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

Unit – 4
Computation of Total Income and Tax Liability

Income of other persons included in Assessee’s total income; Aggregation of income and set-off and carry forward of losses; Deduction from gross total income; Rebates and reliefs; Computation of total income of individuals and firms; Tax liability of an individual and a firm; Five leading cases decided by the Supreme Court.

Income of other persons included in Assessee’s total income;

1. Clubbing of Income:

Under Income-tax Act, 1961, an assessee is generally taxed in respect of his own income. However, there are certain cases where as assessee has to pay tax in respect of income of another person. The provisions for the same are contained in sections 60 to 65 of the Act. These provisions have been enacted to counteract the tendency on the part of the tax-payers to dispose of their property or transfer their income in such a way that their tax liability can be avoided or reduced.

For example, in the case of individuals, income-tax is levied on a slab system on the total income. The tax system is progressive i.e. as the income increases, the applicable rate of tax increases. Some taxpayers in the higher income bracket have a tendency to divert some portion of their income to their spouse, minor child etc. to minimize their tax burden. In order to prevent such tax avoidance, clubbing provisions have been incorporated in the Act, under which income arising to certain persons (like spouse, minor child etc.) have to be included in the income of the person who has diverted his income for the purpose of computing tax liability.

2. Clubbing of Income arising to Spouse:

Income by way of remuneration from a concern in which the individual has substantial interest [section 64(1)(ii)]:

1. In computing the total income of any individual, all such income which arises, directly or indirectly, to the spouse of such individual by way of salary, commission, fees or any other form of remuneration, whether in cash or in kind, from a concern in which such individual has a substantial interest shall be included.

2. However, this provision does not apply where the spouse of the said individual possesses technical or professional qualifications and the income to the spouse is solely attributable to the application of his / her technical or professional knowledge or experience. In such an event, the income arising to such spouse is to be assessed in his / her hands.

3. Where both husband and wife have substantial interest in a concern and both are in receipt of income by way of salary etc. from the said concern, such income will be includible in the hands of that spouse, whose total income, excluding such income is higher.

4. Where any such income is once included in the total income of either spouse, income arising in the succeeding year shall not be included in the total income of the other spouse unless the Assessing Officer is satisfied, after giving that spouse an opportunity of being heard, that it is necessary to do so.

Income arising to the spouse from an asset transferred without adequate consideration [section 64(1)(iv)]:

1. Where there is a transfer of an asset (other than house property), directly or indirectly, from one spouse to the other, otherwise than for adequate consideration or in connection with an agreement to live apart, any income arising to the transferee from the transferred asset, either directly or indirectly, shall be included in the total income of the transferor.

2. In the case of transferor of house property, the provisions are contained in section 27. If an individual transfers a house property to his spouse, without adequate consideration or otherwise than in connection with an agreement to live apart, the transferor shall be deemed to be the owner of the house property and its annual value will be taxed in his hands.

3. It may be noted that any income from the accretion of the transferred asset is not to be clubbed with the income of the transferor.

4. The income arising on transferred assets alone have to be clubbed. However, income earned by investing such income (arising from transferred asset) cannot be clubbed.

5. It is also to be noted that natural love and affection do not constitute adequate consideration. Therefore, where an asset is transferred without adequate consideration, the income from such asset will be clubbed in the hands of the transferor.

6. Where the assets transferred, directly or indirectly, by an individual to his spouse are invested by the transferee in the business, proportionate income arising from such investment is to be included in the total income of the transferor. If the investment is in the nature of contribution of capital, proportionate interest on capital will be clubbed with the income of the transferor.

Such proportion has to be computed by taking into account the value of the aforesaid investment as on the first day of the previous year to the total investment in the business by the transferee as on that day.

3. Clubbing of Minor’s Income [section 64 (1A)]:

1. All income of a minor is to be included in the income of his parent.

2. However, the income derived by the minor from manual work or from any activity involving his skill, talent or specialized knowledge or experience will not be included in the income of his parent.

3. The income of the minor will be included in the income of that parent, whose total income is greater.

4. Once clubbing of minor’s income is done with that of one parent, it will continue to be clubbed with that parent only, in subsequent years. The Assessing Officer, may, however, club the minor’s income with that of the other parent, if, after giving the other parent an opportunity to be heard, he is satisfied that it is necessary to do so.

5. Where the marriage of the parents does not subsist, the income of the minor will be includible in the income of that parent who maintains the minor child in the relevant previous year.

6. However, the income of a minor child suffering from any disability of the nature specified in section 80U shall not be included in the hands of the parent but shall be assessed in the hands of the child.

7. It may be noted that the clubbing provisions are attracted even in respect of income of minor married daughter.

Exemption in respect of clubbed income of minor [section 10(32)]:

In case the income of an individual (i.e. the parent) includes the income of his minor child in terms of section 64(1A), such parent shall be entitled to exemption of Rs. 1500 in respect of each minor child. However, if income of any minor so includible is less than Rs. 1500, then the entire income shall be exempt.

Aggregation of income and set-off and carry forward of losses

Income-tax is levied on the total income of any assessee of a previous year. Total income is calculated by aggregating the income of the assessee under different sources of income falling under one head of income and then all heads of income are put together to find out the net result in the shape of total income. It is not necessary that every source shall result into a profit every year. There may be loss under one source and profit under another source. So when the income of different sources is put together the loss of one source is to be adjusted against the income of another source. When the income of all heads is aggregated, the loss under one head is set-off against the income of another head and if at all the total result is a loss, the same is carried forward over future years for setting off. Sections 70-79 of the Income tax Act, 1961 deal with the provisions regarding set-off losses and carry forward and set-off losses.

Set-off losses:

A. Set-off losses from one source against income from another source within the same head of income:

The income under one head is computed by adding together the incomes from different sources which fall under the same head. Section 70 says that the loss of one source is adjusted against the income of another source falling under the same head of income. Suppose the assessee is running two-three different businesses and the income of the head is calculated by combining different sources. So it is automatic that if there is loss under one source, the same is adjusted or set-off against the available income under other sources in the same head of income.

There are some exceptions to this rule that a loss can be set-off against any other income under the same head:-

a. Speculation loss [section 73(1)]

Any loss computed in respect of speculation business carried on by assessee shall not be set-off except against profits and gains, if any, of another speculation business.

However, losses from other business can be adjusted against profits from speculation business.

b. Long term capital loss [section 70(3)]

Long term capital loss from the transfer of a capital asset shall be allowed to be set-off only out of the long-term capital gain from the transfer of another capital asset. However short term capital loss shall be allowed to be adjusted out of long term as well as short term capital gain.

c. Loss from running and maintenance of race horses [section 74A(3)]

Loss from owning and maintenance of horses shall be set-off only out of the income from owning and maintenance of horses. This means that loss from the activity of owning and maintaining race horses cannot be set-off against any other income.

d. Losses from specified business [section 73A(1)]

A loss in any specified business referred in section 35AD can be set-off only against any other specified business.

However, losses from other business can be set-off against profits from specified business.

e. Loss from an exempted source of income

If a person has loss from a source of income which is exempt under any provision of this Act, such loss cannot be set-off against the income of any other source which is taxable.

B. Set-off loss of one head against the income of another head in the same assessment year i.e., inter-heads set-off:

A loss which could not be set-off within the same head of income shall be allowed to be set-off out of income of any other head in the same assessment year. However, the following points should be considered:

a. Where the net result of the computation under any head of income (other than ‘capital gain’) is a loss, the assessee can set-off such loss against his income assessable for that assessment year under any other head, including ‘capital gains’.

b. Where the net result of the computation under the head ‘profits and gains of business or profession’ is a loss, such loss cannot be set off against income under the head ‘salaries’.

c. Where the net result of computation under the head ‘capital gains’ is a loss, such capital loss cannot be set –off against income under any other head.

d. Where the net result of the computation under the head ‘Income from house property’ a loss and the assessee has income assessable under any other head of income, the amount of such loss exceeding Rs 2 lakhs would not be allowable to be set-off against income under the other head. In other words, the maximum loss from house property which can be set-off against income from any other head is Rs 2 lakhs.

e. Speculation loss, loss from the activity of owning and maintaining race horses and losses from specified business referred to in section 35AD cannot be set off against income under any other head.

Carry forward and set-off losses:

Where in any assessment year, the loss under any head is not adjusted as per rules; the same shall be carry forward and set-off against the income of subsequent years.

1. Carry forward and set-off losses from House property [section 71B]:

i. In any assessment year, if there is a loss under the head “income from house property”, such loss will first be set off against income from any other head to the extent of Rs 200000 during the same year.

ii. The unabsorbed loss will be carried forward to the following assessment year to be set-off against income under the head “Income from house property”.

iii. The loss under this head is allowed to be carried forward up to 8 assessment years immediately succeeding year in which the loss was first computed.

Iv. It is remembered that once a particular loss is carried forward, it can be set only against the income from the same head in the forthcoming assessment years.

2. Carry forward and set-off Business losses [section 72 & 80]:

Under this Act, the assessee has the right to carry forward the loss from the business and profession in cases where such loss cannot be set-off due to the absence or inadequacy of income under any other head in the same year. The loss so carried forward can be set-off against the profits of subsequent previous years.

Section 72 covers the carry forward and set-off losses arising from a business or profession.

The assessee’s right to carry forward business losses under this section is, however, subject to the following conditions:-

i. The loss should have been incurred in business, profession or vocation.

ii. The loss should not be in the nature of a loss in the business of speculation.

iii. The loss may be carry forward and set-off against the income from business or profession though not necessarily against the profits and gains of the same business or profession in which the loss was incurred.

However, a loss carried forward cannot, under any circumstances, be set-off against the income from any head other than “profits and gains of business or profession”.

iv. The loss can be carried forward and set-off only against the profits of the assessee who incurred loss. That is, only the person who has incurred the loss is entitled to carry forward or set off the same. Consequently, the successor of a business cannot carry forward or set-off losses of his predecessor except in the case of succession by inheritance.

v. A business loss can be carried forward for a maximum period of 8 assessment years immediately succeeding the assessment year in which the loss was incurred.

vi. As per section 80, the assessee must have filed a return of loss under section 139(3) in order to carry forward and set-off a loss. In other words, the non-filing of a return of loss disentitles the assessee from carrying forward the loss sustained by him. Such a return should be filed within the time allowed under section 139(1).

3. Loss of speculation business [section 73]:

Where for any assessment year the loss under speculation business has not been wholly set-off against the income of another speculation business, such part of speculation loss shall be carried forward to the following assessment year and set-off only against the profits of any speculation business carried on by the assessee and assessable during those assessment years. The unabsorbed speculation business loss is eligible for carry forward up to 4(four) assessment years immediately succeeding the assessment year for which the loss was computed.

4. Carry forward and set-off losses by Specified businesses [section 73A]:

i. Any loss computed in respect of the specified business referred to in section 35AD shall be set-off only against profits and gains, if any, of any other specified business.

ii. The unabsorbed loss, if any, will be carried forward for set-off against profits and gains of any specified business in the following assessment year and so on.

iii. There is no time limit specified for carry forward and set-off and therefore, such loss can be carried forward indefinitely for set-off against income from specified business.

iv. However, return of loss has to be filed on or before the due date of filing of return under section 139(1) for carry forward of loss from specified business.

5. Losses under the head ‘Capital Gains’ [section 74]:

Section 74 provides that where for any assessment year, the net result under the head ‘capital gains’ is short-term capital loss or long-term capital loss, the loss shall be carried forward to the following assessment year to be set-off in the following manner:

i. Where the loss so carried forward is a short-term capital loss, it shall be set-off against any capital gains, short-term or long-term, arising in that year.

ii. Where the loss so carried forward is a long term capital loss, it shall be set-off only against long term capital gain arising in that year.

iii. Net loss under the head capital gains cannot be set-off against income under any other hand.

iv. Any unabsorbed loss shall be carried forward to the following assessment year up to a maximum of 8 assessment years immediately succeeding the assessment year for which the loss was first computed.

6. Losses from the activity of owning and maintaining race horses [section 74A(3)]:

i. According to provisions of section 74A(3), the losses incurred by an assessee from the activity of owning and maintaining race horses cannot be set-off against the income from any other source other than the activity of owning and maintaining race horses.

ii. Such loss can be carried forward for a maximum period of 4 assessment years for being set-off against the income from the activity of owning and maintaining race horses in the subsequent years.

Unabsorbed Depreciation [section 32(2)]:

With effect from assessment year 2003-04 depreciation which remains unadjusted as either there is no income or less income in the relevant previous year, it can be carried forward till it is fully adjusted from any income during the succeeding previous years. It shall be treated as depreciation of the succeeding previous year. In case there is carry forward business loss as well as carry forward unabsorbed depreciation, then following order should be followed for set-off.

i. Firstly current depreciation.

ii. Secondly brought forward business loss.

iii. Thirdly brought forward / unabsorbed depreciation.

Order of set-off losses:

As per the provisions of section 72(2), brought forward business loss is to be set-off before setting off unabsorbed depreciation. Therefore, the order in which set-off will be effected is as follows –

a. Current year depreciation / current year capital expenditure on scientific research and current year expenditure on family planning, to the extent allowed.

b. Brought forward loss from business / profession [section 72(1)]

c. Unabsorbed depreciation [section 32(2)]

d. Unabsorbed capital expenditure on scientific research [section 35(4)]

e. Unabsorbed expenditure on family planning [section 36(1)(ix)]

Computation of total Income and Tax liability of Individuals:

Income-tax is levied on an assessee’s total income. Total income has to be computed as per the provisions contained in the Income-tax Act, 191. The following steps have to be followed for computing the total income of an assessee:

Step 1 – Determination of residential status

a. Resident

- Resident and ordinarily resident

- Resident but not ordinarily resident

b. Non-resident

Step 2 – Classification of income under different heads

a. Income from salaries

b. Income from house property

c. Income from profit and gains of business or profession

d. Income from capital gains

e. Income from other sources

Step 3 – Computation of income under each head