PRINCIPLES - OF - TAXATION - LAW - Delhi University LLB

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PRINCIPLES OF TAXATION
LAW
UNIT 1 - Concept of application of income & diversion of income
Introduction
Income [Section 2(24)]
Though "Income" is a fundamental term in the Income Tax Act, 1961, a

precise definition of the word "income" is not provided.
Instead, the Act offers an inclusive definition, meaning it aims to

encompass a broad spectrum of financial gains and benefits.
The inclusive nature of the term "income" under Section 2(24) is

designed to cover both traditional and non-traditional forms of income,
including those items that might not ordinarily be considered as income
but are treated as such by statute.
Scope of "Income" for Tax Purposes
The inclusive definition is meant to broaden the scope of what is

considered income for tax purposes, ensuring that various forms of
financial benefits are captured under the term "income."
Legal Provisions in the Income Tax Act, 1961

Income - Section 2(24) - comprises of
Profit and gains
Dividend
Voluntary contributions received by a trust
The value of a perquisite of profit in lieu of salary
Capital gain arising from transfer of capital gain
PRINCIPLES OF TAXATION LAW 1

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
any sum received by the assessee from his employees as

contributions to any provident fund or superannuation fund or any
fund
Assessee - Section 2(7) - An assessee is a person by whom any tax or

any other sum of money is payable under this Act.
Person - Section 2(31) - includes an individual, Hindu undivided family,
company, firm, association of persons or body of individuals (whether
incorporated or not), local authority, and any artificial juridical person
not covered in the previous categories.
Charge of Income-Tax - Section 4 - When any Central Act specifies that
income-tax shall be charged for a particular assessment year at
specified rate(s), income-tax at those rate(s) shall be charged.
General Principles Regarding the Concept of Income through Judicial

Interpretation
Earnings: Income in its ordinary sense refers to any earning, profit, or

gain, whether periodic, regular, or daily, from any source.
Non-recurring: Income does not necessarily need to be recurring.
External Source: A person cannot generate income without an external

source.
Revaluation: No taxable income arises when an assessee revalues

assets and transfers them to a partnership where he is a partner.
Revaluing goods in books does not equate to selling them for a profit.
Illegality: Income earned through illegal means is taxable if it meets the

conditions of receipt or accrual.
Non-monetary: Income does not need to be in the form of money. It

can include receipts in kind or services with monetary value,
emphasizing the substance over form.
Reimbursements: Reimbursements for actual expenses, such as travel

expenses, are not considered income.

Important Case Law
Commissioner of Income Tax v. G.R. Karthikeyan (1993)
Facts:
The assessee, G.R Karthikeyan, participated in the All India Highway

Motor Rally during the accounting year relevant to the assessment year.
He won the first prize of Rs. 20,000 from the Indian Oil Corporation and
an additional Rs. 2,000 from the All India Highway Motor Rally.
The Income Tax Officer included the total sum of Rs. 22,000 in the
income of the assessee based on the definition of "income" under
Section 2(24) of the Income-tax Act, 1961.
Issue:
Whether the total sum of Rs. 22,000 received by the assessee should
be treated as "income" under the Income-tax Act, 1961.
Decision:
1. Inclusive Definition of Income:
The definition of "income" in the Act is inclusive, meaning it is broad

and not limited to the items specifically listed.
2. Nature of Income:
"Income" includes any earning or receipt that fits within its natural
or grammatical meaning.
The word "income" should be given its broadest connotation.
3. Entry 82 of List I of the Seventh Schedule:
The definition of "income" in Section 2(24) should be interpreted

with the same breadth as the word "income" in Entry 82 of List I of
the Seventh Schedule to the Constitution of India.
4. Interpretation of Terms:
The phrase "other games of any sort" encompasses a wide range

of activities, not limited to gambling.
The term "winnings" includes money from both gambling and non-
gambling activities.

5. Taxability of Winnings:
The court noted that entering a contest with the aim of winning
involves skill and endurance, leading to earnings that qualify as
income.
The definition of income is broad and includes any earning,

regardless of its source.
The Supreme Court in the case of Commissioner of Income Tax v. G.R.

Karthikeyan ruled that prize money won from participating in a motor rally
constitutes "income" under Section 2(24) of the Income-tax Act, 1961.
Application of Income and Diversion of Income
Concept Description Taxability
Occurs when the income reaches the

Application of Taxable in the hands
assessee and is then applied to
Income of the assessee.
discharge an obligation.
Occurs when income is diverted to Not taxable in the

Diversion of
another person by an overriding title hands of the
Income
before it reaches the assessee. assessee.
Tests and Principles:
The true test to determine whether an amount is a diversion of income

or an application of income is to see if the amount sought to be
deducted reached the assessee as his income.
If the income reaches the assessee and is then applied to discharge

an obligation, it is an application of income.
If the obligation diverts the income before it reaches the assessee, it

is a diversion of income.
Judicial Interpretations:
1. Bejoy Sing Dudhuria v. C.I.T. (1933)
The stepmother of the Raja had a charge for maintenance on the

properties in the hands of the Raja.
The Privy Council held that what reaches the individual as income is
what is intended to be taxed.

Since the stepmother’s maintenance was charged on the
properties, it was diverted before it reached the Raja as income.
2. CIT v. Sitaldas Tirthaldas (1961)
Legal Context:
Facts:
The assessee, Sitaldas Tirthaldas, for the assessment years sought

to deduct a sum paid for maintenance to his wife, Bai Deviben, and
his children.
The payments were made under a decree by the Bombay High

Court, which included allowances for maintenance, separate
residence, and marriage expenses for daughters.
The Income-tax Department disallowed the deduction.
Legal Issue:
Issue: Determining whether payments made by an assessee

towards maintenance can be considered a diversion of income by
overriding title or an application of income.
Judgment:
Held: The Supreme Court held that in this case, the maintenance
payments were made from the income that had already reached the
assessee. Therefore, it was an application of income, not a
diversion of income by overriding title.
Outcome: The assessee's income had not been diverted at the

source; instead, it was applied to fulfill an obligation after reaching
the assessee.
3. CIT v. Sunil J. Kinariwala (2003)
Legal Context:
Facts:
The assessee, Sunil J. Kinariwala, was a partner in the partnership

firm "M/s Kinariwala R.J.K. Industries" with a ten percent share.
He created a trust and assigned fifty percent of his ten percent right
The trust beneficiaries were his brother's wife, niece, and mother.

For the assessment year, the assessee claimed that fifty percent of
his share income transferred to the trust should be excluded from
his total income, arguing it was a diversion of income at source.
The Income Tax Officer rejected the claim, viewing it as an

application of income.
On appeal, the Appellate Assistant Commissioner allowed the

deduction, but the Tribunal reversed this decision.
The High Court ruled in favor of the assessee, stating the income
was diverted by overriding title and thus should not be included in
his total income.
Issue:
Determining whether income assigned to a trust by a partner of a firm

constitutes a diversion of income by overriding title or an application of
income.
Decision of the Supreme Court:
The Supreme Court ruled in favor of the Revenue and against the
assessee.
The Court held that the income assigned to the trust must be
included in the total income of the assessee.
The income assigned to the trust was considered an application

of income, as the obligation arose after the income had reached
the assessee.
Conclusion
The Supreme Court rulings in the discussed cases clarify that income,
broadly defined under Section 2(24) of the Income-tax Act, 1961,
encompasses various forms of earnings, whether from traditional
sources, winnings, or other financial gains. The distinction between the
application of income and diversion of income by overriding title is
critical, with the true test being whether the income reaches the
assessee first. If it does, it is taxable as an application of income. These
interpretations ensure a comprehensive understanding and application
of income tax law, capturing a wide array of financial transactions
within its scope.

UNIT 2 - Concept of agricultural income
Agricultural Income Under Section 2(1A) of the Income Tax Act, 1961
Legal Provision
Section 2(1A) of the Income Tax Act, 1961:
Definition: The term "agricultural income" encompasses various

sources of income derived from agricultural land.
1. Rent or Revenue (Section 2(1A)(a)):
Any rent or revenue derived from land situated in India and used
for agricultural purposes.
2. Income Derived from Agricultural Land (Section 2(1A)(b)):
Income from the sale of produce by a cultivator or receiver of rent-

in-kind, provided no additional processes beyond those
necessary to make the produce marketable have been performed.
3. Income from Buildings (Section 2(1A)(c)):
Income derived from any building owned and occupied by the

receiver of the rent or revenue of any such land, or occupied by the
cultivator or the receiver of rent-in-kind, provided the building is on
or in the immediate vicinity of the agricultural land and is used for
agricultural purposes.
Section 10 of the Income Tax Act, 1961:
Provision: "Incomes not included in total income."
Clause (1): Agricultural income is exempt from taxation under section

10(1) of the Act.
Basic Conditions for Agricultural Income:

For an income to be classified as agricultural income, the following
conditions must be satisfied:
1. Relation to Land:
2. Location of Land:
3. Use of Land:

Important Case Laws
1) Bacha F. Guzdar v. Commissioner of Income Tax
Facts:
The appellant, Bacha F. Guzdar, was a shareholder in two companies

engaged in the business of growing and manufacturing tea.
The appellant received dividends in the accounting year from these

companies.
Partial Agrcultral Income - According to Rule 24 of the Indian Income-

tax Rules, 1922, 40% of the income of tea companies was taxed as
non-agricultural income, and 60% was exempt as agricultural
income.
The appellant claimed that 60% of the dividend income should be

treated as agricultural income and thus be exempt from tax.
The Revenue contended that the entire dividend income was non-
agricultural and liable to tax.
Legal Issue:
Whether the dividend income received by the appellant from the tea
companies constituted agricultural income under the Income Tax Act
and was thereby exempt from tax.
Decision:
The Income Tax Officer (ITO), Appellate Assistant Commissioner (AAC),

Appellate Tribunal (AT), and the High Court all held that the dividend
income was not agricultural.
The Supreme Court upheld these decisions, ruling that the dividend
income was not agricultural.
Reasoning:
The Court determined that agricultural income refers to revenue derived

directly from land used for agricultural purposes.
Dividends received by a shareholder do not have a direct association

with agricultural land.
The principle established is that the character of income is

determined by the immediate and effective source, not the remote or

ultimate source.
2) Commissioner of Income Tax v. Raja Benoy Kumar Sahas Roy
Facts:
The respondent, Raja Benoy Kumar Sahas Roy, owned 600 acres of
forest land, which included sal and piyasal trees of spontaneous
growth.
The respondent employed numerous workers for agricultural

operations.
The respondent claimed that the income derived from the sale of these
forest trees was agricultural income and thus exempt from tax under
Section 4(3)(vii) of the Income-tax Act, 1922 (corresponding to
Section 10(1) of the Income-tax Act, 1961).
The Income Tax Officer rejected the claim, adding the net income from
the sale of forest trees to the respondent's taxable income after
allowing for maintenance expenditure.
The Appellate Assistant Commissioner and the Income Tax Appellate

Tribunal confirmed this assessment.
On appeal, the High Court of Calcutta was asked to decide whether the
income derived from the sale of the trees was agricultural income and
thus exempt from tax.
Issue:
Whether the income derived from the sale of trees in a forest of

spontaneous growth, where forestry operations were performed,
constitutes agricultural income exempt from tax.
Decision:
The Supreme Court ruled that the expression "land used for
agricultural purposes" in the Income-tax Act does not extend to
forests of spontaneous growth where nothing is done to prepare the
soil or foster tree growth.
To qualify as an agricultural operation, basic activities such as tilling the

land, sowing seeds, planting, etc., must be performed. These are

considered essential to establish that an agricultural operation is being
conducted.
Activities such as weeding, felling, cutting, and guarding, which are

carried out after the initial growth, do not themselves constitute
agricultural operations. These subsequent activities do not qualify the
land for the agricultural exemption under the Income Tax Act.
The Court held that it was necessary to distinguish between income

derived from spontaneous growth and income from trees planted and
maintained through human effort.
Given the time elapsed, the Court refrained from ordering a detailed
inquiry but suggested that a substantial portion of the income was likely
derived from trees planted by the respondent.
3) Premier Construction Co. Ltd. v. Commissioner of Income Tax, Bombay

City
Facts:
The appellant, Premier Construction Co. Ltd., was the managing agent
of a Company.
The remuneration of the appellant was determined under the Managing

agency agreement.
The appellant received remuneration as per this clause, which

exceeded the minimum salary of Rs. 10,000 secured by the agreement.
The principal company’s income was derived partly from the

manufacture of sugar from its own sugarcane (agricultural income) and
from sugarcane purchased from outside.
The appellant claimed that the portion of its remuneration

proportionate to the agricultural income of the principal company
should be treated as agricultural income and hence exempt from
income tax.
Issue:
Whether the portion of the income received by the appellant from the
principal company, proportionate to the agricultural income earned by
the principal company, is 'agricultural income' within the meaning of

Section 2(1) of the Income-tax Act, 1922 (corresponding to Section
2(1A) of the Income-tax Act, 1961), and therefore exempt from
assessment.
Decision:
The Court held that the income received by the appellant as

remuneration under the managing agency agreement was not
agricultural income.
The Court stated that agricultural income must be derived directly from
agricultural activities on the land.
In this case, the appellant's income was derived from the principal
company under a contractual arrangement for personal services.
The source of the appellant's income was the managing agency

agreement, not the agricultural activities directly.
Thus, the remuneration received by the appellant did not fall within the
definition of agricultural income as per the Income-tax Act and was not
exempt from tax.
4) Commissioner of Income Tax v. Maddi Venkatasubbayya

Facts:
The assessee, Maddi Venkatasubbayya, a firm of merchants, purchased

a standing crop of tobacco.
The tobacco was harvested, cured, and sold by the assessee.
The assessee performed agricultural operations
The curing process is a standard agricultural operation to make the

tobacco fit for market.
The Income-tax Officer and the Appellate Assistant Commissioner held

that part of the profits were from non-agricultural sources and thus
taxable.
The Appellate Tribunal, however, held that the entire profit from the
tobacco sale was agricultural income and exempt from tax under
Section 4(3) of the Income-tax Act, 1922.
Issue:

Whether the income derived from the sale of tobacco by the assessee,
who purchased the standing crop and conducted certain operations
before selling it, can be treated as agricultural income exempt from tax
under Section 4(3) of the Income-tax Act, 1922.
Decision:
In this case, the assessee was merely a purchaser of a standing crop

and did not have any interest in the land where the crop was raised.
The burden is on the assessee to prove that the income is

'agricultural income'.
The profits derived from selling the tobacco after performing post-
harvest operations were business profits, not agricultural income.
The character of the income in question was fundamentally different

from rent, revenue, or income derived by performing agricultural
operations by someone with an interest in the land.
The profit from the sale of such commodities is considered business

income, not agricultural income.
The High Court concluded that the part of the profits derived by the
assessee from selling the tobacco, was not agricultural income and was
thus liable to assessment to income-tax.
5) K. Lakshmanan & Co. v. Commissioner of Income Tax

Facts:
The appellant, K. Lakshmanan & Co., is a partnership firm engaged in

agricultural activities, specifically growing mulberry leaves and
rearing silkworms.
The firm purchases silkworm eggs and feeds them mulberry leaves
harvested from trees grown by the appellant.
The silkworms produce silk cocoons by spinning saliva which hardens

into protective cocoons.
These silk cocoons are then sold by the appellant in the market.
Issue:

Whether the income derived from the sale of silk cocoons by the
appellant qualifies as agricultural income under the Income-tax Act.
Decision:
As per Sec. 2(1A)(b) of the Income Tax Act, "what is taken to the
market and sold must be the produce which is raised by the
cultivator.
Although mulberry leaves are cultivated by the appellant and used to

feed silkworms, the silk cocoons produced by the silkworms cannot be
considered agricultural produce of the cultivator.
The Court emphasized that agricultural income under the Act does not
extend to the sale of products that are fundamentally different from
what is directly cultivated by the assessee.
Had the mulberry leaves themselves been sold in the market after
processing, their income could be considered agricultural.
However, since the silk cocoons are the product of silkworms feeding
on mulberry leaves, they do not qualify as agricultural produce.
The Court held that for income to be considered agricultural, the

produce sold must be the direct result of cultivation by the assessee.
Hence, sale of silk cocoons cannot be considered as an agricultural
income.
6) C.I.T. v. H.G. Date

Facts:
H.C. Date, the assessee, sold jaggery (gur) in the market and earned
income from it.
The Income Tax Officer (I.T.O.) assessed this income claimed this
income to be agricultural income.
The Tribunal held that the conversion of sugarcane into jaggery was a
process ordinarily employed in the country to render sugarcane fit for
sale in the market.
Issue:

Whether the income derived by H.C. Date from the sale of jaggery can
be classified as agricultural income under the Income-tax Act.
Decision of the Bombay High Court:
The High Court, considering the facts and the Tribunal's findings,
observed:
Agricultural income, requires that the process employed by the

assessee must be one ordinarily employed to render the produce
marketable.
The second condition is that the produce must be marketable in its

natural condition or with minimal processing, unless there is no
market for it in that condition.
Since Date's sugarcane could not be sold in its natural condition due to
lack of a market, the process of converting it into jaggery was
necessary to make it marketable.
Therefore, the High Court upheld the Tribunal's decision that Date's
income from the sale of jaggery was agricultural income exempt from
income tax.
7) Sakarlal Naranlal v. C.I.T.

Facts:
Sakarlal Naranlal, an individual owning agricultural lands, received a

suggestion to grow a vegetable product called galka (loofah).
He imported galka seeds and cultivated them on his land after preparing
it for cultivation.
The galka grown by Sakarlal Naranlal was not a native variety
After the galkas reached maturity, Sakarlal Naranlal processed them to

create loofahs, which involved several steps.
The final product, loofah, was not sold in India due to potential losses
from purchase taxes; instead, it was shipped abroad
He claimed these losses as business losses arising from non-

agricultural operations
Issue:

Whether the losses incurred by Sakarlal Naranlal from processing
galkas into loofahs can be considered agricultural losses
Decision and Reasoning of the Gujarat High Court:
Income Tax Authorities' Decision:
Considered the processing of galkas into loofahs as a process

ordinarily employed by cultivators to render the produce fit for
market.
They held that the losses suffered by Sakarlal Naranlal in this

process were agricultural losses exempt from taxation.
High Court's Judgment:
Tribunal should have evaluated the marketability of Galkas both in

India and abroad.
Only if Galkas had no market outside India, the conversion process

would be considered agricultural under Section 2(1)(b)(ii).
Found that Galkas were marketable outside India, thus the process
to convert them into Loofahs was not agricultural.
Conclusion
Agricultural income under Section 2(1A) of the Income Tax Act, 1961,
encompasses a variety of income sources directly related to agricultural
activities on land in India. Case laws such as Bacha F. Guzdar,
Commissioner of Income Tax v. Raja Benoy Kumar Sahas Roy, and others
illustrate the nuances in determining what constitutes agricultural income,
emphasizing the necessity of a direct connection to land and agricultural
activities. Judicial interpretations consistently underscore that the character
of income is derived from its immediate source and its relation to
agricultural operations. Therefore, understanding these principles is crucial
for accurately assessing and classifying agricultural income for tax
purposes.
UNIT 3 - Concept of residential status of an individual assessee/HUF
Under Indian Income Tax Act, the determination of an individual's

residential status is crucial as it determines the extent of their tax liability in
India.

Basic Rules for Determining Residential Status:
1. Single Status for Assessment Year: An individual cannot have different

residential statuses for different previous years related to the same
assessment year, even if they have different income sources.
2. Categories of Residential Status:
Resident: Further categorized into "Resident and Ordinarily

Resident" (ROR) and "Not Ordinarily Resident" (NOR).
Non-Resident: Individuals who do not meet the criteria to be

considered residents.
Section 4: Charge of Income Tax

When any Central Act specifies that income-tax shall be charged for a
particular assessment year at specified rate(s), income-tax at those rate(s)
shall be charged.
Essentials of Section 4
1. Annual Tax: Income tax is an annual tax on income.
2. Tax on Person: Tax is charged on every person with taxable income.
3. Tax Rates on Total Income: Tax is charged on the total income of

each person according to the Act's provisions.
4. TDS or Advance Tax: Income is deducted at source or paid in

advance, as required under the Act.
Section 5: Scope of Total Income
1. Residents: The total income of a resident includes all income from any
source:
Received or deemed to be received in India.
Accrued or arisen or deemed to accrue or arise in India.
Accrued or arisen outside India.
2. Non-Ordinarily Residents: For those not ordinarily resident in India,

income accruing or arising outside India is included only if it is from a
business controlled or a profession set up in India.
3. Non-Residents: The total income of a non-resident includes:
Income received or deemed to be received in India.

Income accrued or arisen or deemed to accrue or arise in India
Residential Status of an Individual (Section 6):
1. Resident in India (Section 6(1)):
An individual is considered a resident in India if:
They are in India for 182 days or more in the relevant financial
year
OR, if they were in India for 60 days or more in the current

financial year and 365 days or more in the four years
immediately preceding that year.
2. Resident and Ordinarily Resident (OR):
An individual qualifies as ROR if:
They meet any one of the basic conditions for being a resident
in India.
AND, they satisfy both additional conditions:
They have been a resident in India for at least 2 out of the 10

previous years preceding the current financial year.
Their stay in India totals 730 days or more in the seven years
preceding the current financial year.
3. Not Ordinarily Resident (NOR) (Section 6(6)(a)):
An individual is NOR if:
They meet at least one of the basic conditions for being a

resident.
AND, they do not satisfy both additional conditions required for

ROR.

4. Hindu Undivided Family, firm or other association (Section 6(2))
A Hindu undivided family, firm or other association of persons is

said to be resident in India in any previous year in every case except
where during that year the control and management of its affairs is
situated wholly outside India.

5. Company (Section 6(3))
A company is said to be a resident in India in any previous year
(i) it is an Indian company; or
(ii) its place of effective management, in that year, is in India.
For the purposes of this clause “place of effective management”

means a place where key management and commercial
decisions that are necessary for the conduct of business of an
entity as a whole are made.
6. Deemed Not Ordinarily Resident (Section 6(1A)):

Applicable from the assessment year 2021-22 onwards:
Criteria for Deemed Residency:
1. Indian Citizen with Significant Income:
The individual must be an Indian citizen.
The individual's total income, excluding income from foreign

sources, must exceed ₹15 lakhs during the previous year.
2. Tax Liability in Other Countries:
The individual should not be liable to pay tax in any other

country or territory based on domicile, residence, or any
similar criteria.
3. Non-Resident Status:
The individual must not be considered a resident under the

general residency rules outlined in Section 6(1) of the
Income Tax Act, 1961.
7. Non-Resident:
An individual is a non-resident if they do not satisfy any of the basic

conditions for being a resident. Non resident is defined under
Section 3(30).
Important Case Laws

1) V.V.R.N.M. Subbayya Chettiar v. C.I.T.
Facts of the Case:
The appellant, as the Karta of a Hindu Undivided Family (HUF), resided

in Ceylon (now Sri Lanka) with his family and conducted business in
Colombo.
The appellant had a house in India where his mother lived.
The appellant visited British India for 101 days on seven occasions to
attend to litigation concerning family property and income assessment
proceedings.
Legal Provision:
Section 4A(b) of the Income-Tax Act, 1922 states that a Hindu

undivided family is considered resident in British India unless the

control and management of its affairs are situated wholly outside British
India.
Issue of the Case:
The primary issue was whether the HUF could be considered a resident
in British India under Section 4A(b) of the Income-Tax Act, 1922.
The Supreme Court applied the principle established in Swedish Central

Railway Co. Ltd. v. Thompson regarding "control & management" and
the interpretation of "wholly".
Normally, an HUF is presumed to be a resident, unless it falls under

exceptional circumstances.
In this case, the appellant failed to prove that the control and
management of the HUF's affairs were situated wholly outside British
India.
Therefore, the normal presumption of residency applied, and the HUF

was considered a resident for tax purposes in British India.
2) Narottam and Parekh Ltd. v. C.I.T.

Facts of the Case:
Narottam and Parekh Ltd., a company registered in Bombay, was

engaged in the business of stevedoring in Ceylon (now Sri Lanka).
The company's registered office, board meetings, and shareholder

meetings were all conducted in Bombay.
While day-to-day operations were managed by two managers in

Ceylon, the control and management of the company's affairs were
retained in Bombay.
Legal Issue:
The central issue was whether Narottam and Parekh Ltd. could be
classified as a resident company for tax purposes.
Decision of the High Court:
The High Court held that if the control and management of a company
are exercised wholly from India, then the company is considered a
resident company.

It emphasized the distinction between merely conducting business and
where the actual control and management (the "head and brain") of the
business operations are situated.
The court emphasized that the "de facto" control, or actual control, is
more pertinent than the "de jure" control, or capacity to control.
Since the head and the brain of Narottam and Parekh Ltd. were located
in Bombay, where decisions affecting the company were made, it was
deemed a resident company for the relevant tax year.
3) Vodafone International Holdings B.V. v. Union of India

Facts of the Case:
Hutchinson Telecom International (Hong Kong) held 100% shares of

CGP Investments (Holdings) Ltd. (Cayman Islands), which in turn held
67% shares of Hutchison Essar Ltd. (India).
Vodafone, involved in a transaction with CGP Investments, argued that

there was no Permanent Establishment (PE) in India at the time of
payment.
The Revenue Department contended that tax deduction at source (TDS)

was required under Section 195 since the payment involved was taxable
in India.
Legal Issue:
The primary issue was whether capital gains arising from the transfer of
shares of CGP Investments, a Cayman Islands company, which
indirectly held shares in an Indian company, were taxable in India.
Decision of the Courts:
Bombay High Court: Held that capital gains were taxable in India under
Section 9(1)(i) of the Income Tax Act, 1961, as the transaction involved
an indirect transfer of shares of an Indian company.
Supreme Court: Overturned the Bombay High Court's decision, ruling

that the transaction fell outside India's territorial tax jurisdiction. It
emphasized that the Income Tax Act did not explicitly cover indirect
transfers, and the offshore transaction was structured as Foreign Direct
Investment (FDI) in India, legitimately outside India's tax jurisdiction.

The Supreme Court directed the Income Tax Department to refund Rs.
2500 crores with interest, highlighting the principles of territorial tax
jurisdiction and the bona fide nature of structured FDI.
Conclusion
Determining an individual's residential status under the Indian Income Tax

Act is essential as it directly impacts the scope and extent of their tax
liability. The residential status, defined under Section 6, categorizes
individuals as residents, not ordinarily residents, or non-residents, each
with specific criteria and implications. Understanding these distinctions
helps ensure accurate tax calculations and compliance with the law.
Additionally, the rules and provisions governing Hindu Undivided Families,
firms, associations, and companies emphasize the importance of the
location of control and management in determining residency. Proper
application of these principles is crucial for fair and effective tax
administration.
UNIT 4 - HEADS OF INCOME - Mutual Exclusivity

Section 14 of the Income Tax Act, 1961
Classification of Income: Section 14 of the Income Tax Act specifies six

heads under which all income must be classified for tax purposes.
Specific Heads: The heads A (Salaries), C (Income from House

Property), D (Profits and Gains of Business or Profession), and E
(Capital Gains) are specific and cover distinct types of income.
Residuary Head: Head F (Income from Other Sources) is a residuary

clause, covering any income not classified under the specific heads.
Mutual Exclusivity: Income should be taxed under the specific head if it

clearly fits within one of them.
Choice of Head: If an income item could potentially fall under more than
one head, the taxpayer can choose the head that is most beneficial for
them.
Department’s Role: The tax department must assess income under the
appropriate specific head, unless the taxpayer opts for a more
beneficial head.

Important Case Law
1) East India Housing and Land Development Trust Ltd. v. Commissioner
of Income-tax
Case Background:
East India Housing and Land Development Trust Ltd. was incorporated
with the objective of buying and developing markets. It purchased land
in Calcutta and constructed shops and stalls for rental purposes.
The company received income amounting from tenants occupying

these shops and stalls during the assessment year 1953-54.
Income Tax Assessment:
The Income-tax Officer assessed this income under Section 9 of the

Income-tax Act, 1922 (equivalent to Section 22 of the Income-tax Act,
1961), treating it as "income from property."
The company appealed to the Supreme Court, disputing whether this

income should be taxed under Section 10 (business income) instead.
Legal Issue:
Whether the income derived from letting out shops and stalls should be
classified as "business income" under Section 10 (equivalent to Section
28 of the Income-tax Act, 1961) or as "income from property" under
Section 9 (equivalent to Section 22 of the Income-tax Act, 1961).
Supreme Court Decision:
The Supreme Court ruled that the income received from the shops and
stalls was indeed "income from property." This classification was
irrespective of the fact that the company was formed for the purpose of
developing markets and had to comply with municipal regulations.
The Court emphasized that the classification of income under

different heads in the Income-tax Act is mutually exclusive. Income
falling under a specific head must be assessed accordingly, even if it
could theoretically be classified under another head.
Income from property and business income are distinct categories

under the Income-tax Act. The nature of income is determined based
on the source and its specific treatment as outlined in the Act.
UNIT 4 HEAD A - Salary

Source of Income under "Salaries" (Sections 15 to 17 of the Income Tax
Act, 1961)
Section 15: Chargeability of Income under the Head "Salaries"
Section 15 specifies the types of income chargeable under the head
"salaries":
1. Salary Due:
Any salary due from an employer or a former employer to an

assessee in the previous year, whether paid or not.
2. Salary Paid:
Any salary paid or allowed to the assessee in the previous year by

or on behalf of an employer or a former employer, even if not due or
paid before it became due.
3. Arrears of Salary:
Any arrears of salary paid or allowed to the assessee in the previous

year by or on behalf of an employer or a former employer, if not
charged to income tax for any earlier previous year.
Section 16: Deductions from Salaries
This section deals with the permissible deductions from the income
chargeable under the head "salaries". While the detailed deductions are
specified in the Income Tax Act, they commonly include standard
deductions, entertainment allowance, and professional tax.
Section 17: Definition of "Salary", "Perquisite", and "Profits in Lieu of

Salary"
Section 17 provides definitions relevant to the computation of income under
the head "salaries":
1. Salary:
Includes wages, any annuity or pension, gratuity, fees,

commissions, perquisites, or profits in lieu of or in addition to any
salary or wages.
2. Perquisites:
Rent-Free Accommodation:

The value of rent-free accommodation provided to the assessee
by his employer.
Concession in Rent:
The value of any concession in the matter of rent for

accommodation provided to the assessee by his employer.
3. Exclusions from Salary for Perquisites Calculation:
Dearness allowance or dearness pay unless it enters into the

computation of superannuation or retirement benefits.
Employer's contribution to the provident fund account of the

employee.
Allowances exempted from the payment of tax.
Value of the perquisites specified in this clause.
Important Case Laws

1) C.I.T. v. L.W. Russel
Facts:
The respondent, L.W. Russel, was employed by the English and

Scottish Joint Co-operative Wholesale Society Ltd. (the Society), an
entity incorporated in England.
The Society had a superannuation scheme for male European staff

in India, Ceylon, and Africa.
Membership in the scheme was a condition of employment.
The Society contributed one-third of the premium for an insurance

policy to secure an annuity for each member upon reaching
superannuation age or upon specific contingencies.
In the 1956-57 assessment year, the Society contributed Rs. 3,334/-

for Russel's premium.
The Income Tax Officer (ITO), Kozhikode, included this amount as

taxable under section 7(1), sub-clause (v) of the Income Tax Act,
1922.

Russel appealed, and the case eventually reached the Supreme
Court after decisions by the Appellate Assistant Commissioner and
Income Tax Appellate Tribunal against him, and a favorable decision
by the High Court.
Supreme Court's Analysis:
The section aims to tax the remuneration of an employee,

presupposing an employer-employee relationship.
The term "perquisite" includes various emoluments, fees, or profits

attached to an office or position, as defined in the Oxford
Dictionary.
The substantive part of section 7(1) and clause (v) of Explanation 1,

Income tax Act, 1922 combined, indicate that if an employer allows
or pays a sum for an employee's life insurance or annuity, it is
considered a perquisite and thus taxable.
For the sum to be taxable, it must be:
Paid to the employee, or
Allowed to him, or
Due to him from the employer.
The term "allowed" implies the employee has a right to the

perquisite, which must not be contingent.
In Russel's case, the amounts were vested in the trust until he

reached the age of superannuation, with the beneficiary determined
by specific contingencies.
Hence, no vested interest was present in the contributed sum until

the contingency occurred.
Decision:
The Supreme Court concluded that the contributed sum did not
constitute a perquisite under section 7(1) since Russel had no
vested right until reaching the age of superannuation.
Consequently, the amount was not taxable as a perquisite.
The appeal by the Revenue was dismissed, upholding the High

Court's decision in favor of Russel.

2) Ram Pershad v. C.I.T.
Facts:
Position and Terms:
Assessee became the Managing Director of a company for a

period of 20 years.
The general management of the company was in his hands, with

the Board of Directors exercising control over him in certain
circumstances.
He could resign from his office upon giving three months'

notice.
His remuneration included Rs. 2000 per month, Rs. 500 per
month as allowance, 10% of the gross profit, free boarding, and
lodging in a hotel for himself and his wife.
He could be terminated from his service if he acted

irresponsibly or against the company's interest.
Assessment Year: 1956-57
The assessee was assessed in respect of Rs. 53,913, which was

payable to him as 10% of the gross profit but was given up by
him.
Issue:
Whether the amount of Rs. 53,913 was a revenue receipt and

chargeable as salary under Section 7 of the Indian Income Tax Act,
1922 (corresponding to Section 15 of the Income Tax Act, 1961).
Key Points and Legal Findings:
1. Nature of Employment:
The test to determine if a person is a servant or an agent is to

check whether they are under the 'direct control and
supervision' of the employer.
However, this test is not universally applicable. The nature of the

business and the duties of the employee must also be
considered.

2. Capacity of Managing Director:
Directors are generally considered 'agents' of the company.
A Managing Director may have a dual capacity (both as an

agent and as an employee).
3. Relevant Documentation:
The Articles of Association and the terms and conditions of the

agreement are crucial in determining the nature of the
employment relationship.
4. Tax Implications:
The amount of Rs. 53,913 was considered a revenue receipt and

thus payable to him as 'salary' under Section 7 of the IT Act,
1922.
The voluntary foregoing of the amount by the assessee was

treated as mere application of income, meaning it was still
taxable income.
Conclusion
The income tax treatment of salaries is designed to comprehensively
capture various forms of remuneration. The framework ensures that all
income received as salary, including any dues, payments, or arrears, is
subject to tax. It also accounts for specific deductions and clearly
defines what constitutes salary and perquisites. This structured
approach ensures transparency and consistency in taxing salary
income, making it easier for individuals to understand their tax
obligations and for authorities to enforce tax regulations effectively.
UNIT 4 HEAD C - Determine value of house property for imposing tax

Section 22: Chargeability under "Income from House Property"
1. Conditions for Taxability:
Property must consist of buildings or lands appurtenant thereto.
The assessee should be the owner of such property.
Property should not be used for business or profession, the profits

of which are taxable.
Tax is charged on the "annual value" of the property.

2. Annual Value:
Tax is based on the annual value of the property, not necessarily the
rent received.
Annual value is defined as the sum for which the property might
reasonably be expected to let from year to year
The definition of annual value was modified by the Taxation Laws

(Amendment) Act, 1975.
It includes both the expected rental income and actual rent received
if it exceeds the expected sum.
Section 23: Determination of Annual Value
Methods to Determine Annual Value:
Sum for which the property might reasonably be expected to let

from year to year.
Actual rent received if it exceeds the expected sum.
Adjustments for vacancies and local authority taxes paid by the

owner.
Special Cases (Section 23(2)):
If the property is self-occupied or cannot be occupied due to the

owner's employment elsewhere, the annual value is taken as nil,
unless:
The property is let during part or whole of the previous year.
Any other benefit is derived from the property.
Stock-in-Trade Exception (Section 23(5)):
If property is held as stock-in-trade and not let out, the annual value
is considered nil for up to two years after completion of
construction.
Section 24: Deductions from Income from House Property
Deductions allowed:
30% of the annual value.
Interest payable on borrowed capital for acquisition, construction,

etc.

Certain limits apply, such as a maximum deduction of thirty
thousand rupees in specific cases.
Important Case Laws

1) C.I.T v. Biman Behari Shaw
The Calcutta High Court dealt with the assessment of annual value under
the Income Tax Act, focusing on properties dedicated to religious deities as
per a will.
Case Background:
Properties Involved: Premises No. 12, Benode Behari Shah Lane, and
122-A, Manicktola Street, Calcutta, were part of a debutter estate
dedicated to religious deities.
The assessee argued that these properties had no letting value due to
legal restrictions outlined in the will, which prevented any occupation
except by designated persons for religious purposes.
The Income-tax Officer assessed the notional annual value of the

properties based on their potential rental value in the open market,
despite them not being actually let out.
The assessee contested the assessment, arguing that the properties

had no actual rental income and were legally restricted from being let
out to others.
Legal Issue:
Whether the properties had bona fide annual value as per Section 9(2)
of the Income Tax Act, 1922 (equivalent to Section 23 of the Income Tax
Act, 1961), despite the legal restrictions on their use.
High Court Decision:
Interpretation of Section 9(2): The High Court interpreted that for

taxation purposes, the annual value is deemed to be the sum for which
the property might reasonably be expected to let from year to year. The
use of the word "might" indicates a potential or notional rental value,
not contingent on actual rental income.
The Court upheld the Revenue's contention that the legal injunctions in
the will, while relevant, do not negate the assessment of annual value

based on market expectations.
Therefore, the Court ruled in favor of the Revenue, affirming that the
properties indeed had a bona fide annual value for taxation purposes,
irrespective of the absence of actual rental income due to the legal
restrictions.
The case reaffirms that under tax law, the annual value of properties
is assessed based on potential market rent, even if the property is not
let out or generates no actual income, as long as it could reasonably
be expected to yield rental income.
2) East India Housing and Land Development Trust Ltd. v. Commissioner

of Income-tax
Case Background:
East India Housing and Land Development Trust Ltd. was incorporated
with the objective of buying and developing markets. It purchased land
in Calcutta and constructed shops and stalls for rental purposes.
The company received income amounting from tenants occupying

these shops and stalls during the assessment year 1953-54.
The Income-tax Officer assessed this income under Section 9 of the

Income-tax Act, 1922 (equivalent to Section 22 of the Income-tax Act,
1961), treating it as "income from property."
The company appealed to the Supreme Court, disputing whether this

income should be taxed under Section 10 (business income) instead.
Legal Issue:
Whether the income derived from letting out shops and stalls should be
classified as "business income" under Section 10 (equivalent to Section
28 of the Income-tax Act, 1961) or as "income from property" under
Section 9 (equivalent to Section 22 of the Income-tax Act, 1961).
The Supreme Court ruled that the income received from the shops and
stalls was indeed "income from property." This classification was
irrespective of the fact that the company was formed for the purpose of
developing markets and had to comply with municipal regulations.

The Court emphasized that the classification of income under
different heads in the Income-tax Act is mutually exclusive. Income
falling under a specific head must be assessed accordingly, even if it
could theoretically be classified under another head.
Income from property and business income are distinct categories

under the Income-tax Act. The nature of income is determined based
on the source and its specific treatment as outlined in the Act.
3) R.B. Jodhamal Kuthiala v. C.I.T

Case Background:
R.B. Jodhamal Kuthiala, a registered firm deriving income from various

sources including interest on securities and property.
The firm had purchased Nedous Hotel in Lahore before partition. After
partition, Lahore became part of Pakistan, and the hotel was declared
evacuee property, vested in the Custodian in Pakistan.
The firm claimed losses for certain assessment years but sought
deduction of interest paid on the loans related to the Nedous Hotel.
The Income-tax authorities disallowed the deduction of interest paid to

the bank, arguing that the firm was no longer the owner of the property
as it had become evacuee property under the Custodian in Pakistan.
Legal Issue:
Whether the firm could be considered the owner of the Nedous Hotel
for the purpose of computing income under Section 9 of the Income-tax
Act, 1922 (Section 22 of the Income-tax Act, 1961).
The Supreme Court emphasized that for taxation purposes under

Section 9 (Section 22), the owner must be the person who can exercise
the rights of ownership directly, not merely on behalf of someone else.
The Court considered previous rulings and the provisions of the

Pakistan (Administration of Evacuee Property) Ordinance, 1949.
The property being declared evacuee property and vested in the

Custodian in Pakistan, the Court held that the firm was not the owner of
the Nedous Hotel for the purposes of Section 9 of the Income Tax Act.

The Court reasoned that ownership under Section 9 requires the ability
to exercise ownership rights in one's own right, not merely to claim
residual rights.
Since the Custodian of Evacuee Property had exclusive control and

management powers over the property, including rights to lease, sell, or
mortgage, the firm did not possess these rights.
The Court clarified that while an evacuee may retain residual rights in
the property, these do not constitute ownership under Section 9 for tax
purposes.
The Decision emphasized that tax laws must be interpreted in a manner

consistent with their principles, focusing on actual ownership and
control, rather than theoretical or residual rights.
Consequently, the Court concluded that the Custodian was the legal
owner for tax purposes, and the firm’s claims related to the property
could not be entertained.
Conclusion
Calculation Of Tax on House Property
1. Gross Annual Value (GAV)
Gross Annual Value is the potential income that property could earn if it
were rented out at its fair market value.
Self-Occupied Property: If you live in the house yourself, the Gross

Annual Value is considered zero. There is no rental income to be
taxed.
Let-Out Property: If the property is rented out, the Gross Annual

Value is typically the actual rent received or the expected rent
(which is higher of the fair rent, municipal value, or standard rent
fixed under rent control laws).
2. Municipal Taxes Deduction

You can deduct the property tax paid during the year from the Gross
Annual Value to arrive at the Net Annual Value.
3. Net Annual Value (NAV)
Net Annual Value is calculated as follows:
NAV=Gross Annual Value−Property Tax

4. Standard Deduction
From the NAV, you can deduct a standard deduction of 30% to cover
expenses related to the property like repairs, maintenance, etc. This
deduction is allowed under Section 24(a) of the Income Tax Act.
5. Deduction on Interest on Home Loan
If you have taken a home loan for the property, you can also deduct the
interest paid on the loan during the year. This deduction is available
under Section 24(b) of the Income Tax Act.
6. Income from House Property
After deducting the standard deduction and interest on home loan, the
resulting value is your income from house property. This income is
taxable at the slab rates applicable to you.
Additional Notes:
Loss from House Property: If your deductions (including interest on

home loan) exceed the NAV, it results in a loss from house property.
This loss can be set off against income from other heads.
Carry Forward of Loss: If the loss cannot be fully set off in the
current year, it can be carried forward for up to 8 subsequent years
and set off against house property income only.
UNIT 4 HEAD D - PGBP - Bad Debts

Deduction in respect of Bad Debt
Section 36(1)(vii) and Section 36(2) of Income tax act 1961 - Conditions
for claiming deduction
1. Existence of Debt:
A bad debt deduction presupposes the existence of a debt

relationship. If there was never a debtor-creditor relationship or no
admitted debt owing to the assessee, no deduction can be claimed.
2. Business Debt:
The bad debt must be in respect of the business and arise from
business operations carried out in the relevant accounting year.
3. Inclusion in Income Computation:

The debt must have been taken into account in computing the
income of the assessee. This includes money lent in the ordinary
course of business like banking or money lending.
4. Actual Write-off:
The debt must be written off as irrecoverable in the accounts of the

assessee for the relevant accounting year.
Closure of individual debtor accounts is not mandatory; reduction in

the loans and advances account or debtors on the asset side of the
balance sheet with provision for bad debts is sufficient.
5. Nature of Debt:
The bad debt should be of revenue nature, not capital. Losses

arising from bad debts are considered revenue losses eligible for
deduction..
Important Case Laws

1) B.D. Bharucha v. C.I.T.
Facts:
B.D. Bharucha advanced a sum to film distributors who agreed to share

profits from the film "Shabab" after deduction of interest. The film
project proved unsuccessful, and Bharucha wrote off a sum as a bad
debt in his books.
Legal Conclusion:
The Supreme Court held that Bharucha was entitled to claim the sum as
a bad debt deduction.
The loss incurred was considered a revenue loss, not a capital loss, as
it arose from his business activities of film distribution and financing.
2) C.I.T. v. Mysore Sugar Co. Ltd

Facts of the Case:
Mysore Sugar Co. Ltd. purchased sugarcane from local growers and
processed it in their factory to produce sugar.
As part of their business operations, the company made advances to

the local growers for sugarcane seedlings, fertilizers, and cash to
ensure a steady supply of sugarcane for their operations.

Due to drought, the company could not operate its sugar mills, and the
local growers could not grow or deliver sugarcane.
The advances made in that year remained unrecovered as they could

only be adjusted against future supplies of sugarcane.
The Mysore Government appointed a committee to investigate and

recommended that the company should waive some of its dues in
recognition of the hardships faced.
Income Tax Claim: The company claimed a deduction under Section

10(2)(x) and Section 10(2)(xv) of the Indian Income-tax Act, 1922
(corresponding to Section 36(1)(vii) and Section 37 of the Income-tax
Act, 1961).
Legal Issues:
The Income Tax Officer denied the deduction, arguing that the payment
was not a trade debt or a bad debt but an ex-gratia payment akin to a
gift.
The company appealed to the Appellate Assistant Commissioner and

then to the Income-tax Appellate Tribunal, which also rejected the claim
stating that these were not bad debts but advances not related to sales
contributing to business profits.
The High Court disagreed, holding that the expenditure was not capital
in nature but deductible as revenue expenditure under Section 10(1) of
the Indian Income-tax Act, 1922.
The Supreme Court held that to determine if an expenditure is capital

or revenue, one must consider whether it was laid out to acquire an
asset of enduring benefit or if it was an outgoing in the course of
business.
In this case, the advances made were for the purpose of ensuring a
steady supply of sugarcane for the company's operations. There was
no element of investment for enduring benefit beyond the current
business needs.
Therefore, the amount waived was characterized as a revenue loss. It

was incurred in the course of business to facilitate ongoing
operations rather than for long-term capital benefits.

The Supreme Court dismissed the appeal, affirming that the amount
waived by the company was deductible as revenue expenditure under
Section 10(1) of the Indian Income-tax Act, 1922.
UNIT 4 HEAD D - PGBP - Difference b/w Business expenditure and capital

expenditure
Section 37 of the Income Tax Act, 1961 allows for deductions in respect of
expenses that are not covered under specific sections like 30 to 36 or
section 80VV, and are not capital expenditures or personal expenses.
1. General Rule: Any expenditure laid out or expended wholly and

exclusively for the purposes of the business or profession can be
claimed as a deduction under Section 37, provided it meets certain
criteria.
2. Expenditure Types:
Business Expenses: These are expenses directly related to carrying

on the business or profession. They include costs incurred for day-
to-day operations, such as rent, salaries, wages, office expenses,
etc.
Criteria for Deduction: The expenditure must be:
Wholly and exclusively for the business purposes.
Not a capital expenditure, which means it should not result in

the creation of an asset or have an enduring benefit beyond the
year in which it is incurred.
Not a personal expense of the taxpayer.
3. Capital Expenditure vs. Business Expenditure:
Capital Expenditure: This refers to expenses that are incurred to

acquire, improve, or maintain a long-term asset. Such expenses are
not deductible as revenue expenditure but may be eligible for
depreciation or amortization deductions over time.
Business Expenditure: These are expenses incurred in the day-to-

day operations of the business, which are deducted from the
income of the business in the same accounting period in which they
are incurred.
4. Tests for Capital vs. Business Expenditure:

Test of Enduring Benefit: If the expenditure results in an asset or
advantage of enduring benefit to the business, it's likely capital
expenditure.
Test of Fixed or Circulating Capital: This test distinguishes whether

the expenditure is on acquiring a capital asset or stock-in-trade for
immediate sale.
Important Case Laws

1) C.I.T. v. The Travancore Sugar and Chemicals Ltd.
Facts:
The respondent company, Travancore Sugar and Chemicals Ltd., was

formed to take over three undertakings run by the Government: a sugar
manufacturing concern, a distillery, and a tincture factory.
The assets were to be purchased at agreed values
The agreement stipulated that, besides the cash consideration, the

Government would receive 20% (later reduced to 10%) of the net
profits earned by the company annually, up to a maximum of Rs.
40,000, after accounting for depreciation and remuneration payable to
the company's treasurers and secretaries.
For the assessment year 1958-59, a sum of Rs. 42,480 became payable
to the Government as per the agreement.
However, the High Court ruled that this payment was capital
expenditure, not revenue expenditure, and thus not deductible.
The Supreme Court was asked to review whether the payment was
deductible as a revenue expense or whether it was considered a
diversion of profits.
Key Legal Provisions:
Section 28 of the Income-tax Act, 1961: Imposes a charge on the

profits and gains of any business, profession, or vocation carried on by
the assessee.
Section 37 of the Income-tax Act, 1961 : Allows for the deduction of

any expenditure, not being capital expenditure or personal expenses,
incurred wholly and exclusively for the purposes of the business.

The Supreme Court concluded that the payment to the government was
a deductible expense under the Income Tax Act, as it was an integral
part of the business operation and not a diversion of profits or a capital
expenditure.
The Court found that the payment was integral to the company's
acquisition of the profit-earning assets and was part of the cost of
acquiring the business.
2) Empire Jute Co. Ltd. v. C.I.T.

Facts:
The assessee, Empire Jute Co. Ltd., was a limited company engaged in
the manufacture of jute.
The company was a member of the Indian Jute Mills Association. To

adjust production to market demand, the Association had an agreement
to restrict working hours per week for mills.
Members of the Association could register as a "Group of Mills" and

utilize the working hours of other group members.
During the assessment year, the assessee purchased loom hours from
four different jute manufacturing companies
The Income-tax Officer disallowed the deduction of this expenditure,

but the Appellate Assistant Commissioner allowed it. The Revenue
appealed, and the Tribunal and the High Court sided with the Revenue.
The assessee appealed to the Supreme Court.
Issue:
Whether the expenditure for the purchase of loom hours was capital or
revenue expenditure.
The Supreme Court held that for an expenditure to be deductible under

Section 37 of the Income-tax Act, 1961, it must be incurred wholly and
exclusively for the purpose of business and must be of a revenue
nature.
The Court explained that the character of the expenditure should be

determined from the perspective of the recipient and not the payer.

The purchase of loom hours allowed the assessee to relax the
restriction on working hours, enabling it to operate its looms for longer
periods, thereby increasing profitability.
The purchase of loom hours did not create a new asset or expand the
profit-making apparatus of the assessee; it merely allowed the existing
machinery to be used more intensively.
This advantage was not of an enduring nature; it was temporary, limited

to six months, and the hours could not be carried forward to the next
week.
Thus, the expenditure was considered to be in the nature of a cost for

operating the profit-making structure, making it revenue expenditure.
3) C.I.T. v. Jalan Trading Co. (P) Ltd.

Facts:
Bharat Barrel had a sole selling agency agreement with a firm, Jalan
Trading Co., starting for two years with a renewal option.
The respondent, a private company acquired the benefits of this

agreement through a deed of assignment
The respondent acted as the sole selling agent of Bharat Barrel. The
agreement was renewed with a renewal clause.
According to the new agreement, the respondent paid the assignors

75% of their profits as royalty.
For the assessment year, The respondent claimed a deduction of sum

being 75% of its net profits paid as per the agreement.
This deduction was disallowed by the assessing officer, appellate

authorities, and the High Court.
Issue:
Whether the payment was made for the acquisition of an asset or benefit of
an enduring nature, thus making it a capital expenditure not deductible
under the Income-tax Act.
The Supreme Court affirmed the decision of the lower authorities,

stating that the payment was for the acquisition of a capital asset.

The Court established that the character of the expenditure should be
determined by its purpose.
If the expenditure is for acquiring an asset or advantage for enduring

benefit, it is capital expenditure.
The payment of 75% of the profits was for acquiring the right to carry
on the sole selling agency business on a long-term basis.
This right was an asset of enduring benefit to the respondent.
The fact that the payment was periodic did not change its nature from
capital to revenue expenditure.
The aim and object of the expenditure, which was to acquire a long-
term benefit, determined its character as capital expenditure.
The Court reiterated that when the expenditure is made to acquire an

asset or an enduring benefit, it is capital in nature regardless of whether
the payment is made in a lump sum or periodically.
4) L.B. Sugar Factory and Oil Mills v. C.I.T.

Facts:
The assessee, L.B. Sugar Factory and Oil Mills, contributed money for
constructing Deoni Dam and the Deoni Dam Majhala road under the
Sugarcane Development Scheme for constructing roads around its
factory.
The Income Tax Officer disallowed the deductions, treating them as

capital expenditure.
The Tribunal and the High Court upheld the disallowance.
Issues:
1. Whether the sums represented expenditure wholly and exclusively for

the purpose of the business of the assessee.
Decision:
The expenditure under the Sugarcane Development Scheme was held

to be revenue in nature.
The construction of roads around the factory facilitated transportation

of sugarcane, benefiting the assessee's business.

The roads belonged to the government, and the assessee did not
acquire any enduring asset.
The expenditure was considered to be wholly and exclusively for the

business purposes, thus deductible under Section 37(1) of the Income-
tax Act, 1961.
5) Bikaner Gypsum Ltd. v. C.I.T.

Facts:
The assessee, Bikaner Gypsum Ltd. had a mining lease allowing them to
extract gypsum.
Clause 3 of Part III of the lease restricted mining operations within 100
yards of railway property without permission.
The railway authorities expanded into the lease area, requiring the
station to be moved to an alternative site.
It was agreed that the expenses of Rs. 12 lakhs for shifting would be
borne equally by the railways, the state, the fertilizer company, and the
assessee.
The assessee paid Rs. 3 lakhs and claimed this as a business

deduction.
The ITO and the High Court disallowed the claim, treating it as capital
expenditure.
Issue:
Whether the payment for the removal of restrictions imposed by the railway
authorities was capital or revenue expenditure.
Decision:
The Supreme Court held that the expenditure was revenue in nature.
The payment was made to remove an obstruction to the assessee's

existing mining operations, enabling it to continue its business.
The payment did not result in the acquisition of any capital asset or an
advantage of enduring nature.
Therefore, the expenditure was deductible as it was incurred for the

removal of a business restriction.
6) C.I.T. v. General Insurance Corporation

Facts:
The respondent, General Insurance Corporation, incurred expenses for

stamp duty and registration fees for increasing its authorized share
capital and issuing bonus shares.
The assessing officer disallowed both as revenue expenditure.
The CIT (Appeals) and the Tribunal allowed the expenditure for the
bonus shares but not for the increase in authorized share capital.
The Bombay High Court affirmed the Tribunal's decision.
Issue:
Whether the expenditure incurred for issuing bonus shares is allowable as
revenue expenditure.
Decision:
The Supreme Court held that expenditure for increasing share capital by
issuing fresh shares is capital expenditure.
However, issuance of bonus shares by capitalization of reserves is only

a reallocation of funds with no fresh capital inflow.
Since the capital employed remains unchanged, no enduring benefit or

advantage is conferred.
Thus, the expenditure on issuing bonus shares is revenue in nature.
The Supreme Court affirmed the decision in favor of the assessee,

allowing the expenditure as deductible.
Conclusion:
Expenditures incurred for business purposes are deductible if they are
directly related to the operation of the business and do not result in the
acquisition of long-term assets or enduring benefits. Costs that are part of
day-to-day business activities or those that maintain the existing profit-
making structure are generally considered revenue in nature and eligible for
deduction. However, expenses that result in the creation of new assets or
provide long-term benefits are deemed capital in nature and are not
deductible as revenue expenditures. The key is whether the expense
contributes to the ongoing operation of the business without creating an
enduring advantage.

UNIT 4 HEAD E - Capital Gains
Capital Asset (Section 2(14))
Definition: According to Section 2(14) of the Income Tax Act:
Capital asset includes:
Property of any kind held by an assessee, whether or not connected

with their business or profession.
Securities held by a Foreign Institutional Investor in accordance with

SEBI regulations.
Exclusions: It does not include:
Stock-in-trade, except certain securities.
Personal effects like movable property (excluding jewelry,

archaeological collections, drawings, paintings, sculptures, or any
work of art).
Agricultural land in specified areas under certain conditions.
Specific government bonds and deposit schemes.
Key Definitions:
Short-term capital assets: Held for three years or less (Section

2(42A)).
Short-term capital gains: Arising from the transfer of short-term capital

assets (Section 2(42B)).
Long-term capital assets: Held for more than three years (Section
2(29A)).
Long-term capital gains: Arising from the transfer of long-term capital

assets (Section 2(29B)).
Transfer: Defined under Section 2(47), which outlines transactions

constituting transfers for capital gains tax purposes. Section 47 deals
with transactions not amounting to transfer
Section 45 - Computation:
Capital gains are computed under Section 45, considering the full value
of consideration received or accrued from the transfer of a capital
asset.

Adjusted cost of acquisition and cost of improvement are crucial in
computing capital gains which is mentioned under Section 48.
Capital Gains = Final sale - (Transfer Cost+Acquisition

Cost+Improvement Cost)
Section 46 - Capital Gains on Distribution of Assets by Companies in

Liquidation:
Section 46(1):
During the liquidation of a company, when assets are distributed to

shareholders, this distribution is not treated as a transfer by the
company for capital gains purposes under Section 45.
Section 46(2):
When shareholders receive money or other assets from the

company during liquidation:
They are taxed on the amount received or the market value of

the assets on the date of distribution.
This adjusted amount is considered the full value of the

consideration for calculating capital gains under Section 48.
Important Case Laws

1) N. Bagavathy Ammal v. C.I.T.
Facts:
Two sisters, shareholders in Mo Estate (Private) Ltd., received

agricultural lands as part of a compromise decree in company
liquidation.
The Income Tax Officer reopened assessment, treating the receipt of

agricultural land as a taxable event.
Legal Principles:
The Supreme Court clarified that the distribution of assets in a

company's liquidation does not constitute a "transfer" under Section
45.
Section 46(1) specifically excludes such distributions from being treated

as transfers for capital gains tax purposes.

Section 46(2) imposes capital gains tax on shareholders receiving
money or assets from the liquidating company, based on the market
value of assets received.
Conclusion:
The Court upheld the applicability of Section 46(2) for taxing

distributions to shareholders in company liquidation.
It reaffirmed that the definition of "capital asset" under Section 2(14)

broadly covers all kinds of assets, including those received in
liquidation.
UNIT 4 HEAD F - Income From Other Sources

Head F: Income from Other Sources (Sections 56-59)
1. Section 56: Income from Other Sources
Defines income chargeable under the head "Income from Other

Sources".
Includes income not falling under any other heads of income (like
salary, house property, business/profession, or capital gains).
Examples include interest income, rental income from movable

property, dividends, etc.
2. Section 57: Deductions Allowed from Income from Other Sources
Section 57(i): Standard deduction of 30% on rental income from

let-out property.
Section 57(ii): Deductions for any other expenditure (except those

specifically disallowed).
Section 57(iii): Deductions for expenditure laid out or expended

wholly and exclusively for the purpose of making or earning income,
not being capital expenditure.
3. Section 58: Chargeability of Income under Head "Income from Other

Sources"
Specifies how income from other sources is to be computed.
Provides rules for determining the tax liability on such income.
4. Section 59: Profits Chargeable to Tax

Details the nature of profits chargeable to tax under the head
"Income from Other Sources".
Covers specific scenarios such as income from dividends, interest,

royalties, winnings from lotteries, etc
Important Case Laws

1) C.I.T. v. Rajendra Prasad Moody (1978)
Facts of the Case:
Two brothers (the assessee) borrowed money to invest in shares of

certain companies during the assessment year.
They paid interest on the borrowed money but did not receive any
dividends on the shares purchased with that money.
The question was whether the interest on money borrowed for

investment in shares is allowable as expenditure under Section
57(iii) of the Income-Tax Act, 1961, even if the shares did not yield
any dividend during the relevant assessment year.
Legal Issues:
Interpretation of Section 57(iii): Section 57(iii) allows deduction of

expenditure laid out or expended wholly and exclusively for the
purpose of making or earning income, provided it's not capital
expenditure.
The shares did not yield any dividend income during the
assessment year in question.
The Supreme Court held that the crucial factor in determining the
deductibility of expenditure under Section 57(iii) is whether the
expenditure was laid out or expended wholly and exclusively for the
purpose of making or earning income.
The court clarified that Section 57(iii) does not require that income
must actually be earned as a result of the expenditure for it to be
deductible.
The focus is on the purpose of the expenditure, not its actual

outcome in terms of income earned.

Therefore, the Supreme Court ruled that the interest paid on
borrowed money for investing in shares remains deductible under
Section 57(iii), even if the shares did not yield any dividend income
during the relevant assessment year.
The key criterion is that the expenditure must be laid out with the
purpose of making or earning income, regardless of whether
income was actually earned.
UNIT 5 - Clubbing of Income (avoidance, escaping) (Husband-Wife) Sec.

64
General Principle
Income-tax is generally levied on an assessee in respect of their own

income.
However, there are specific provisions under the Income-tax Act where
the income earned or received by one person is included in the total
income of another person.
Specific Circumstances for Inclusion of Income
1. Transfer of Income Without Transfer of Assets (Section 60)
If a person transfers income to another person without transferring

the asset that produces the income, the income is included in the
hands of the transferor.
"Transfer" includes any settlement, trust, covenant, agreement, or

arrangement.
2. Income of Spouse and Son’s Wife
Remuneration to Spouse (Section 64(1)(ii))
Income earned by a spouse from a concern in which the

individual has a substantial interest is included in the individual's
total income.
Exceptions:
If the spouse possesses technical or professional

qualifications and the income is solely attributable to their
knowledge or experience.

If both husband and wife have a substantial interest in the
concern and both receive income, the income is included in
the total income of the spouse with the higher non-concern
income.
Substantial interest is defined as:
Holding not less than 20% of the equity shares or 20% of

the profits of a non-company concern.
Income from Assets Transferred to Spouse (Section 64(1)(iv))
Income from assets transferred to a spouse without adequate

consideration, or not in connection with an agreement to live
apart, is included in the transferor's total income.
The relationship of husband and wife must exist on the date of

transfer.
Income from Assets Transferred to Son’s Wife (Section 64(1)(vi))
Income arising to the son's wife from assets transferred by the

individual after June 1973, without adequate consideration, is
included in the transferor's total income.
Income from Assets Transferred for Spouse’s Benefit (Section

64(1)(vii))
Income arising from assets transferred directly or indirectly for

the benefit of the spouse, without adequate consideration, is
included in the transferor's total income.
Important Case Laws

1)Philip John Plasket Thomas v. C.I.T.
Facts of the Case:
The appellant entered into an engagement with Mrs. Judith Knight
Thomas transferred 750 'A' shares in a company to Judith Knight,

citing consideration of his forthcoming marriage.
The marriage was solemnized soon after transfering shares and

Judith Knight’s name was updated to Mrs. Judith Thomas in the
company's records.

Income-tax Officer included the dividends from the transferred
shares in Thomas's total income, leading to a dispute.
Legal Issue:
Whether the dividends paid to Mrs. Judith Thomas could be

included in the income of P.J.P. Thomas and taxed in his hands
Under Section 16(3)(a)(iii) of the Income-tax Act, 1922 (now Section

64(1)(iv) of the Income-tax Act, 1961), the income of the wife or
minor child from assets transferred by the husband, without
adequate consideration or without an agreement to live apart,
should be included in the husband's total income for tax purposes.
The Supreme Court emphasized that the relationship of husband

and wife must subsist at the time of the transfer of the asset. The
term "directly or indirectly to the wife by the husband" requires that
the transferor and transferee must be married when the asset is
transferred.
Since the transfer of shares occurred before the marriage,

dividends from the shares could not be included in the total income
of P.J.P. Thomas for tax purposes.
2) Batta Kalyani v. Commissioner of Income Tax

Facts of the Case:
Smt. Batta Kalyani is a proprietor of hardware and paint shops.
Kalyani employed her husband, to manage her business, and paid

him a salary.
The ITO included the salary paid to her husband in Kalyani's total
income under Section 64(1)(ii) of the Income-tax Act, 1961, arguing
that he did not possess technical or professional qualifications and
that his income was not attributable to any such knowledge or
experience.
The AAC overturned the ITO’s decision, holding that the salary paid
to him was covered by the proviso to Section 64(1)(ii) and therefore
not includable in Kalyani's total income.

The Tribunal reversed the AAC's decision, agreeing with the ITO
that the proviso to Section 64(1)(ii) did not apply.
Legal Issue:
Whether the salary paid to the assessee’s husband should be

included in the assessee's total income under Section 64(1)(ii) of
the Income-tax Act, 1961.
Interpretation of "Technical or Professional Qualification":
The court clarified that the term "technical or professional

qualification" in the proviso to Section 64(1)(ii) does not strictly
refer to formal qualifications like certificates, diplomas, or
degrees from recognized institutions.
The legislative intent, as evidenced by the phrase "knowledge

and experience" in the latter part of the proviso, indicates that
practical expertise and experience are sufficient to meet the
criteria of possessing a technical or professional qualification.
The Andhra Pradesh High Court concluded that the Tribunal erred in
its narrow interpretation of "technical or professional qualification."
However, in the specific facts of this case, the court agreed with the
Tribunal’s finding that the income of the assessee's husband was
includable in the assessee's total income under Section 64(1)(ii)
because the salary paid was not solely attributable to any technical
or professional knowledge or experience possessed by the
husband.
3) J.M. Mokashi v. Commissioner of Income Tax (1994)

Facts of the Case:
J.M. Mokashi, a practicing physician and cardiologist.
Mokashi employed his wife, who had completed her first year of
Arts at Bombay University, as a receptionist-cum-accountant in his
practice.
During the accounting period relevant to the assessment year,

Mokashi paid his wife a salary

The ITO included this salary in Mokashi’s income under Section
64(1)(ii) of the Income-tax Act, 1961.
Both the Appellate Assistant Commissioner and the Tribunal

confirmed the ITO’s decision.
Legal Issue:
Whether the income of the assessee’s wife is includible in the

assessee's income under Section 64(1)(ii) of the Income-tax Act,
1961.
Interpretation of "Concern":
The court clarified that the term "concern" in Section 64(1)(ii) is

of wide importance and includes any company, firm, individual,
or any other entity engaged in business or professional
activities.
Explanation 2 to Section 64(1)(ii):
This explanation sets a lower limit for an individual's interest in

the concern for the applicability of Section 64(1)(ii).
An individual with at least a 20% share in the profits of a

concern is deemed to have a substantial interest. The court
emphasized that this includes those with 100% interest in the
concern.
Conditions in the Proviso to Section 64(1)(ii):
The court emphasized that the two conditions in the proviso to

Section 64(1)(ii) are cumulative:
1. The spouse must possess technical or professional

qualifications.
2. The income must be solely attributable to the application of

the spouse's technical or professional knowledge and
experience.
Application to Facts:
In the present case, Mokashi's wife did not possess any

technical or professional qualifications nor was she paid for any

technical or professional services.
Therefore, the proviso to Section 64(1)(ii) did not apply, and the
salary paid to Mokashi’s wife was rightly included in his income
under the clubbing provisions of Section 64(1)(ii)
4) Mohini Thapar v CIT

Facts of the Case:
Karam Chand Thaper made cash gifts to his wife, Smt. Mohini Devi
Thaper.
Smt. Mohini Devi Thaper invested the gifted money in shares and
other interest-yielding securities.
An income was earned from the deposits and shares held by her.
IThe Income-tax Officer included this income in the income of

Karam Chand Thaper for the assessment year
The Assistant Commissioner, the Tribunal, and the High Court

upheld this inclusion.
After Karam Chand Thaper's death, Smt. Mohini Thaper appealed to

the Supreme Court.
Legal Issue:
Whether the income from the deposits and shares held by Smt.
Mohini Thaper can be included in the income of Karam Chand
Thaper.
Relevant Statutory Provision: Section 16(3)(a)(iii) of the Income-tax

Act, 1922 (corresponding to Section 64(1)(iv) of the Income-tax Act,
1961) states:
Interpretation of the Section:
The Supreme Court held that Section 16(3)(a)(iii) includes not

only the income that arises directly from the assets transferred
but also that which arises indirectly from the assets transferred.
Application to the Case:

In this case, the cash gifts made by Karam Chand Thaper to his
wife were the transferred assets.
Smt. Mohini Devi Thaper invested these assets in shares and

other interest-yielding securities, and the income earned from
these investments had a direct and proximate connection to the
original transferred assets.
Thus, the income from the shares and securities was deemed to
have a nexus with the assets transferred by Karam Chand
Thaper to his wife.
Conclusion
The Income-tax Act includes specific provisions where income earned
by one person can be taxed in the hands of another, such as transfers
without asset transfer, spousal income, and income from transferred
assets. Key cases illustrate these provisions, highlighting conditions for
clubbing income based on relationships and the timing of asset
transfers. Understanding these principles ensures accurate tax
assessments and compliance.
UNIT 6 - Assessment
The term "assessment" is used in the Income-tax Act as meaning
sometimes the computation of income, sometimes as the determination of
the amount of tax payable and sometimes the procedure laid down in the
Act for imposing liability upon the tax payer.
Section 144: Best Judgment Assessment
Section 144 outlines the conditions under which the AO can make a "best
judgment assessment":
1. Conditions for Best Judgment Assessment:
The assessee fails to file a return under section 139(1) or fails to file
a revised return under section 139(4) or (5).
The assessee fails to comply with the terms of a notice under

section 142(1) or fails to comply with a direction under section
142(2A).

The assessee, having filed a return, fails to comply with the terms of
a notice under section 143(2).
2. Procedure:
The AO considers all relevant material gathered and, after giving the
assessee an opportunity of being heard, makes the assessment to
the best of his judgment.
The AO determines the sum payable by the assessee based on this

assessment.
Section 147: Income Escaping Assessment

Section 147 of the Income Tax Act provides the Assessing Officer (AO) with
the authority to reassess income that has escaped assessment.
1. Reason to Believe:
If the AO has reason to believe that any income chargeable to tax

has escaped assessment for a particular assessment year, he may
assess or reassess such income.
This includes assessing any other income that escapes assessment

and comes to the AO's notice during the reassessment
proceedings.
2. Time Limit:
Reassessment can be done within four years from the end of the
relevant assessment year.
If the reassessment is after four years, it is only permitted if the

income escaped due to the failure of the assessee to file a return
under section 142(1) or 148 or to fully and truly disclose all material
facts necessary for the assessment.
3. Explanation 1:
Simply producing account books or evidence before the AO does

not amount to full disclosure if the material evidence could have
been discovered by the AO with due diligence.
Important Case Laws
1) State of Kerala v. C. Velukutty

Facts:

The respondent had two offices in Kozhikode: the head office at Court
Road and a branch office at Big Bazar
Both offices maintained separate accounts.
Goods were transferred from the branch to the head office and
recorded as such in the accounts.
During a surprise inspection at the head office, secret accounts were

discovered.
The Sales Tax Officer issued a notice proposing to reassess the

turnover, which had escaped assessment.
The respondent accepted reassessment for the head office but

objected to the reassessment of the branch office since no secret
books were found there.
The Sales Tax Officer reassessed the turnover, finding that the secret
accounts of the head office showed transactions 135% higher than
those in the regular books.
He applied this percentage to reassess the branch office's turnover.
Decisions of Lower Authorities:
The Appellate Assistant Commissioner and the Sales-tax Appellate

Tribunal confirmed the reassessment order.
The High Court overturned these decisions, ruling that the

reassessment of the branch office based on conjecture was an error of
law.
The Supreme Court upheld the High Court's decision.
The Court emphasized that "best judgment assessment" should not be

arbitrary or capricious but should be based on reasonable nexus to the
available material.
The Court highlighted that an assessment, even if involving some

guess-work, must be honest and fair, considering relevant materials
and circumstances.
The Court found that the reassessment of the branch office was
arbitrary as it was based on a mere assumption that the branch office

had the same level of undisclosed turnover as the head office.
The reassessment lacked material evidence to support the application

of the 135% ratio from the head office's secret accounts to the branch
office.
The Court concluded that the High Court was correct in setting aside
the orders of the Tribunals.
2) CIT v. Burlop Dealers Ltd.

Facts:
For the assessment year, the respondent assessee submitted a profit

and loss account showing profit from a joint venture with H. Menory Ltd.
The assessee claimed that half the profit, was paid to Ratiram under a
partnership agreement.
The Income-tax Officer (ITO) accepted the returns
The assessee disclosed a total profit from H. Menory Ltd. and claimed
half was transferred to Ratiram Tansukhrai.
The ITO taxed the entire profit finding the partnership agreement with
Ratiram was a device to reduce profits.
This view was upheld by the Appellate Assistant Commissioner, the

Income-tax Appellate Tribunal, and the High Court.
The ITO issued a notice under Section 34 of the Income-tax Act, 1922,
to reopen the assessment previously allowed as paid to Ratiram
The assessee's return did not include this amount, and the ITO
reassessed the income under Section 34(1)(a) of the Income-tax Act,
1922
The ITO had information that the partnership agreement was a share
transaction, indicating that income had escaped assessment.
The Supreme Court held that the assessee had disclosed all necessary
facts through their books of account and evidence.
It was the ITO's responsibility to draw inferences from these facts, and
failure to do so meant the escaped income could not be reassessed
under Section 34(1)(a).

3) Gemini Leather Stores v. Income Tax Officer
Facts:
The appellant, a partnership firm, was assessed to income-tax for the

assessment year with turnover of Rs. 15 lakhs.
The Income-tax Officer (ITO) made a best judgment assessment on

rejecting the return and books of account produced by the assessee.
The assessed turnover was reduced by the Appellate Assistant

Commissioner and further reduced by the Appellate Tribunal.
The ITO issued a notice under Section 148 of the Income-tax Act, 1961,
proposing to reassess the income for the said assessment year,
believing income had escaped assessment under Section 147.
The assessee filed a writ petition before the Allahabad High Court
challenging the validity of the notice, claiming the ITO lacked
jurisdiction.
Issue before the High Court:
Whether the ITO had reason to believe that income chargeable to tax
had escaped assessment for the assessment year in question due to
the assessee's omission or failure to fully and truly disclose all facts.
Decision of the High Court:
The High Court upheld the ITO's action, stating that the firm had used
undisclosed drafts for making purchases in Madras and Calcutta, which
represented undisclosed income.
These transactions were not considered during the original assessment,

warranting reassessment.
The Supreme Court allowed the appeal, quashing the notice dated
March 31, 1965, and the subsequent proceedings.
The Court held that:
The assessee did not disclose the transactions evidenced by the

drafts initially.
After discovering the drafts, the ITO had all primary facts and it was
his responsibility to make necessary inquiries and draw proper

inferences about whether the amounts invested in the drafts should
be included in the total income.
The ITO's failure to do so was an oversight.
Therefore, it could not be said that income escaped assessment

due to the assessee's omission or failure to fully and truly disclose
all material facts.
The ITO had all material facts at the time of the original assessment
and could not use Section 147(a) to remedy an error resulting from
his oversight.
4) I.T.O. v. Lakshmi Mewal Das

Facts:
The respondent was assessed for the assessment year under Section
23(3) of the Income-tax Act, 1922, with a total income
The Income-tax Officer (ITO) allowed a deduction which included as

interest expenses
All documents related to the return were produced during the original
assessment.
The respondent received a notice stating that certain portions of the

income for the assessment year had escaped assessment, and he was
directed to submit a fresh return for reassessment.
The notice was issued under Section 147(a) of the Income-tax Act,
1961, based on the ITO's "reason to believe" that income had escaped
assessment.
The respondent contested the notice through his lawyer, arguing that
there was no material basis for the ITO's belief that income had
escaped assessment.
With no response from the ITO, the assessee filed a writ petition, and
the High Court quashed the notice by majority, accepting the
assessee's contention.
The ITO appealed to the Supreme Court.
Issue:

Whether the conditions for reopening an assessment under Section
147(a) were met, specifically if the ITO had a valid "reason to believe"
that income had escaped assessment due to the assessee's omission
or failure to disclose fully and truly all material facts.
The Supreme Court upheld the High Court's decision, quashing the
notice and the subsequent reassessment proceedings.
The Supreme Court concluded that the ITO's powers to reopen

assessments are not unlimited and must be exercised in accordance
with the statutory requirements.
5) Srikrishna (P) Ltd. v. I.T.O.

Facts:
For the Assessment Year, the assessee disclosed certain hundi loans
The Income Tax Officer (ITO) accepted the assessee's averment and
completed the assessment.
During the assessment proceedings for the succeeding year, the

assessee again showed hundi loans
The ITO investigated and found many loans to be bogus, including

those from near relatives of the directors or principal shareholders.
The ITO added to the income as undisclosed income.
Noticing similarities in the hundi loans, the ITO issued a notice under
Section 148 to reassess
The assessee filed a writ petition in the Calcutta High Court challenging
the notice, claiming the ITO had no reasonable ground to believe
income had escaped assessment due to any failure on the assessee's
part to disclose material facts.
A Single Judge allowed the writ petition, but the Division Bench
reversed this decision.
The Supreme Court granted special leave to appeal.
Issue:
Whether the ITO had sufficient material to issue a notice under Section
148

The Supreme Court upheld the validity of the notice issued under
Section 148.
The Supreme Court found that the ITO had reasonable grounds to
believe that income had escaped assessment due to the assessee’s
failure to disclose fully and truly all material facts.
The issuance of the notice under Section 148 was justified, and the
Court decided in favor of the Revenue.

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Though "Income" is a fundamental term in the Income Tax Act, 1961, a

Instead, the Act offers an inclusive definition, meaning it aims to

The inclusive nature of the term "income" under Section 2(24) is

Scope of "Income" for Tax Purposes

The inclusive definition is meant to broaden the scope of what is

Legal Provisions in the Income Tax Act, 1961

Profit and gains

Voluntary contributions received by a trust

The value of a perquisite of profit in lieu of salary

Capital gain arising from transfer of capital gain

PRINCIPLES OF TAXATION LAW 1

any sum received by the assessee from his employees as

Assessee - Section 2(7) - An assessee is a person by whom any tax or

General Principles Regarding the Concept of Income through Judicial

Earnings: Income in its ordinary sense refers to any earning, profit, or

Non-recurring: Income does not necessarily need to be recurring.

External Source: A person cannot generate income without an external

Revaluation: No taxable income arises when an assessee revalues

Illegality: Income earned through illegal means is taxable if it meets the

Non-monetary: Income does not need to be in the form of money. It

Reimbursements: Reimbursements for actual expenses, such as travel

PRINCIPLES OF TAXATION LAW 2

The assessee, G.R Karthikeyan, participated in the All India Highway

1. Inclusive Definition of Income:

The definition of "income" in the Act is inclusive, meaning it is broad

The word "income" should be given its broadest connotation.

3. Entry 82 of List I of the Seventh Schedule:

The definition of "income" in Section 2(24) should be interpreted

The phrase "other games of any sort" encompasses a wide range

PRINCIPLES OF TAXATION LAW 3

The definition of income is broad and includes any earning,

The Supreme Court in the case of Commissioner of Income Tax v. G.R.

Application of Income and Diversion of Income

Concept Description Taxability

Occurs when the income reaches the

Occurs when income is diverted to Not taxable in the

Tests and Principles:

The true test to determine whether an amount is a diversion of income

If the income reaches the assessee and is then applied to discharge

If the obligation diverts the income before it reaches the assessee, it

1. Bejoy Sing Dudhuria v. C.I.T. (1933)

The stepmother of the Raja had a charge for maintenance on the

PRINCIPLES OF TAXATION LAW 4

2. CIT v. Sitaldas Tirthaldas (1961)

The assessee, Sitaldas Tirthaldas, for the assessment years sought

The payments were made under a decree by the Bombay High

The Income-tax Department disallowed the deduction.

Issue: Determining whether payments made by an assessee

Outcome: The assessee's income had not been diverted at the

3. CIT v. Sunil J. Kinariwala (2003)

The assessee, Sunil J. Kinariwala, was a partner in the partnership

PRINCIPLES OF TAXATION LAW 5

The Income Tax Officer rejected the claim, viewing it as an

On appeal, the Appellate Assistant Commissioner allowed the

Determining whether income assigned to a trust by a partner of a firm

Decision of the Supreme Court:

The income assigned to the trust was considered an application

PRINCIPLES OF TAXATION LAW 6