lets on hire, the machinery, plant or furniture belonging to him and also buildings, and letting of buildings, is inseparable from the letting of the said machinery, plant or furniture, the income from such letting, if it is not chargeable to income-tax under the head profits and gains of business or profession;

(vii) any sum under a key man insurance policy, including the sum allocated by way of bonus on such policy, if such income is not taxable under the head “Salaries” or “Profits and gains of business and profession”.

(viii) any sum of money, the aggregate value of which exceeds Rs. 50,000 is received without consideration or property is received without consideration or movable property is received for an inadequate consideration by an individual or HUP, if the amount of such gift or inadequate consideration exceeds Rs. 50, 000 [section 56(2)(vii)]

(ix) any property being shares of a closely held company received without consideration or for inadequate consideration by the firm or a closely held company if aggregate value of the amount of such gift or inadequate consideration exceeds Rs. 50,000. [section 56(2)(viia)]

(x) where a closely held company receives in any previous year from any resident person, any consideration for issue of shares that exceeds the face value of shares, then the aggregate consideration
received for such shares which is in excess of fair market value shall be taxable.

(xi) income by way of interest received on compensation or on enhanced compensation to be taxed in the year in which such interest is received.

(xii) Forfeiture of advance received for transfer of a capital asset to be taxed under the head “income from other sources” [section 56(2)(ix)]

These are the incomes, which have been specified, in particular, to be chargeable under the head income from other sources.

Deductions not allowable under the head income from other source [section 58]

1. Any personal expenses of the assessee.

2. Any interest chargeable to tax under the Act which is payable outside India on which tax has not been paid or deducted at source.

3. Any payment taxable in India as salaries, if it is payable outside India unless tax has been paid thereon or deducted at source.

4. Any payment to a relative or associate concern otherwise than by account payee cheque or draft or ECS though a bank account, if the aggregate of such payments exceed Rs. 10,000 during a day.

5. Any expenditure or allowances in connection with income by way of earnings from lotteries, cross word puzzles, races including horse races, card games and other games of any sort or from gambling or betting of any form or nature.

6. 30% of expenditure in respect of sum which is payable to a resident on which tax is deductible at source, if such tax has not been deducted or after deduction has not been paid on or before the due date of return specified in section 139(1).

 Deductions allowable under the head income from other source [section 57]

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