HEADS

OF
INCOME
Heads of income.
14. Save as otherwise provided by this Act, all income shall, for the purposes of
charge of income-tax and computation of total income, be classified under the
following heads of income :—
A.—Salaries. B.—
[***]
C.—Income from house property.
D.—Profits and gains of business or profession.
E.—Capital gains.
F.—Income from other sources.

Expenditure incurred in relation to income not includible in total income.

14A. (1) For the purposes of computing the total income under this Chapter, no
deduction shall be allowed in respect of expenditure incurred by the assessee in
relation to income which does not form part of the total income under this Act.
(2) The Assessing Officer shall determine the amount of expenditure incurred in
relation to such income which does not form part of the total income under this
Act in accordance with such method as may be prescribed, if the Assessing
Officer, having regard to the accounts of the assessee, is not satisfied with the
correctness of the claim of the assessee in respect of such expenditure in relation
to income which does not form part of the total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation to a case where
an assessee claims that no expenditure has been incurred by him in relation to
income which does not form part of the total income under this Act :
Provided that nothing contained in this section shall empower the Assessing
Officer either to reassess under section 147 or pass an order enhancing the
assessment or reducing a refund already made or otherwise increasing the liability
of the assessee under section 154, for any assessment year beginning on or before
the 1st day of April, 2001.

How Section 14A Of The Income Tax Act, 1961 Gets Invoked

The basic principle of taxation is to tax the net income, i.e., gross
income minus the expenditure. Applying the same analogy, the exemption from
tax is also allowable in respect of net income.
Section 14 specifies five heads of income which are chargeable to tax. In order
to be chargeable, an income has to be brought under one of the five heads.
Sections 15 to 59 of the Income Tax Act, 1961 ("Act") lay down the provisions
for computing income for the purpose of chargeability to tax under those heads.
Sections 15 to 59 quantify the total income chargeable to tax. The permissible
deductions enumerated in sections 15 to 59 are to be allowed only with,
reference to income which is brought under one of the above heads and is
chargeable to tax.

The basic reason for insertion of section 14A of the Act was that certain
incomes are not includible while computing total income as these are exempt
under certain provisions of the Act and hence the relatable expense should not
be allowed as deduction. In other words, section 14A clarifies that expenses
incurred can be allowed only to the extent they are relatable to the earning of
taxable income. Therefore, the purpose behind Section 14A of the Act, by not
permitting deduction of the expenditure incurred in relation to income, which
does not form part of total income, is to ensure that the assessee does not get
double benefit in case of composite transactions. In this article we are touching
upon various issues arising under section 14A of the Act:

Section 14A was first inserted by Finance Act, 2001 with retrospective effect
w.e.f. 01.04.1962. It is to be noted that Section 14A was inserted by Finance
Act, 2001 and the provisions were fully workable without their being any
mechanism provided for computing the expenditure. Although Section 14A was
made effective from 01.04.1962 but proviso was inserted by Finance Act, 2002,
providing that Section 14A shall not empower assessing officer either to
reassess under Section 147 or pass an order enhancing the assessment or
reducing a refund already made or otherwise increasing the liability of the
assessee under Section 154, for any assessment year beginning on or before
01.04.2001. Thus, all concluded assessments prior to 01.04.2001 were made
final and not allowed to be re-opened.

Prior to introduction of section 14A, the law was that when an assessee had a
composite and indivisible business which had elements of both taxable and non-
taxable income, the entire expenditure in respect of said business was deductible
and, in such a case, the principle of apportionment of the expenditure relating to
the non-taxable income did not apply.
Case Law.

Rajasthan State Warehousing Corporation Vs. CIT

Case Note:
Income-tax - Exemption - Income-tax Officer allowed only expenditure as
could be allocated to taxable income and disallowed rest of it which was
referable to non-taxable income, being exempt under Section 10(29) of Act - On
appeal, Commissioner accepted claim of Appellant that entire expenditure was
deductible - Tribunal and High Court confirmed order of officer - Hence, this
Appeal - Whether, business of Assessee being one and indivisible, Tribunal was
right in holding that the expenses have to allocated in the same percentage as
the different sources of income - Held, if exempted income and taxable income
were earned from one and indivisible business then apportionment of
expenditure could not be sustained - Therefore, income from various ventures
was earned in course of one and indivisible business - Hence, impugned order
upholding apportionment of expenditure and allowing deduction of only that
proportion of it which was referable to taxable income, was unsustainable -
Appeal allowed.

Ratio Decidendi:
"If exempted income and taxable income are earned from one and indivisible
business then apportionment of expenditure cannot be sustained."

Facts.

Rajasthan State warehousing Corporation, derived its income from interest,

letting out the warehouses and administrative charges for procurement of
foodgrains while working for the Food Corporation of India as well as the State
Government.
 It claimed deduction of expenditure of Rs. 38,13,555.17 under Section 37 of
the Income Tax Act in computing its income under the head 'profits and gains
of business or profession.' The Revenue allowed only so much of the
expenditure as could be allocated to the taxable income and disallowed the rest
of it which was referable to the non-taxable income, being exempt under
Section 10(29) of the Act.
Hence this appeal.

Contention of the Assessee.

Assessee relied on the judgements in the cases of CIT v. Indian Bank Ltd.
[1965]56ITR77(SC)
CIT v. Maharashtra Sugar Mills Ltd. [1971]82ITR452(SC) and

Contention of the revenue.

The expenditure which is attributable to the exempted income is not a
permissible deduction..

Statutory Provision.
Section 37(1) of the Income Tax Act.

37. General. (1) Any expenditure ,not being expenditure of the nature described
in Section 30 to 36 and not being in the nature of capital expenditure or personal
expenses of the assessee , laid out or expended wholly and exclusively for the
purposes of the business or profession shall be allowed as deduction in
computing the income chargeable under the head "Profits and gains of business
or profession.

Reasoning of the Court.

A plain reading of the above provision makes it clear that Section 37 is a
residuary provision and allows an expenditure, not covered under Sections 30 to
36, in computing the income chargeable under the head "profits and gains of
business or profession," provided its other requirements are satisfied. They are :
(i) the expenditure should not be In the nature of capital expenditure or personal
expenses of the assessee; (ii) it should have been laid out or expended wholly
and exclusively for the purposes of the business or profession; and (iii) it should
have been expended in the previous year.

The disallowance of the expenditure was not for non-compliance of

requirements of Section 37(1) of the Act but for the reason that the expenditure
was incurred on an activity from which income was exempted under the Act.

A similar question arose in the case of Indian Bank Limited vs CIT

56ITR77(SC) .
In that case the respondent-assessee, in the course of its business, borrowed
moneys for investment in securities. Part of its income, derived from securities,
was exempt under the Income-tax Act, 1922 . It sought to deduct the interest
paid on the entire borrowed amount. The question before the Court was
whether a portion of the interest which was referable to investment on securities
from which income was exempt, was allowable.
Section 10 (2)(iii) and (xv) of the Act of 1922, was precursor of Section 37(1)
of the Act. It was held by this Court that in allowing a deduction which was
permissible one need not look beyond the expenditure to see whether it had the
quality of directly or indirectly producing taxable income and, therefore, there
was no warrant for disallowing a proportionate part of the interest referable to
money borrowed for the purchase of securities yielding tax free interest.

That judgment was followed in the case of Maharashtra Sugar Mills Ltd. AIR
1971 SC 2434 :
There the assessee-company was manufacturing sugar in its factory and was
also growing sugar-cane for purposes of its factory. On the question of
deduction of expenditure, so much of the managing agency commission which
was referable to the growing of sugar-cane, was disallowed on the ground that
the income from sugar-cane cultivation was agricultural income and not
exigible to tax.
It was held by this Court that the entire managing agency commission was laid
out for the purpose of the business carried on by the assessee and was allowable
and that the fact that the income from growing of sugar-cane, & part of that
business was not taxable under the Act, was not a relevant circumstance.

Revenue relied on the decision in Waterfall Estates Ltd. v. CIT

[1996]219ITR563(SC) .
That was a case under Section 37(1) of the Act. The assessee in that case was
carrying on different ventures, profits from some of them were taxable and from
the Other were exempt under the Act. In respect of the earlier assessment years
expenditure with reference to each activity was worked out separately without
claiming any expenditure referable to the head-office.

In the assessment year 1965-66 the assessee claimed deduction of the entire
expenditure including that relating to the head-office. The finding recorded by
the Tribunal was that there was no proof that different ventures constituted the
same business.
On that finding the Tribunal took the view that the apportionment of the
expenditure was valid. The High Court of Madras confirmed the order of the
Tribunal and the same was upheld by this Court. There, it is evident, the result
turned against the assessee due to absence of the finding of fact that different
ventures carried on by it constituted one indivisible business, which meant that
there was no nexus between the venture in question and the business comprising
of other ventures carried from the head office and therefore so much of the
expenditure incurred on the head office which was attributable to that venture
was not a permissible deduction in computing profits of the business. Indeed,
such expenditure does not properly fall within the meaning of the expenditure
'laid out or expended wholly and exclusively for the purpose of the business or
profession.'

In view of the above discussion, the following principles may be laid down:
(i) if income of an assessee is derived from various heads of income, he is
entitled to claim deduction permissible under the respective head whether or not
computation under each head results in taxable Income;

(ii) if income of an assessee arises under any of the heads of income but from
different items e.g. different house properties or different securities etc., and
income from one or more items alone is taxable whereas income from the other
item is exempt under the Act, the entire permissible expenditure in earning the
income from that head is deductible: and

(iii) in computing 'profits and gains of business or profession' when an assessee

is carrying on business in various ventures and some among them yield taxable
income and the others do not the question of allow ability of the expenditure
under Section 37 of the Act will depend on:

(a) fulfilment of requirements of that provision noted above; and (b) on the fact
whether all the ventures carried on by him constituted one indivisible business
or not; if they do the entire expenditure will be a permissible deduction but if
they do not the principle of apportionment of the expenditure will apply because
there will be no nexus between the expenditure attributable to the venture not
forming integral part of the business and the expenditure sought to be deducted
as the business expenditure of the assessee.
Therefore, held in favour of the Assessee.
 SALARY
AND
PREREQUISITES
Salary and Perquisites.

Statutory Provisions.

Section 15. Salaries.-

The following income shall be chargeable to income-tax under the head

“Salaries”—

(a) any salary due from an employer or a former employer to an assessee in the
previous year, whether paid or not;
(b) any salary paid or allowed to him in the previous year by or on behalf of an
employer or a former employer though not due or before it became due to him;
(c) any arrears of salary paid or allowed to him 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.

Explanation 1.—For the removal of doubts, it is hereby declared that where any
salary paid in advance is included in the total income of any person for any
previous year it shall not be included again in the total income of the person
when the salary becomes due.

Explanation 2.—Any salary, bonus, commission or remuneration, by whatever

name called, due to, or received by, a partner of a firm from the firm shall not
be regarded as “salary” for the purposes of this section.

Section 17. “Salary”, “perquisite” and “profits in lieu of salary” defined.- For

the purposes of sections 15 and of this section,—

(1) “salary” includes —

(i) wages;
(ii) any annuity or pension;
(iii) any gratuity ;
(iv) any fees , commissions, perquisites or profits in lieu of or in addition to any
salary or wages;
(v) any advance of salary;
(va) any payment received by an employee in respect of any period of leave not
availed of by him;
(vi) the annual accretion to the balance at the credit of an employee participating
in a recognised provident fund.
(vii) the contribution made by the Central Government or any other employer in
the previous year, to the account of an employee under a pension scheme .

(2) “perquisite” includes—

(i) the value of rent-free accommodation provided to the assessee by his
employer;
(ii) the value of any concession in the matter of rent respecting any
accommodation provided to the assessee by his employer;
(iv) any sum paid by the employer in respect of any obligation which, but for
such payment, would have been payable by the assessee;
(v) any sum payable by the employer, whether directly or through a fund, other
than a recognised provident fund or an approved superannuation fund or a
Deposit-linked Insurance Fund , to effect an assurance on the life of the assessee
or to effect a contract for an annuity;
(vi) the value of any other fringe benefit or amenities as may be prescribed.
Provided that nothing in this clause shall apply to,—
(i) the value of any medical treatment provided to an employee or any member
of his family .

(3) “profits in lieu of salary” includes—

(i) the amount of any compensation due to or received by an assessee from his
employer or former employer at or in connection with the termination of his
employment or the modification of the terms and conditions relating thereto;
(ii) any payment due to or received by an assessee from an employer or a
former employer or from a provident or other fund.
(iii) any amount due to or received, whether in lump sum or otherwise, by any
assessee from any person—
(A) before his joining any employment with that person; or
(B) after cessation of his employment with that person.
Case Laws.

1. Ram Pershad v. C.I.T. (1972) 2 SCC 696

Facts.
The assessee and his wife owned a large number of shares in a private limited
company engaged in the business of running hotels.

By virtue of Article 109 of the Articles of Association of the said company, the
assessee became the first Managing Director on terms and conditions agreed to
and embodied in an agreement, dated November 20, 1955, between himself and
the company.
Under the said agreement, the assessee was ,to receive Rs 2.000/- per month,
fixed sum of Rs 500/-per month as car allowance, 10% of gross profits of the
company and he and his wife were entitled to free board and lodging in the
hotel.
For the assessment year 1956-57 , the assessee was assessed in respect of
Rs.53,913/-payable to him as 10% of the gross profits of the company which he
gave up soon after the accounts were finalised but before they were passed by
the general meeting of the shareholders.
The above amount was given up by him because the company would not be
making net profits if the stipulated commission was paid to him.
The assessee claimed that the amount given up by him was not liable to be
included in his total income because the amount had not accrued to him at all, at
any rate, in the relevant accounting year.
Even assuming that it had accrued in the relevant accounting year , it is not
taxable under the Income-Tax Act.

The Income-tax Officer, the Appellate Assistant Commissioner, the Tribunal

and on a reference, the High Court have all held that the 10% commission on
gross profits amounting to Rs 53,913/- was taxable as ‘salary’ and that the
income had accrued to the assessee during the previous year.

Against the judgment of the High Court, this appeal is by special leave, raising
the following questions.
(1) Whether the sum of Rs 53,913/- was a revenue receipt of the assessee of the
previous year which is chargeable under Salary or business income?
Question for consideration.
It is not disputed that the commission payable to the assessee would be a
revenue receipt .
It is also not disputed that if it is chargeable as salary , no other question would
arise that the amount of Rs. 53,913/- had accrued to the assessee in the year of
account.
It is therefore necessary for us to consider whether the 10% gross profits
payable to the assessee under the terms of the agreement appointing him as the
Managing Director is liable to be assessed as salary or under the head ‘income
from business’.

‘Salary’ under the Income tax Act includes also commission, wages,
perquisites, etc.

Contention of the assessee.

On behalf of the assessee, it was contended that in order to assess the income as
salary it must be held that there was a relationship of master and servant
between the company and the assessee.
For such a relationship to exist, it must be shown that the employee must be
subject to the supervision and control of the employer in respect of the work
that the employee has to do.
Where, however, there is no such supervision or control it will be a relationship
of principal and agent or an independent contractor.
Applying these tests, it is submitted that the appointment of the assessee as a
Managing Director is not that of a servant but as an agent of the company and
accordingly the commission payable to him is income from business and not
salary.

Reasoning of the Court.

A servant acts under the direct control and supervision of his master.
An agent, on the other hand, in the exercise of his work is not subject to the
direct control or supervision of the principal, though he is bound to exercise his
authority in accordance with all lawful orders and instructions which may be
given to him from time to time by his principal.

But this test is not universal in its application and does not determine in every -
case, having regard to the nature of employment, that he is a servant.
A doctor may be employed as a medical officer and though no control is
exercised over him in respect of the manner he should do the work nor in
respect of the day to day work, he is required to do, he may nonetheless be a
servant if his employment creates a relationship of master and servant.
A person who is engaged to manage a business may be a servant or an agent
according to the nature of his service and the authority of his employment.
Generally it may be possible to say that the greater the amount of direct control
over the person employed, the stronger the conclusion in favour of his being a
servant.
Similarly the greater the degree of independence the greater the possibility of
the services rendered being in the nature of principal and agent.
It is not possible to lay down any precise rule of law to distinguish one kind of
employment from the other.

The nature of the particular business and the nature of the duties of the
employee will require to be considered in each case in order to arrive at a
conclusion as to whether the person employed is a servant or an agent.
In each case the principle for ascertainment remains the same.
Though an agent as such is not a servant, a servant is generally for some
purposes his master’s implied agent, the extent of the agency depending upon
the duties or position of the servant.
It is again true that a director of a company is not a servant but an agent
inasmuch as the company cannot act in its own person but has only to act
through directors who qua the company have the relationship of an agent to its
principal.
A Managing Director may have a dual capacity. He may both be a Director as
well as employee. It is therefore evident that in the capacity of a Managing
Director he may be regarded as having not only the capacity as persona of a
director but also has the persona of an employee, as an agent depending upon
the nature of his work and the terms of his employment.

Where he is so employed, the relationship between him as the Managing

Director and the Company may be similar to a person who is employed as a
servant or an agent for the term ‘employed’ is facile enough to cover any of
these relationships.
The nature of his employment may be determined by the articles of association
of a company and/or the agreement if any, under which a contractual
relationship between the Director and the company has been brought about.
if the the Director is designated an employee of the company, his
remuneration will be assessable as salary.
In other words, whether or not a Managing Director is a servant of the company
apart from his being a Director can only be determined by the article of
association and the terms of his employment.

Referred Case .

In Anderson v. James Sutherland (Peterhead) Limited [AIR 1941 SC 203] it

was held that :
The managing director has two functions and two capacities.
Qua Managing Director he is a party to a contract with the company, and this
contract is a contract of employment.
In Piyare Lal Adishwar Lal v. Commissioner of Income-tax [40 ITR 17] it was
held that :
It is difficult to lay down any one test to distinguish the relationship of master
and servant from that of an employer and independent contractor. In many cases
the test laid down is that in the case of master and servant, the master can order
or require what is to be done and how it is to be done but in the case of an
independent contractor an employer can only say what is to be done but not how
it shall be done

But this test also does not apply to all cases, e.g. in the case of ship’s master, a
chauffeur or a reporter of a newspaper .....

In certain cases it has been laid down that the index of a contract of service are:
(a) the master’s power of selection of the servant;
(b) the payment of wages or other remunerations;
(c) the master’s right to control the method of doing the work; and
(d) the master’s right to suspension or dismissal.
In Lakshminarayan Ram Gopal v. Government of Hyderabad. [25 ITR 449
(SC)] the functions which were inconsistant with being a servant were specified.
They were:
(1) The power to assign the agreement .
(2) The right to continue in employment as the agents of the company .
(3) The remuneration by way of commission of the amount of sale proceeds of
the produce of the company; and
(4) The power of sub-delegation of functions given to the agent .

In Commissioner of Income-tax, Bombay v. Armstrong Smith [(1946) 14 ITR

606 (Bom)]
 the articles of association of the company provided that the assessee was to be
the Chairman and Managing Director of the Company until he resigned office
or died or ceased to hold at least one share in the capital of the company;
that all the other directors were to be under his control and were bound to
conform to his directions in regard to the company’s business;that his
remuneration was to be voted by the company at its annual general meeting and
that the sum received by him for managing the company’s business which arose
from out of the contractual relationship with the company provided by the
articles for performing the services of managing the company’s business.
In these circumstances it was held that assesee was the servant of the company
and as such , the remuneration he received was taxable as salary .

It was laid down that :

“A director of a company as such is not a servant of the company and that the
fees he receives are by way of gratuity, but that does not prevent a director or a
managing director from entering into a contractual relationship with the
company, so that, quite apart from his office of director as becomes entitled to
remuneration as an employee of the company. Further that relationship may be
created either by a service agreement or by the articles themselves. Now, in this
case there is no question of any service agreement outside the articles and,
therefore, the relationship between the company and the assessee, depends upon
the articles.”
However the decided cases do not assist in coming to the conclusion that the
test for determining whether the person employed by a company is a servant or
agent is solely dependent on the extent of supervision and control exercised on
him.
The real question in this case is one of construction of the articles of association
and the relevant agreement which was entered into between the company and
the assessee.
If the company is itself carrying on the business and the assessee is employed to
manage its affairs in terms of its articles and the agreement, he could be
dismissed or his employment can be terminated by the company if his work is
not satisfactory, it could hardly be said that he is not a servant of the company
Articles of Association of the Company in the present case provided that the
assessee shall be the Managing Director of the company for 20 years on terms
and conditions embodied in the agreement.
Subject to the agreement, the general management of the business of the
company shall be in the hands of the Managing Director of the company who
shall have power and authority on behalf of the company to do the several
things specified therein which are usually necessary and desirable for the
management of the affairs of the company.
It was further provided that the receipts signed by the Managing Director or on
his behalf for any moneys or goods or property received in the usual course of
business of the company shall be effectual discharge on behalf of and against
the company for moneys, funds, etc.
That the Managing Director shall also have power to sign cheques on behalf of
the company and is authorised to sub-delegate all or any of the powers.
It was also provided that the Managing Director is expressly allowed generally
to work for and contract with the company and specifically to do the work of
agent , and also to do any other work for the company upon such terms and
conditions and on such remuneration as may from time to time be agreed upon
between him and the Directors of the Company.
Other powers conferred on the MD were :
the Managing Director shall have charge and custody of all the property, books
of account, papers, documents and effects belonging to the said company
wheresoever situate.
the Managing Director shall work for the executions of the decisions that may
be arrived at by the Board from time to time and shall be empowered to do all
that may be necessary in the execution of the decisions of the management of
the company and shall do all things usual, necessary or desirable in the
management of the affairs of the company or carrying out it objects.

One of the clauses of the agreement, stipulated that :

If Ram Pershad , Managing Director, is found to be acting otherwise than in
the interests of the company ‘or is found to be not diligent to his duties as a
Managing Director, the company in General Meeting may terminate his services
before the expiry of the said period of 20 years.

A perusal of the articles and terms and conditions of the agreement definitely
indicates that the assessee was appointed to manage the business of the
company in terms of the articles of association and within the powers prescribed
therein.
The very fact that apart from his being a Managing Director he is given the
liberty to work for the company as an agent is indicative of his employment as a
Managing Director not being that of an agent.
Several of the clauses of the agreement specifically empowered the Board of
Directors to exercise control over the Managing Director:
for instance to accept the title of the property to be sold by the company,
providing for the welfare of the employees,
the power to appoint attorneys as the Directors think fit, etc.
Under the terms of’ the agreement the assessee can be removed within the
period of 20 years for not discharging the work diligently or if he is found not to
be acting in the interest of the company as Managing Director.
These terms are inconsistent with the plea of the assessee that he is an agent of
the company and not a servant.
The control which the company exercises over the assessee need not necessarily
be one which tells him what to do from day to day.
That would be a too narrow view of the test to determine the character of the
employment.
Nor does supervision imply that it should be a continuous exercise of the power
to oversee or superintend the work to be done.
The control and supervision is exercised and is exercisable in terms of the
articles of association by the Board of Directors and the company in its general
meeting.
As a Managing Director he functions also as a member of the Board of
Directors whose collective decisions he has to carry out in terms of the articles
of association and he can do nothing which he is not permitted to do.

Since the Board of Directors are to manage the business of the Company they
have every right to control and supervise the assessee’s work whenever they
deem it necessary.
Every power which is given to the Managing Director therefore emanates from
the articles of association which prescribes the limits of the exercise of that
power.

The powers of the assessee have to be exercised within the terms and limitations
prescribed thereunder and subject to the control and supervision of the Directors
which is indicative of his being employed as a servant of the company.
Under these circumstances the remuneration payable to the assessee is salary
and is taxable as such under the Income Tax Act.
 2. C.I.T. v. L.W. Russel AIR 1965 SC 49.

Facts.

The respondent, L.W. Russel, is an employee of the English and Scottish Joint
Cooperative Wholesale Society Ltd., Kozhikode, hereinafter called “the
Society”, which was incorporated in England.
The Society established a superannuation scheme for the benefit of the male
European members of the Society’s staff employed in India, Ceylon and Africa
by means of deferred annuities.
The terms of such benefits were incorporated in a trust deed .
Every European employee of the Society shall become a member of that scheme
as a condition of employment.
Under the terms of the scheme the trustee has to effect a policy of insurance for
the purpose of ensuring an annuity to every member of the Society on his
attaining the age of superannuation or on the happening of a specified
contingency.

The Society contributes 1/3 of the premium payable by such employee.

During the year 1956-57 the Society contributed Rs 3333 towards the premium
payable by the respondent.

The IncomeTax Officer, included the said amount in the taxable income of the
respondent for the year 1956-57 under Section 17 of the Act.
The appeal preferred by the respondent against the said inclusion to the
Appellate Assistant Commissioner of Income Tax, was dismissed.
The further appeal preferred to the Income Tax Appellate Tribunal received the
same fate.

The assessee thereupon filed an application to the Income Tax Appellate

Tribunal for stating a case to the High Court.
Pursuant to this the Tribunal submitted a statement of case referring the
following three questions of law to the High Court :

(1) Whether the contributions paid by the employer to the assessee under the
terms of a trust deed in respect of a contract for a deferred annuity on the life of
the assessee is a ‘perquisite’ as contemplated by Section 17 of the Indian
Income Tax Act?
(2) Whether the said contributions were allowed to or due to the applicant by or
from the employer in the accounting year?

On the first question the High Court held that the employer’s contribution under
the terms of the trust deed was not a perquisite as contemplated by Section 17
of the Act.
On the second question it came to the conclusion that the employer’s
contributions were not allowed to or due to the employee in the accounting year.
Against this the Commissioner of Income Tax has preferred the present appeal ,
questioning the correctness of the said answers.

Contention of the Revenue.

The amount contributed by the Society under the scheme towards the insurance
premium payable by the trustees for arranging a deferred annuity on the
respondent’s superannuation is a perquisite within the meaning of Section 17 of
the Act .
The fact that the respondent may not have the benefit of the contributions on
the happening of certain contingencies will not make the said contributions
nonetheless a perquisite.

The employer’s share of the contributions to the fund earmarked for paying
premiums of the insurance policy, vests in the respondent as soon as it is paid
to the trustee and the happening of a contingency only operates as a deferment
of the vested right.

Reasoning of the Court.

The provisions of the superannuation scheme must be examined in detail as

the scope of the respondent’s right in the amounts representing the employer’s
contributions thereunder depends upon it.

The trust deed and the rules embody the superannuation scheme. The scheme is
described as the “English and Scottish Joint Cooperative Wholesale Society
Limited Overseas European Employees’ Superannuation Scheme ”.
It is established for the benefit of the male European members of the Society’s
staff employed in India, Ceylon and Africa by means of deferred annuities.
The Society itself is appointed thereunder as the first trustee.
The trustees shall act as agents for and on behalf of the Society and the
members respectively; they shall effect or cause to be effected such policy or
policies as may be necessary to carry out the scheme and shall collect and
arrange for the payment of the moneys payable under such policy or policies
and shall hold such moneys as trustees for and on behalf of the person or
persons entitled thereto under the rules of the Scheme.
The object of the Scheme is to provide for pensions by means of deferred
annuities for the members upon retirement from employment on attaining
certain age under the certain conditions .

The gist of the Scheme is:

The object of the Scheme is to provide for pensions to its employees.
It is achieved by creating a trust.
The Trustees appointed thereunder are the agents of the employeras well as of
the employees and hold the moneys received from the employer, the employee
and the insurer in trust for and on behalf of the person or persons entitled
thereto under the rules of the Scheme.

The Trustees are enjoined to take out policies of insurance securing a deferred
annuity upon the life of each member, and funds are provided by contributions
from the employer as well as from the employees.
The Trustees realise the annuities and pay the pensions to the employees.
Under certain contingencies , an employee would be entitled to the pension only
after superannuation.
If the employee leaves the service of the Society or is dismissed from service or
dies in the service of the Society, he will be entitled only to get back the total
amount of the portion of the premium paid by him, though the trustees in their
discretion under certain circumstances may give him a proportion of the
premiums paid by the Society.
The entire amount representing the contributions made by the Society or part
thereof, as the case may be, will then have to be paid by the Trustees to the
Society.
Under the scheme the employee has not acquired any vested right in the
contributions made by the Society. Such a right vests in him only when he
attains the age of superannuation.
Till that date that amount vests in the Trustees to be administered in accordance
with the rules that is to say, in case the employee ceases to be a member of the
Society by death or otherwise, the amounts contributed by the employer with
interest thereon, subject to the discretionary power exercisable by the trustees,
become payable to the Society.
Till a member attains the age of superannuation the employer’s share of the
contributions towards the premiums does not vest in the employee.
At best he has a contingent right therein. In one contingency the said amount
becomes payable to the employer and in another contingency, to the employee.

The issue to be ascertained in the present case is whether such a contingent

right is hit by the provisions of section 17 .
Section 17 (2) : “perquisite” includes—
(v) any sum payable by the employer, whether directly or through a fund, other
than a recognised provident fund or an approved superannuation fund or a
Deposit-linked Insurance Fund , to effect an assurance on the life of the assessee
or to effect a contract for an annuity;

This section imposes a tax on the remuneration of an employee.

It presupposes the existence of the relationship of employer and employee.
The present case is sought to be brought under the head “perquisites in lieu of,
or in addition to, any salary or wages, which are allowed to the employee or are
due to him, whether paid or not, on behalf of a company.”

The expression “perquisites” is defined in the Oxford Dictionary as

“casual emolument, fee or profit attached to an office or position in addition to
salary or wages”.
Section 17(2) (v) of the Act gives an inclusive definition which includes within
the meaning of “perquisites” any sum payable by the employer, whether directly
or through a fund , to effect an assurance on the life of the assessee or in respect
of a contract for an annuity on the life of the assessee.

A reading of the substantive part of Section 1 7(2 ) (v) makes it clear that if a
sum of money is allowed to the employee by or is due to him from or is paid to
enable the latter to effect an insurance on his life, the said sum would be a
perquisite within the meaning of Section1 7(2) of the Act and, therefore, would
be liable to tax.
But before such sum becomes taxable , it shall either be paid to the employee or
allowed to him by or due to him from the employer.
So far as the expression “paid” is concerned, there is no difficulty, for it takes in
every receipt by the employee from the employer whether it was due to him or
not.
The expression “due” followed by the qualifying clause “whether paid or not”
shows that there shall be an obligation on the part of the employer to pay that
amount and a right on the employee to claim the same.
The expression “allowed”, it is said, is of a wider connotation and any credit
made in the employer’s account is covered thereby.
The said expression in the legal terminology is equivalent to “fixed, taken into
account, set apart, granted”.
It takes in perquisites given in cash or in kind or in money or money’s worth
and also amenities which are not convertible into money.

It implies that a right is conferred on the employee in respect of those

perquisites.
One cannot be said to allow a perquisite to an employee if the employee has no
right to the same.
It cannot apply to contingent payments to which the employee has no right till
the contingency occurs. In short, the employee must have a vested right therein.
If that be the interpretation of Section 17 of the Act, it is not possible to hold
that the amounts paid by the Society to the Trustees to be administered by them
in accordance with the rules framed under the Scheme are perquisites allowed to
the respondent or due to him.
Till he reaches the age of superannuation, the amounts vest in the Trustees and
the beneficiary under the trust can be ascertained only on the happening of one
or other of the contingencies provided for under the trust deed. On the
happening of one contingency, the employer becomes the beneficiary, and on
the happening of another contingency, the employee becomes the beneficiary.
The principle that unless a vested interest in the sum accrues to an employee it
is not taxable, applies to the present case.
In the present case , no interest in the sum contributed by the employer under
the scheme vested in the employee as it was only a contingent interest
depending upon his reaching the age of superannuation.
It is not a perquisite allowed to him by the employer or an amount due to him
from the employer within the meaning of Section 7(1) of the Act.
Therefore, the High Court has given correct answers to the questions of law
submitted to it by the Income Tax Appellate Tribunal.
In the result, the appeal fails and is dismissed.
INCOME FROM
HOUSE
PROPERTY
Income From House Property.

Statutory Provisions. ( Sections 22 to 27 of the Income Tax Act.)

22. Income from house property.- The annual value of property consisting of
any buildings or lands appurtenant thereto of which the assessee is the owner ,
other than such portions of such property as he may occupy for the purposes of
any business or profession carried on by him the profits of which are chargeable
to income-tax, shall be chargeable to income-tax under the head “Income from
house property”.
23. Annual value how determined.- (1) For the purposes of section 22, the
annual value of any property shall be deemed to be—
(a) the sum for which the property might reasonably be expected to let from
year to year; or
(b) where the property or any part of the property is let and the actual rent
received or receivable by the owner in respect thereof is in excess of the sum
referred to in clause (a), the amount so received or receivable; or
(c) where the property or any part of the property is let and was vacant during
the whole or any part of the previous year and owing to such vacancy the actual
rent received or receivable by the owner in respect thereof is less than the sum
referred to in clause (a), the amount so received or receivable :
Provided that the taxes levied by any local authority in respect of the property
shall be deducted (irrespective of the previous year in which the liability to pay
such taxes was incurred by the owner according to the method of accounting
regularly employed by him) in determining the annual value of the property of
that previous year in which such taxes are actually paid by him.

Explanation.—For the purposes of clause (b) or clause (c) of this sub-section,

the amount of actual rent received or receivable by the owner shall not include,
subject to such rules as may be made in this behalf, the amount of rent which
the owner cannot realise.
(2) Where the property consists of a house or part of a house which—
(a) is in the occupation of the owner for the purposes of his own residence; or
(b) cannot actually be occupied by the owner by reason of the fact that owing to
his employment, business or profession carried on at any other place, he has to
reside at that other place in a building not belonging to him,
the annual value of such house or part of the house shall be taken to be nil.
(3) The provisions of sub-section (2) shall not apply if—
(a) the house or part of the house is actually let during the whole or any part of
the previous year; or
(b) any other benefit therefrom is derived by the owner.
(4) Where the property referred to in sub-section (2) consists of more than one
house—
(a) the provisions of that sub-section shall apply only in respect of one of such
houses, which the assessee may, at his option, specify in this behalf;
(b) the annual value of the house or houses, other than the house in respect of
which the assessee has exercised an option under clause (a), shall be determined
under sub-section (1) as if such house or houses had been let.

24. Deductions from income from house property.- Income chargeable under
the head “Income from house property” shall be computed after making the
following deductions, namely:—
(a) a sum equal to thirty per cent of the annual value;
(b) where the property has been acquired, constructed, repaired, renewed or
reconstructed with borrowed capital, the amount of any interest payable on such
capital:
Provided that in respect of property referred to in sub-section (2) of section 23,
the amount of deduction shall not exceed thirty thousand rupees :
Provided further that where the property referred to in the first proviso is
acquired or constructed with capital borrowed on or after the 1st day of April,
1999 and such acquisition or construction is completed within three years from
the end of the financial year in which capital was borrowed, the amount of
deduction under this clause shall not exceed one lakh fifty thousand rupees.
Provided also that no deduction shall be made under the second proviso unless
the assessee furnishes a certificate, from the person to whom any interest is
payable on the capital borrowed, specifying the amount of interest payable by
the assessee for the purpose of such acquisition or construction of the property,
or, conversion of the whole or any part of the capital borrowed which remains
to be repaid as a new loan.

Explanation.—For the purposes of this proviso, the expression “new loan”

means the whole or any part of a loan taken by the assessee subsequent to the
capital borrowed, for the purpose of repayment of such capital.

25. Amounts not deductible from income from house property.-25. Amounts not
deductible from income from house property.- Notwithstanding anything
contained in section 24, any interest chargeable under this Act which is payable
outside on which tax has not been paid or deducted and in respect of which
there is no person in India who may be treated as an agent , shall not be
deducted in computing the income chargeable under the head “Income from
house property”.
26. Property owned by co-owners.- Where property consisting of buildings or
buildings and lands appur- tenant thereto is owned by two or more persons and
their respective shares are definite and ascertainable, such persons shall not in
respect of such property be assessed as an association of persons, but the share
of each such person in the income from the property as computed in accordance
with sections 22 to 25 shall be included in his total income.
27. “Owner of house property”, “annual charge”, etc., defined.- For the
purposes of sections 22 to 26—
(i) an individual who transfers otherwise than for adequate consideration any
house property to his or her spouse, not being a transfer in connection with an
agreement to live apart, or to a minor child not being a married daughter, shall
be deemed to be the owner of the house property so transferred;
(ii) the holder of an impartible estate shall be deemed to be the individual owner
of all the properties comprised in the estate ;
(iii) a member of a co-operative society, company or other association of
persons to whom a building or part thereof is allotted or leased under a house
building scheme of the society, company or association, as the case may be,
shall be deemed to be the owner of that building or part thereof ;
(iiia) a person who is allowed to take or retain possession of any building or part
thereof in part performance of a contract , shall be deemed to be the owner of
that building or part thereof ;
(iiib) a person who acquires any rights (excluding any rights by way of a lease
from month to month or for a period not exceeding one year) in or with respect
to any building or part thereof, shall be deemed to be the owner of that building
or part thereof;
(vi) taxes levied by a local authority in respect of any property shall be deemed
to include service taxes levied by the local authority in respect of the property.
Leading Cases.

In the case of C.I.T. v. Biman Behari (68 ITR 815), the central issue revolved
around whether certain properties dedicated to deities could be subject to taxation
under the "Income from House Property" provisions of the Income Tax Act. Let's
break down the facts, legal arguments, and the court's decision:

Facts:

Banku Behari Saha executed a will in 1925, dedicating several properties to two
deities he had installed in Calcutta.
The will explicitly stated that these properties were dedicated to the deities for
religious purposes and were not to be used for any other activities.
A temple was constructed on the dedicated properties, and no income was
generated from them.
However, the Income Tax Officer computed the annual value of these properties
as if they were to be rented out in the open market.
Legal Arguments:

The Appellate Assistant Commissioner and the Appellate Tribunal ruled in favor
of the assessee (the person liable to pay tax). They argued that since the properties
were dedicated to deities for religious purposes and could not be used for other
functions, they had no bona fide annual value.
The Tribunal believed that the properties' religious and restrictive use exempted
them from taxation.
Court's Decision:

The Commissioner of Income-tax appealed, arguing that even if the properties

were not generating income, they should still be taxed based on their notional
income value.
The Court held that the Income Tax Act mandates taxation based on the notional
annual value of properties, even if they are not generating actual income.
The Court cited two previous Bombay High Court decisions that supported the
idea that the liability to pay tax is based on the ownership of the property and its
notional value.
The presence of restrictions, such as those prohibiting the use of properties for
any purpose other than religious worship, may reduce the notional value but does
not exempt the properties from taxation.
Ultimately, the Court ruled in favor of the revenue, emphasizing that the
properties had a notional annual value even with the presence of restrictions.
In summary, this case highlighted the principle that properties subject to taxation
under the "Income from House Property" provisions should be assessed based on
their notional annual value, even if they are not generating actual income. The
existence of restrictions, such as religious dedications, may reduce the value but
does not exempt the property from taxation. This decision upholds the principle
that the liability to pay tax depends on property ownership and its notional value,
even when it's not generating income.

In the case of East India Housing & Land Development Trust Ltd. v. C.I.T. (1961)
42 ITR 49, the key issue was whether the income received by the appellant from
letting out shops and stalls in a market it had set up could be taxed as "income
from property" under Section 22 of the Income Tax Act, or as "profits or gains of
business" under Section 28 of the Act. Here is a breakdown of the facts, the
appellant's contention, the court's reasoning, and the court's decision:

Facts:

The appellant, a private company, was incorporated with the objective of

developing landed properties and promoting markets.
In 1946, the appellant purchased land in Calcutta and set up a market,
constructing shops and stalls on the land.
For the relevant assessment year, the appellant received income from the tenants
of these shops and stalls.
The Income Tax Officer assessed this income as "income from property" under
Section 22 of the Income Tax Act.
Appellant's Contention:

The appellant argued that since it was formed with the primary objective of
promoting and developing markets, the income derived from the shops and stalls
should be taxed as "profits or gains of business" under Section 28 of the Income
Tax Act, rather than as "income from property" under Section 22.
Court's Reasoning:

The Court noted that the appellant, according to the Calcutta Municipal Act, had
to obtain a license and maintain various services on the property. However, this
fact alone did not transform the income derived from letting out property into
"profits or gains of business" under the Income Tax Act.

The Income Tax Act specifies six distinct heads of income: salaries, interest on
securities, income from property, profits and gains of business, income from other
sources, and capital gains. These classifications are based on the sources from
which income is derived.

The Court emphasized that these heads of income are mutually exclusive, and
income derived from different sources should be computed for taxation based on
the appropriate section.

The appellant's income, received from letting out shops and stalls, was income
derived from property and fell under the specific head described in Section 22.
The primary source of income was the occupation of the shops and stalls, and the
temporary nature of this occupation did not change the character of the income.

Court's Decision:
The Court ruled against the appellant, affirming that the income received from
shops and stalls was assessable under Section 22 of the Income Tax Act as
"income from property."
The Court pointed out that the source of the income was occupation of the
property, making it a matter of little importance whether the occupation was
temporary or shifting.
The appeal was dismissed with costs.
This case underscores the principle that income is taxed based on its source and
character, and the specific heads of income outlined in the Income Tax Act
determine the appropriate taxation provisions. In this case, the income derived
from property, even if the property was used for business purposes, was correctly
taxed under the "income from property" provisions.

In the case of R.B. Jodha Mal Kuthiala v. C.I.T. (1971) 3 SCC 369, the primary
issue was whether the assessee continued to be the owner of a hotel property in
Pakistan, which was declared an evacuee property and vested in the Custodian of
Evacuee Property, for the purpose of computation of income under Section 22 of
the Income Tax Act. Here's a summary of the facts, contentions, reasoning, and
the court's decision:

Facts:

The assessee was a registered firm deriving income from various sources,
including interest on securities, property, business, and others.
In 1946, the assessee purchased a hotel in Lahore for Rs 46 lakhs, partly financed
by loans.
After the creation of Pakistan, the hotel was declared an evacuee property and
vested in the Custodian in Pakistan.
In its tax returns, the assessee claimed losses, primarily due to the interest paid on
loans. The Income Tax Officer disallowed these losses as the property was
declared an evacuee property.
Contention of the Assessee:
The assessee contended that the property vested in the Custodian only for
administration purposes and that the assessee still retained ownership of the
property. The term "owner" should refer to the person with the ultimate right to
the property.
Contention of the Revenue:

The Revenue argued that for income tax purposes, the "owner" should be
interpreted as the person entitled to the income. Legal ownership is the focus of
Section 22, not any beneficial interest in the property.
Court's Reasoning:

The Court examined the provisions of the Pakistan (Administration of Evacuee

Property) Ordinance, 1949, which governed the administration of evacuee
properties.
The Ordinance vested all evacuee properties in the Custodian with effect from
March 1, 1947, and gave the Custodian significant powers over those properties.
The Court noted that while the evacuees retained some residual right or interest in
the property, their rights were significantly curtailed. They could not take
possession, lease, sell, mortgage, or realize income from the property.
The Court emphasized that for the purpose of Section 22, the owner must be the
person who can exercise the rights of the owner in his own right, not on behalf of
the owner.
The Court cited the "income from property" as the focus of Section 22, and the
person entitled to the income is considered the owner for tax purposes.
The Court also distinguished the concept of ownership as a legal right from
ownership under Section 22 of the Income Tax Act.
Referred Cases:

The Court referred to the case of Official Assignee for Bengal where it was held
that the property did not cease to be subject to taxation after an adjudication of
insolvency, and the Official Assignee was considered the "owner" for tax
purposes.
The Court also referenced Nawab Bahadur of Murshidabad v. Commissioner of
Income-tax, where it was determined that the Nawab was considered the "owner"
of properties despite certain restrictions on alienation.
Court's Decision:

The Court concluded that for the purpose of Section 22, the assessee could not be
considered the owner of the hotel property in Pakistan during the relevant
assessment years since it was under the administration of the Custodian of
evacuee property in Pakistan.
The appeal was dismissed.
This case illustrates that, for tax purposes, the term "owner" in Section 22 refers to
the person entitled to the income from the property, and legal ownership plays a
significant role in determining who is considered the owner in the eyes of the law
for tax assessment purposes.

In the case of Chennai Properties and Investment Ltd. v. CIT (2015), the issue at
hand revolved around whether the income derived by a company from letting out
properties should be treated as income from a business or as rental income from
house property for tax assessment purposes. Here's a summary of the case:

Facts:

The Assessee Company's primary objective was to acquire and hold properties in
the city and to let out those properties.
The Assessee had rented out these properties, and the rental income received was
disclosed as income from business in their tax return.
The Assessing Officer disagreed with this classification and considered the
income to be from the house property, subjecting it to different tax treatment.
Judicial Proceedings:
The Commissioner of Income Tax (Appeals) sided with the Assessee and held that
the income should be considered as business income.
The Income Tax Appellate Tribunal upheld this decision.
However, the High Court ruled in favor of the Department, classifying the income
as income from the house property.
Court's Reasoning:

The Memorandum of Association of the Appellant-company stated that its main

objective was to acquire and hold properties and to let out those properties. This
was the principal business activity of the company.
The return filed by the Assessee showed that the entire income came from letting
out these properties, and this was accepted by the Assessing Officer.
The Court referred to the judgment in 'Karanpura Development Co. Ltd. v.
Commissioner of Income Tax, West Bengal,' which held that the nature of the
activity and the objects of the company must be considered to determine the
classification of income.
The Court emphasized that there is no clear distinction, and the dividing line can
be difficult to find. In this case, the business of letting out properties was evident.
The Constitution Bench judgment in 'Sultan Brothers (P) Ltd. v. Commissioner of
Income Tax' clarified that the entry in the object clause of a company's
memorandum is not the sole determinant. Each case should be examined from a
businessman's perspective to determine whether the letting is part of a business.
The Court concluded that in this case, letting of the properties was, in fact, the
business of the Assessee, and the income should rightly be disclosed under the
head "Income from Business" rather than as "income from the house property."
Consequently, the Court allowed the appeal, set aside the High Court's judgment,
and restored that of the Income Tax Appellate Tribunal.
This case emphasizes that the nature of the business activity and the main
objectives of the company should be considered when determining whether
income derived from letting out properties is to be treated as income from a
business or income from a house property for tax purposes.
In the case of Raj Dadarkar & Associates v. CIT (2017), the issue at hand was the
tax treatment of income generated from sub-licensing a market portion that the
appellant firm had acquired from the Municipal Corporation Greater Bombay.
Here's a summary of the case:

Facts:

The Maharashtra Housing and Developing Authority (MHADA) constructed

buildings with a reservation for a Municipal retail market on the plot.
The Market Department of the Municipal Corporation Greater Bombay (MCGB)
auctioned the market portion on a monthly license basis in 1993.
The appellant firm participated in the auction, won the bid, and took possession of
the market portion.
The appellant had to make substantial additions/alterations to the premises to
make it suitable for a market.
The appellant collected various types of receipts from sub-licensees, including
compensation, leave and license fees, and service charges.
Tax Treatment:

Initially, the appellant declared the income from sub-licensing as "Profits and
Gains of Business or Profession" in their tax return.
Later, the tax authorities reclassified the income as "Income from House
Property."
The reasons for this reclassification were that the appellant was deemed the owner
of the property by virtue of Section 27(iiib) of the Income Tax Act, lease
compensation was referred to in agreements, and property tax was levied on the
appellant.
Arguments:
The appellant argued that their primary business was sub-letting premises, and
thus, the income should be treated as business income.
They referred to the partnership deed's object clause, which mentioned taking
premises on rent and sub-letting.
The High Court had mainly focused on whether the appellant was a "deemed
owner" under Section 27(iiib) of the Act.
Court's Decision:

The Supreme Court stated that the tax treatment depends on whether the activity
of sub-letting premises is considered the business of the appellant.
The object clause in the partnership deed alone was not conclusive. Each case
should be examined on its facts.
The Court agreed that the appellant was deemed the owner under Section 27(iiib)
of the Act.
The primary question was whether the income should be categorized as "Income
from House Property" or "Profits and Gains of Business or Profession."
The Court upheld the previous findings of the Income Tax Appellate Tribunal
(ITAT) that the income was from letting out property and not from a systematic
business operation.
The appellant did not provide sufficient material to show that sub-letting was their
primary business activity.
In conclusion, the Supreme Court upheld the tax authorities' decision to classify
the income as "Income from House Property" rather than business income, as the
appellant did not establish that sub-letting was their main business activity.
PROFITS AND
GAINS OF
BUSINESS
AND
PROFESSION
Income from Profits & gains of business or profession

Under the Income Tax Act, 'Profits and Gains of Business or Profession' are
also subjected to taxation. The term "business" includes any (a) trade,
(b)commerce, (c)manufacture, or (d) any adventure or concern in the nature of
trade, commerce or manufacture. The term "profession" implies professed
attainments in special knowledge as distinguished from mere skill; "special
knowledge" which is "to be acquired only after patient study and application".
The words 'profits and gains' are defined as the surplus by which the receipts
from the business or profession exceed the expenditure necessary for the
purpose of earning those receipts. These words should be understood to include
losses also, so that in one sense 'profit and gains' represent plus income while
'losses' represent minus income.

The following types of income are chargeable to tax under the heads profits and
gains of business or profession:-

a. Profits and gains of any business or profession

b. Any compensation or other payments due to or received by any person

specified insection 28 of the Act

c. Income derived by a trade, profession or similar association from specific

services performed for its members

d. Profit on sale of import entitlement licences, incentives by way of cash

compensatory support and drawback of duty

e. The value of any benefit or perquisite, whether converted into money or

not, arising from business
f. Any interest, salary, bonus, commission, or remuneration received by a
partner of a firm, from such a firm

g. Any sum whether received or receivable in cash or kind, under an

agreement for not carrying out any activity in relation to any business or not to
share any know-how, patent, copyright, franchise, or any other business or
commercial right of similar nature or technique likely to assist in the
manufacture or processing of good

h. Income from speculative transactions.

In the following cases, income from trading or business is not taxable under
the head "profits and gains of business or profession":-

1. Rent of house property is taxable under the head " Income from house
property". Even if the property constitutes stock in trade of recipient of rent or
the recipient of rent is engaged in the business of letting properties on rent.

2. Deemed dividends on shares are taxable under the head "Income from
other sources".

3. Winnings from lotteries, races etc. are taxable under the head "Income
from other sources".

Profits and gains of any other business are taxable, unless such profits are
subjected to exemption.
General principals governing the computation of taxable income under the
head "profits and gains of business or profession:-

1. Business or profession should be carried on by the assessee. It is not the

ownership of business which is important , but it is the person carrying on a
business or profession, who is chargeable to tax.

2. Income from business or profession is chargeable to tax under this head

only if the business or profession is carried on by the assessee at any time
during the previous year. This income is taxable during the following
assessment year.

3. Profits and gains of different business or profession carried on by the

assessee are not separately chargeable to tax i.e. tax incidence arises on
aggregate income from all businesses or professions carried on by the assessee.
But, profits and loss of a speculative business are kept separately.

4. It is not only the legal ownership but also the beneficial ownership that
has to be considered.

5. Profits made by an assessee in winding up of a business or profession are

not taxable, as no business is carried on in that case. However, such profits may
be taxable as capital gains or as business income, if the process of winding up is
such as to involve the carrying on of a trade.

6. Taxable profit is the profit accrued or arising in the accounting year.

Anticipated or potential profits or losses, which may occur in future, are not
considered for arriving at taxable income. Also, the profits, which are taxable,
are the real profits and not notional profits. Real profits from the commercial
point of view, mean a gain to the person carrying on the business and not profits
from narrow, technical or legalistic point of view.
7. The yield of income by a commercial asset is the profit of the business
irrespective of the manner in which that asset is exploited by the owner of the
business.

8. Any sum recovered by the assessee during the previous year, in respect of
an amount or expenditure which was earlier allowed as deduction, is taxable as
business income of the year in which it is recovered.

9. Modes of book entries are generally not determinative of the question

whether the assessee has earned any profit or loss.

10. The Income tax act is not concerned with the legality or illegality of
business or profession. Hence, income of illegal business or profession is not
exempt from tax.

MEANING OF “BUSINESS” & “PROFESSION” AS PER INCOME TAX

ACT.

Business :
“Business” simply means any economic activity carried on for earning profits.
Sec. 2(3) has defined the term as “ any trade, commerce, manufacturing activity
or any adventure or concern in the nature of trade, commerce and
manufacture”.

In this connection it is not necessary that there should be a series of transactions

in a business and also it should be carried on permanently. Neither repetition
nor continuity of similar transactions is necessary.

Profession :
“Profession” may be defined as a vacation, or a job requiring some thought,
skill and special knowledge like that of C.A., Lawyer, Doctor, Engineer,
Architect etc. So profession refers to those activities where the livelihood is
earned by the persons through their intellectual or manual skill.
Basis of Charge [ Sec. 28]

The following income shall be chargeable to income-tax under the head “Profits
and gains of business or profession”,—

(i) the profits and gains of any business or profession which was carried on by
the assessee at any time during the previous year;

(ii) any compensation or other payment due to or received by,—any person, by

whatever name called, managing the whole or substantially the whole of the
affairs of an Indian company, at or in connection with the termination of his
management or the modification of the terms and conditions relating thereto;

(iii) income derived by a trade, professional or similar association from specific

services performed for its members ;

(iv) the value of any perquisite or benefit arising from business or profession ,
whether convertible into moneyor not,;

(v) any interest, commission , salary, remuneration , or bonus due to, or

received by, a partner of a firm from such firm :

(vi) any sum received under a Keyman insurance policy including the sum
allocated by way of bonus on such policy.

(vi) income from speculative transactions.

(vii) any sum, whether received or receivable, in cash or kind, under an

agreement for—

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

(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise
or any other business or commercial right of similar nature

(viii) any profit on the transfer of the Duty Free Replenishment Certificate

(ix) any profit on the transfer of the Duty Entitlement Pass Book Scheme

(x) profits on sale of a license granted under the Imports (Control) Order, 1955,
made under the Imports and Exports (Control) Act, 1947 (18 of 1947)
Business Income not Taxable under the head “Profits and Gains of
Business or Profession” :
In the following cases, income from trading or business is not taxable under
Sec. 28, under the head “Profits and Gains of Business or Professions” :

Nature of Income Head under which it is chargeable to Tax

Rent of house property is taxable under Sec.
22 under the head “ Income from House
Rental income in the case of Property” even if property constitutes Stock-
dealer in property in-trade of recipient of rent or the recipient of
rent is engaged in the business of
letting properties on rent.
Dividend on shares are taxable under section
56(2)(i), under the head “Income from other
sources” , even if they are derived from
Dividend on shares in the case of shares held as stock in trade or the recipient
a dealer-in-shares. of dividends is a dealer-in-shares. However,
dividend received from an Indian company is
not chargeable to tax in the hands of
shareholders.
Winning form Lotteries, races, etc. are
taxable under the head “Income from Other
Winning from Lotteries etc.
Sources” ( even if derived as a regular
business activity)

EXPENSES WHICH CAN BE CLAIMED AS DEDUCTIBLE

EXPENSES .

Name of Expenses… Section

1. Rent, Rates, Taxes, Repairs & Insurance of 30
Premises/Buildings used for the purpose of the business
2. Repairs and insurance of Plant & Machinery, Furniture used in 31
business or professions.
3. Depreciation on Building, , Plant & Machinery, Furniture 32
owned by the assessee
4. Expenditure on scientific research : any expenditure (not 35
being in the nature of capital expenditure) laid out or expended
on scientific research related to the business.
5. Revenue Expenditure incurred by the assessee himself : If 35(1)(i)
the assessee himself carries on Scientific Research and
incurred Revenue Expenditure which must relate to Business
is allowed asDeductions.
Contribution made to Outsiders : Where the assessee makes 35(1)(ii)(iii)
contribution to other Institutions for carry on scientific
research for this purpose, a weighted deductions is allowed
which is equal to 1 ¼ times of any sum paid to a scientific
research association or to a university, college or other
institutions.
6.. Expenditure on acquisition of patent rights or copyrights : 35A
Any expenditure of a capital nature incurred on the acquisition
of patent rights used for the purposes of the business after the
28-02-1966 [but before the 1-04-1998], be allowed for each of
the relevant previous years, a deduction equal to the
appropriate fraction of the amount of such expenditure.
7. Expenditure for obtaining license to 35ABB
operate telecommunication services : In respect of any
expenditure, being in the nature of capital expenditure,
incurred for acquiring any right to operate telecommunication
services [either before the commencement of the business to
operatetelecommunication services or thereafter at any time
during any previous year] and for which payment has actually
been made to obtain a license be allowed for each of the
relevant previous years, a deduction equal to the appropriate
fraction of the amount of such expenditure
8. Amortisation of certain preliminary expenses 35D
: This Deduction is available to Indian Company or a resident
non-corporate assessee. A foreign company even if it is
resident cannot claim such Deduction u/s 35D.
Expenses incurs, after the 31st day of March, 1970,
(i) before the commencement of his business, or
(ii) after the commencement of his business, in either for
extension of his [industrial] undertaking or towards setting up
a new [industrial] unit,
the assessee shall be allowed a deduction of an amount equal
to - one-tenth (1/10 th. ) of such expenditure for each of the ten
successive previous years beginning with the previous year in
which the business commences or the new [industrial] unit
commences production or operation.
9. Amortisation of expenditure in case of amalgamation or 35DD
demerger. : The Tax payer is an Indian company and incurs
 any expenditure, on or after the 01-04-1999, wholly and
exclusively for the purposes of amalgamation or demerger of
an undertaking, the assessee shall be allowed a deduction of an
amount equal to..
- one-fifth (1/5) of such expenditure for each of the five(5)
successive previous years beginning with the previous year in
which the amalgamation or demerger takes place.
10. Deduction for expenditure on prospecting, etc., for certain 35E
minerals : This Deduction is allowed only in case of an Indian
company or a resident person (other than a company) and it is
not available to Foreign Compnay.
This Section provides for the amortization of expenditure
incurred after the 31st day of March, 1970 wholly and
exclusively on any operation relating to prospecting for the
minerals or group of associated minerals or on the
development of amine or other natural deposit of any such
minerals or group of associated minerals.
The Deduction shall be allowed for each one of the relevant
previous years a deduction of an amount equal to one-tenth
(1/10) of the amount of such expenditure.
11. Other Deductions: 36
a. Insurance Premium paid for Stock and/ or Stores
b. Insurance Premium paid towards Health Insurance Scheme
of Employees
c. Bonus & Commission paid to Employees
d. Interest paid on borrowed Capital for Business/ Profession
e. The pro rata amount of discount on a zero coupon bond
f. Employer’s contribution towards a Recognised Provident
Fund (RPF) or an approved superannuation fund.
g. Employer’s contribution towards an approved Gratuity Fund
created by him for the exclusive benefit of his employees.
h. The amount of any Bad Debt or part thereof which
is written off as irrecoverable in the accounts of the assessee
for the previous year.

General Deduction : Section 37(1) is a residuary section . In order to claim

deduction under this section, the following conditions should be satisfied :

Condition-1: The expenditure should not be of the nature described under

section 30 and 36.
Condition-2 : It should not be in the nature of capital expenditure.
Condition-3 : It should not be personal expenditure of the assessee.
Condition-4 : It should have been incurred in the previous year.
Condition-5 : It should be in respect of business carried on by the assessee.
Condition-6 : It should have been expended wholly and exclusively for the
purpose of such business.
Condtion-7 : It should not have been incurred for any purpose which is an
offence or is prohibited by any law.

17 The following Expenditures are allowed, if incurred, for furtherance of

Business without any limit :
(a) Entertainment
(b) Compliments
(c) Traveling
(d) Advertisement
(e) Maintenance of Guest House

EXPENSES ARE CONSIDERED AS “EXPENSES NOT

DEDUCTIBLE.”

The following amounts shall not be deducted in computing the income

chargeable under the head “Profits and gains of business or profession”,—

1. Any interest, royalty, fees for technical services or other sum chargeable
under this Act, which is payable,—

(A) Outside India; or

(B) In India to a non-resident, not being a company or to a foreign company,

on which tax is deductible at source and such tax has not been deducted or,
after deduction, has not been paid during the previous year, or in the subsequent
year before the expiry of the time.

2. Any interest, commission or brokerage,, fees for professional services or fees

for technical services payable to a resident, or amounts payable to a contractor
or subcontractor, being resident, for carrying out any work, on which tax is
deductible at source and such tax has not been deducted or, after deduction, has
not been paid,—

3. Any sum paid on account of securities transaction tax

4. Any sum paid on account of any rate or tax levied on the profits or gains of
any business or profession or assessed at a proportion of, or otherwise on the
basis of, any such profits or gains is not deductible.

5. any sum paid on account of wealth-tax.

6. any payment which is chargeable under the head “Salaries”, if it is

payable—

(A) outside India; or

(B) to a non-resident,

and if the tax has not been paid thereon nor deducted therefrom.

7. Any payment to a provident or other fund established for the benefit of

employees of the assessee, unless the tax shall bededucted at source from any
payments made

8. Where the assessee incurs any expenditure in respect of which payment is

made in a sum exceeding twenty thousand rupees (Rs.20,000) otherwise than by
an account payee cheque drawn on a bank or account payee bank draft,
no deduction shall be allowed in respect of such expenditure.

9. Where the assessee incurs any expenditure in respect of which payment has
been or is to be made to any person is of opinion that such expenditure is
excessive or unreasonable having regard to the fair market value of the goods,
services or facilities for which the payment is made shall not be allowed as
a deduction.

10. No deduction shall be allowed in respect of any provision made by the

assessee for the payment of Gratuity to his employees on their Retirement or on
Termination of their employment for any reason.

DEEMED PROFITS AND HOW THEY ARE CHARGED TO TAX

The following receipts are chargeable to tax as business income :

1. Recovery against any deduction [ Sec. 41(1)]

In any of the earlier years a deduction was allowed to the taxpayer in respect
of loss, expenditure or trading liability incurred by the assessee and
subsequently during any previous year,—
(a) the Taxpayer has obtained, whether in cash or in any other manner
whatsoever, any amount in respect of such loss or expenditure or some benefit
in respect of such trading liability shall be deemed to be profits and gains of
business or profession and accordingly chargeable to income-tax as the income
of that previous year, whether the business or profession in respect of which the
allowance or deduction has been made is in existence in that year or not.

2. Sale of Assets used for Scientific Research [ Sec. 41(3)]

Where an asset representing expenditure of a capital nature on scientific
research is sold, without having been used for other purposes, and the proceeds
of the sale together with the total amount of the deductions made, the amount of
the deduction exceed the amount of the capital expenditure, the excess or the
amount of thedeductions so made, whichever is the less, shall be chargeable to
income-tax as income of the business orprofession of the previous year in which
the sale took place.

3. Recovery of Bad Debt . Sec.41(4) :

if the amount subsequently recovered on any such Bad Debt or part allowed
earlier is greater than the difference between the debt or part of debt and the
amount so allowed, the excess shall be deemed to be profits and gains of
business or profession, and accordingly chargeable to income-tax as the income
of the previous year in which it is recovered, whether the business
or profession in respect of which the deduction has been allowed is in existence
in that year or not.

4. Adjustment of Loss [ Sec. 41(5)] :

Generally, Loss of a business cannot be carried forward after 8 years. An
exception is, however, provided by Sec. 41(5). This exception is applicable if
the following conditions are satisfied :

1. Where the business or profession referred to in this section is no longer

in existenc.
2. any loss which arose in that business or profession during the previous
year in which it ceased to exist and which could not be set off against any
other income of that previous year.
3. Such Business is not a speculation business.
4. After discontinuation of such business or profession, there is a receipt
which is deemed as business income.
MEANING OF “ SET-OFF & CARRY FORWARD ” OF BUSINESS
LOSSES.

Set-Off means adjustment of certain losses against the income under other
sources in the same assessmentyear. Carrying Forward of unadjusted losses to
be set-off in subsequent years is called Carry Forward.

How Business Losses are adjusted.

If there is a loss in the business, the same can be adjusted against profits made
in any other business of the same tax payer. The Loss, if any, still remaining,
can be adjusted against Income from any Other Source.

From A/Y 2005-2006 loss from Business cannot be set off against Salary
Income.

However, Loss sustained in speculative business can be adjusted only against

profits earned in another speculative business.

Business Loss can be carried forward for a maximum period of next 8

(Eight) Assessment Years and adjusted against Business Profit of the
subsequent years.

Unabsorbed Depreciation can be Set-Off even if Business/Profession is

discontinued and can be carried forward for unlimited number of years.

However, for claiming the benefit of carry forward of losses, the tax payer has
to invariably file his returns withindue date.

While one endeavors to derive income, the possibility of incurring losses cannot
be ruled out. Based on the principles of natural justice, a set-off should be
available for loss incurred. The income tax laws in India recognise this and
provide for adjustment and utilisation of the losses. However, there are conditions
which have been introduced to prevent misuse of such provisions.

The relevant provisions have been summarised here:

A) Set off of loss under the same head of income.(section 70) (Intra-head set
off)
Income of a person is computed under five heads. ‘Sources’ of income derived
by an individual may be many but yet they could be classified under the same
head. For instance, an individual may have a dual employment, yet the income
would be classified under the head ‘Salaries’. However, given the mechanism of
computing taxable salary income, it would be safe to say that an individual cannot
incur losses under this head of income.
Consider a situation where assesse A has two properties – one, occupied by him
and the other, let out. A pays interest on loan of Rs 1.50 lakh on the property
occupied and derives net rental income of Rs 1.50 lakh from the let-out property.
In case of a self-occupied property, income is computed as nil and interest
expenditure results in loss. The loss of Rs 1.50 lakh can be set off against rent
income of Rs 1.50 lakh; the income chargeable under the head ‘House property’
will be ‘Nil’.
An exception to intra head set off is loss under the head ‘Capital gains’, which
may arise from transfer of any capital asset. Long-term capital loss (LTCL) arises
from transfer of shares or units where holding period is more than 12 months and
in respect of other assets holding period is more than 36 months prior to sale.
Transfer of assets held for less than prescribed period results in short-term capital
loss. Long-term capital loss cannot be set off against short term capital gains
(STCG).
Further, loss incurred from speculation loss (eg. from shares or commodities)
cannot be set off against any other income.
Also, it is unlikely that the benefit of set off of loss under an activity or source
will be available, where the income from an activity or source is exempt from
taxation.
Summary of exceptions to Intra-head set off:
1. Loss from speculation business cannot be set of against profit from a non
speculation business
2. LTCL can only be set off against LTCG and cannot be set off against STCG
3. No loss can be set-off against casual income i.e. Income from lotteries, cross
word puzzles, betting gambling and other similar games.
4. No expenses can be claimed against casual income
5. Loss from the activity of owning and maintaining race horses cannot be set
off against other incomes
6. Loss from an exempted source cannot be set off
(e.g. Share of loss of firm, agricultural losses, cultivation expenses)

B) Set off Loss from one head against Income from another Head .
(Inter head set off)

A person may have various sources of income computed under different heads of
income. Loss under one head of income is generally allowed to be set off against
income under another head.
For instance, X has only one property, which is occupied by him and the loss is
Rs 1.50 lakh. He derives salary of Rs 10 lakh during the year. Here, he can set off
the loss of Rs 1.50 lakh against his salary income by making appropriate
declarations to his employer, thereby making his net taxable income Rs 8.50 lakh.
Certain exceptions to the provisions are that the loss from business or profession
cannot be set off against salary income. Capital loss, whether long term or short
term, can be set off only against capital gains income.
Where during a given year, there is no sufficient income to absorb the loss,
unabsorbed loss can be carried forward and set off against income, in the future
years as explained here.
Summary of exceptions to Inter-head set off:
1. Loss from speculation cannot be set of against any other head.
(Interpretation: Loss from other heads can be set-off against business income.)
For Example: House property loss can be set-off against Speculative Incomes but
speculation loss cannot be set off against House property)
2. Business loss cannot be set-off against salary income. (It can be set-off
against other incomes)
3. Loss under the head Capital Gains (LTCL or STCL) cannot be set-off against
any other head.
(Interpretation: Loss from other heads can be set-off against Capital Gains)
4. No loss can be set-off against casual income
5. No expenses can be claimed against casual income
6. Loss from the activity of owning and maintaining race horses cannot be set
off
7. Loss from an exempted source cannot be set off (e.g. Share of loss of firm,
agricultural income, cultivation expenses)

Meaning of certain terms.

Amortization.
1. The paying off of debt with a fixed repayment schedule in regular instalments
over a period of time. Consumers are most likely to encounter amortization with
a mortgage or car loan.
2. The spreading out of capital expenses for intangible assets over a specific
period of time (usually over the asset's useful life) for accounting and tax
purposes. Amortization is similar to depreciation, which is used for tangible
assets, and to depletion, which is used with natural resources. Amortization
roughly matches an asset’s expense with the revenue it generates.

Written-Down Value.

The value of an asset after accounting for depreciation or amortization. Written-

down value is also called book value or net book value. It is calculated by
subtracting accumulated depreciation or amortization from the asset's original
value. Written-down value reflects the asset's present worth from an accounting
perspective. An asset's written-down value will appear on the company's
balance sheet.

Written-down value can be calculated by a method of depreciation that is

sometimes called the diminishing balance method. This accounting technique
reduces the value of an asset by a set percentage each year. Different
depreciation techniques are used to capitalize the expenses of different types of
assets. The taxable gain on a sale is often determined by comparing the sales
from the item to its written-down value. When an asset is intangible, such as a
patent, it is amortized rather than depreciated.

Under Section 43(6) in The Income- Tax Act, " written down value"
means-
(a) in the case of assets acquired in the previous year, the actual cost to the
assessee;
(b) in the case of assets acquired before the previous year, the actual cost to the
assessee less all depreciation actually allowed to him under this Act.
Block of assets. Section 2(11) of the Income Tax Act
2(11) "block of assets" means a group of assets falling within a class of assets
comprising—
(a) tangible assets, being buildings, machinery, plant or furniture;
(b) intangible assets, being know-how, patents, copyrights, trade-marks,
licences, franchises or any other business or commercial rights of similar nature,
in respect of which the same percentage of depreciation is prescribed .
Leading Cases.
(A) Section 32. Depreciation.

1. I.C.D.S. Ltd. Vs. CIT. (2013)3SCC541

Facts.
The Assessee is a public limited company, classified by the Reserve Bank of
India (RBI) as a non-banking finance company. It is engaged in the business of
hire purchase, leasing and real estate etc.
The vehicles, on which depreciation was claimed, are stated to have been
purchased by the Assessee against direct payment to the manufacturers. The
Assessee, as a part of its business, leased out these vehicles to its customers and
thereafter, had no physical affiliation with the vehicles.
In fact, lessees were registered as the owners of the vehicles.
In its return of income for the relevant assessment years, the Assessee claimed,
among other heads, depreciation in relation to certain assets i.e.vehicles ,
which, as explained above, had been financed by the Assessee but registered in
the name of third parties.
The Assessing Officer disallowed claims of depreciation on the ground that the
Assessee's use of these vehicles was only by way of leasing out to others and
not as actual user of the vehicles in the business of running them on hire.
It had merely financed the purchase of these assets and was neither the owner
nor user of these assets.
On appeal, the High Court held that in view of the fact that the vehicles were
not registered in the name of the Assessee, and that the Assessee had only
financed the transaction, it could not be held to be the owner of the vehicles,
and thus, was not entitled to claim depreciation in respect of these vehicles.
Hence, this appeal by the Assessee.
Relevant Statutory provisions.

Section 32 of the Income Tax Act on depreciation, reads as follows:

32. (1) In respect of depreciation of--
(i) buildings, machinery, plant or furniture, being tangible assets;
(ii) know-how, patents, copyrights, trade marks, licences, franchises or any
other business or commercial rights of similar nature, being intangible assets
acquired on or after the 1st day of April, 1998, owned, wholly or partly, by the
Assessee and used for the purposes of the business or profession, the following
deductions shall be allowed-
(i) in the case of assets of an undertaking engaged in generation or generation
and distribution of power, such percentage on the actual cost thereof to the
Assessee as may be prescribed;
(ii) in the case of any block of assets, such percentage on the written down value
thereof as may be prescribed
Provided that no deduction shall be allowed under this clause in respect of--
(a) any motor car manufactured outside India, unless it is used--
(i) in a business of running it on hire for tourists; or

(ii) outside India in his business or profession in another country; and

(b) any machinery or plant if the actual cost thereof is allowed as a deduction in
one or more years under an agreement entered into by the Central Government
under Section 42.
BLOCK OF ASSET [SECTION 2(11)]
Prior to the 1986, the Income-tax Act required the calculation of depreciation in
respect of each capital asset separately. Due to differences in depreciation rates
depending on the date of purchase, the type of asset, the intensity of use etc.,
computation of depreciation allowance involved a detailed exercise on the part
of the assessee and AO. Moreover, the system of granting the terminal
allowance or taxing the balancing charge at the time an asset was sold,
demolished, discarded, etc., necessitated the maintenance of records of
depreciation already allowed in respect of each asset.
The amendments sought to simplify the system to a great extent by introducing
the concept of "block of assets". Sec. 2(11) defines the term block of assets as
"a group of assets falling within a class of assets, being building, machinery,
plant & furniture, in respect of which the same percentage of depreciation is
prescribed."
CONDITIONS FOR CLAIMING DEPRECIATION [SECTION 32(1)]

The assets must be owned, wholly or partly, by the assessee.

Co-owners are entitled to claim depreciation to the extent of the value of the
asset owned by each co-owner.

The asset should be actually used for the purpose of business or profession of
the assessee.

Depreciation is not allowable on the cost of land.

Where the asset is not exclusively used for the purpose of business or
profession, the depreciation shall be allowed proportionately with regards to
such usage of assets (sec. 38).

Section 32(1) provides that depreciation is to be computed at the prescribed

percentage on the written down value of the asset which in turn is calculated
with reference to actual cost of the assets. In the context of computing
depreciation, it is important to understand the meaning of the term ‘WDV’ &
‘Actual Cost’

WRITTEN DOWN VALUE [SECTION 43(6)]

WDV under the Income-tax Act, means

where the asset is acquired in the previous year the actual cost of asset shall be
treated as WDV
where the asset is acquired in earlier year WDV shall be equal to the actual cost
incurred less depreciation allowed under The Income Tax Act.
Meaning of the term Depreciation.
Depreciation is the monetary equivalent of the wear and tear suffered by a
capital asset that is set aside to facilitate its replacement when the asset becomes
dysfunctional.
In P.K. Badiani v. Commissioner of Income Tax. 4 SCC 562, the Supreme
Court has observed that allowance for depreciation is to replace the value of an
asset to the extent it has depreciated during the period of accounting relevant to
the assessment year and as the value has, to that extent, been lost, the
corresponding allowance for depreciation takes place.
Black's Law Dictionary (5th Edition) defines 'depreciation' to mean, inter alia:
A fall in value; reduction of worth. The deterioration or the loss or lessening in
value, arising from age, use, and improvements, due to better methods. A
decline in value of property caused by wear or obsolescence and is usually
measured by a set formula which reflects these elements over a given period of
useful life of property.... Consistent gradual process of estimating and allocating
cost of capital investments over estimated useful life of asset in order to match
cost against earnings...
The 6th Edition defines it, inter alia, in the following ways:
In accounting, spreading out the cost of a capital asset over its estimated useful
life.
A decline in the value of property caused by wear or obsolescence and is
usually measured by a set formula which reflects these elements over a given
period of useful life of property.
Parks in Principles & Practice of Valuation states: As for building, depreciation
is the measurement of wearing out through consumption, or use, or effluxion of
time.
Paton has in his Account's Handbook observed that depreciation is an out-of-
pocket cost as any other costs. He has further observed the depreciation charge
is merely the periodic operating aspect of fixed asset costs.
The provision on depreciation in the Act reads that the asset must be "owned,
wholly or partly, by the Assessee and used for the purposes of the business".
Therefore, it imposes a twin requirement of 'ownership' and 'usage for business'
for a successful claim under Section 32 of the Act.
Contention of the Revenue.
The Revenue attacked both legs of this portion of the section by contending: (i)
that the Assessee did not use these trucks in the course of its business.
(ii) that the Assessee is not the owner of the vehicles in question and argued that
depreciation can be claimed by an Assessee only in a case where the Assessee is
both, the owner and user of the asset.

Reasoning of the Court.

(i) that the Assessee did not use these trucks in the course of its business.
Revenue argued that since the lessees were actually using the vehicles, they
were the ones entitled to claim depreciation, and not the Assessee.
However this argument is not acceptable.
Section 32 requires that the Assessee must use the asset for the "purposes of
business". It does not mandate usage of the asset by the Assessee itself. As long
as the asset is utilized for the purpose of business of the Assessee, the
requirement of Section 32 will stand satisfied, notwithstanding non-usage of the
asset itself by the Assessee.
In the present case , the Assessee is a leasing company which leases out trucks
that it purchases. Therefore, on a combined reading of Section 2(13) and
Section 2(24) of the Act, the income derived from leasing of the trucks would
be business income, or income derived in the course of business, and has been
so assessed. Hence, it fulfills the aforesaid second requirement of Section 32 of
the Act viz. that the asset must be used in the course of business.
In the case of CIT v. Shaan Finance (P) Ltd. 3 SCC 605; the Supreme Court
while interpreting the words "used for the purposes of business" in case of
analogous provisions of Section 32A(2) and Section 33 of the Act, dealing with
Investment Allowance and Development Rebate respectively, held thus:
Sub-section (2) covers all items in respect of which investment allowance can
be granted. These items are, ship, aircraft or machinery or plant of certain kinds
specified in that Sub-section.
In respect of a new ship or a new aircraft, Section 32-A(2)(a) expressly
prescribes that the new ship or the new aircraft should be acquired by an
Assessee which is itself engaged in the business of operation of ships or aircraft.
Under Sub-section (2)(b), however, any such express requirement that the
Assessee must himself use the plant or machinery is absent. Section 32-A(2)(b)
merely describes the new plant or machinery which is covered by Section 32-A.
The plant or machinery is described with reference to its purpose. For example,
Sub-section (2)(b)(i) prescribes "the purposes of business of generation or
distribution of electricity or any other form of power".
Sub-section (2)(b)(ii) refers to small-scale industrial undertakings which may
use the machinery for the business or manufacture or production of any article,
and
Sub-section (2)(b)(iii) refers to the business of construction, manufacture or
production of any article or thing . Sub-section 2(b), therefore, refers to the uses
to which the machinery can be put. It does not specify that the Assessee himself
should use the machinery for these purposes. In the present case, the person to
whom the machinery is hired does use the machinery for specified purposes
under Section 32-A(2)(b)(iii).
That person, however, is not the owner of the machinery. Looking to the
requirements specified in Section 32-A the Assessees, in the present case, fulfil
all the requirements of that section, namely, (1) the machinery is owned by the
Assessees; (2) the machinery is used for the purpose of the Assessees' business
and; (3) the machinery is as specified in Sub-section (2).
In CIT v. Castle Rock Fisheries.(1997) 10 SCC 77, it was held where the
business of the Assessee consists of hiring out machinery and/or where the
income derived by the Assessee from the hiring of such machinery is business
income, the Assessee must be considered as having used the machinery for the
purposes of its business.
In CIT v. Vinod Bhargava . (1988) 169 ITR 549 (AP) it was held that where
leasing of machinery is a mode of carrying on business by the Assessee the
Assessee would be entitled to development rebate. The Court observed that:
Once it is held that leasing out of the machinery is one mode of doing business
by the Assessee and the income derived from leasing out is treated as business
income it would be contradictory, in terms, to say that the machinery is not used
wholly for the purpose of the Assessee's business.
 Hence, the first contention of the Revenue that the Assessee did not use these
trucks in the course of its business is rejected. The Assessee did use the vehicles
in the course of its leasing business. The fact that the trucks themselves were
not used by the Assessee is irrelevant for the purpose of the section.

Second contention
(ii) that the Assessee is not the owner of the vehicles in question .
Reasoning of the Court.
No depreciation allowance is granted in respect of any capital expenditure
which the Assessee may be obliged to incur on the property of others.
Therefore, the entire case hinges on the question of ownership; if the Assessee
is the owner of the vehicles, then he will be entitled to the claim on
depreciation, otherwise, not.
In Mysore Minerals Ltd., M.G. Road, Bangalore v. CIT (1999) 7 SCC 106, it
was held that :
“authorities shows that the very concept the depreciation suggests that the tax
benefit on account of depreciation legitimately belongs to one who has invested
in the capital asset is utilizing the capital asset and thereby losing gradually
investment caused by wear and tear, and would need to replace the same by
having lost its value fully over a period of time.”
Black's Law Dictionary (6th Edn.) defines 'owner' as under:
Owner. The person in whom is vested the ownership, dominion, or title of
property; proprietor. He who has dominion of a thing, real or personal,
corporeal or incorporeal, which he has a right of enjoy and do with as he
pleases, even to spoil or destroy it, as far as the law permits, unless he be
prevented by some agreement or covenant which restrains his right.
The term is, however, a nomen generalissimum, ( i.e. a name which applies
generally to a number of things; as, land, which is a general name by which
everything attached to the freehold will pass.) and its meaning is to be gathered
from the connection in which it is used, and from the subject-matter to which it
is applied.
The primary meaning of the word as applied to land is one who owns the fee
and who has the right to dispose of the property, but the terms also included one
having a possessory right to land or the person occupying or cultivating it.
The term "owner" is used to indicate a person in whom one or more interests are
vested his own benefit. The person in whom the interests are vested has 'title' to
the interests whether he holds them for his own benefit or the benefit of another.
Thus the term "title" unlike "owner".
It defines the term 'ownership' as-
Collection of right to use and enjoy property, including right to transmit it to
others .... The right of one or more persons to possess or use a thing to the
exclusion of others. The right by which a thing belongs to some one in
particular, to the exclusion of all other persons. The exclusive right of
possession, enjoyment or disposal; involving as an essential attribute the right to
control, handle, and dispose.
The same dictionary defines the term "own" as 'To have a good legal title'.
These definitions essentially make ownership a function of legal right or title
against the rest of the world. However, as seen above, it is "nomen
generalissimum, and its meaning is to be gathered from the connection in which
it is used, and from the subject-matter to which it is applied."
A scrutiny of the material facts at hand raises a presumption of ownership in
favour of the Assessee. The vehicle, along with its keys, was delivered to the
Assessee upon which, the lease agreement was entered into by the Assessee
with the customer. Moreover, the relevant clauses of the agreement between the
Assessee and the customer specifically provided that:

(i) The Assessee was the exclusive owner of the vehicle at all points of time;
(ii) If the lessee committed a default, the Assessee was empowered to re-possess
the vehicle (and not merely recover money from the customer);
(iii) At the conclusion of the lease period, the lessee was obliged to return the
vehicle to the Assessee;
(iv) The Assessee had the right of inspection of the vehicle at all times.
The Revenue's objection to the claim of the Assessee is founded on the lease
agreement. It argued that at the end of the lease period, the ownership of the
vehicle is transferred to the lessee at a nominal value not exceeding 1% of the
original cost of the vehicle, making the Assessee in effect a financer.
However we are not persuaded to agree with the Revenue. As long as the
Assessee has a right to retain the legal title of the vehicle against the rest of the
world, it would be the owner of the vehicle in the eyes of law. A scrutiny of the
sale agreement cannot be the basis of raising question against the ownership of
the vehicle. The clues qua ownership lie in the lease agreement itself, which
clearly point in favour of the Assessee.
After the lessee takes possession of the vehicle under a lease deed from the
Appellant-company ,it shall be paying lease rent as prescribed . The ownership
of the vehicles would vest with the Appellant-company. In case of default of
lease rent, in addition to expenses, interest etc. the Appellant company is
entitled to take possession of the vehicle that was leased out. Finally on the
expiry of the lease tenure, the lessee should return the vehicle to the Appellant
company in working order.
It is true that a lease of goods or rental or hiring agreement is a contract under
which one party for reward allows another the use of goods. A lease may be for
a specified period or in perpetuity. A lease differs from a hire purchase
agreement in that lessee or hirer, is not given an option to purchase the goods. A
hiring agreement or lease unlike a hire purchase agreement is a contract of
bailment, plain and simple with no element of sale inherent.
A bailment has been defined in Section 148 of the Indian Contract Act, as "the
delivery of goods by one person to another for some purpose, upon a contract
that they shall, when the purpose is accomplished, be returned or otherwise
disposed of according to the directions of the person delivering them.
From the above discussion, it is clear that the transactions occurring in the
business of the Assessee-Appellant are leases under agreement, but not hire
purchase transactions. In fact, they are transactions of 'hire'.
As far as the factual portion is concerned ,leasing of vehicles is nothing but
hiring of vehicles. These two aspects are one and the same.
The only hindrance to the claim of the Assessee, , is Section 2(30) of the MV
Act, which defines ownership as follows:
"owner" means a person in whose name a motor vehicle stands registered, and
where such person is a minor, the guardian of such minor, and in relation to a
motor vehicle which is the subject of a hire-purchase agreement, or an
agreement of lease or an agreement of a hypothecation, the person in possession
of the vehicle under that agreement.
 The general opening words of the Section say that the owner of a motor vehicle
is the one in whose name it is registered, which, in the present case, is the
lessee.
The subsequent specific statement on leasing agreements states that in respect
of a vehicle given on lease, the lessee who is in possession shall be the owner.
The Revenue thus, argued that in case of ownership of vehicles, the test of
ownership is the registration and certification. Since the certificates were in the
name of the lessee, they would be the legal owners of the vehicles and the ones
entitled to claim depreciation.
Therefore, the general and specific statements on ownership construe ownership
in favour of the lessee, and hence, are in favour of the Revenue.
However there is no merit in the Revenue's argument.
Section 2(30) is a deeming provision that creates a legal fiction of ownership in
favour of lessee only for the purpose of the MV Act. It defines ownership for
the subsequent provisions of the MV Act, not for the purpose of law in general.
It serves more as a guide to what terms in the MV Act mean. Therefore, if the
MV Act at any point uses the term owner in any Section, it means the one in
whose name the vehicle is registered and in the case of a lease agreement, the
lessee. That is all. It is not a statement of law on ownership in general.
Perhaps, the repository of a general statement of law on ownership may be the
Sale of Goods Act.
Section 2(30) of the MV Act must be read in consonance with Sub-sections (4)
and (5) of Section 51 of the MV Act.
The MV Act mandates that during the period of lease, the vehicle be registered,
in the certificate of registration, in the name of the lessee and, on conclusion of
the lease period, the vehicle be registered in the name of lessor as owner. The
Section leaves no choice to the lessor but to allow the vehicle to be registered in
the name of the lessee Thus, no inference can be drawn from the registration
certificate as to ownership of the legal title of the vehicle; and
Moreover ,if the lessee was in fact the owner, he would have claimed
depreciation on the vehicles, which was not done. It would be a strange
situation to have no claim of depreciation in case of a particular depreciable
asset due to a vacuum of ownership. The entire lease rent received by the
Assessee is assessed as business income in its hands and the entire lease rent
paid by the lessee has been treated as deductible revenue expenditure in the
hands of the lessee. This reaffirms the position that the Assessee is in fact the
owner of the vehicle, in so far as Section 32 of the Act is concerned.
Therefore, in the facts of the present case, the lessor i.e. the Assessee is the
owner of the vehicles. As the owner, it used the assets in the course of its
business, satisfying both requirements of Section 32 of the Act and hence, is
entitled to claim depreciation in respect of additions made to the trucks, which
were leased out.
The gist of the decision of the Supreme Court in the case of Shaan Finance (P)
Ltd. is that where the business of the Assessee consists of hiring out machinery
and/or where the income derived by the Assessee from the hiring of such
machinery is business income, the Assessee must be considered as having used
the machinery for the purpose of business.
In the present case, the business of the Assessee consists of hiring out
machinery and trucks where the income derived by the Assessee from hiring of
such machinery is business income. Therefore, the Assessee-Appellant viz.
ICDS should be considered as having used the trucks for the purpose of
business.

Consequently, the appeal is allowed.

CAPITAL
GAINS
CAPITAL GAINS.

LEADING CASE.

1.N. BAGAVATHY AMMAL V. C.I.T. JT 2003(1) SC 363

Statutory Provisions.

Section. 2(14) “Capital Asset” means property of any kind held by an assessee,
whether or not connected with his business or profession, but does not include—
(i) any stock-in-trade, consumable stores or raw materials held for the purposes
of his business or profession ;
(ii) personal effects, that is to say, movable property (including wearing apparel
and furniture) held for personal use by the assessee or any member of his family
dependent on him, but excludes— (a) jewellery; (b) archaeological collections;
(c) drawings; (d) paintings; (e) sculptures; or (f) any work of art.
(iii) agricultural land in India.

45. Capital gains.-

(1) Any profits or gains arising from the transfer of a capital asset effected in the
previous year shall be chargeable to income-tax under the head “Capital gains”,
and shall be deemed to be the income of the previous year in which the transfer
took place.

Section 46. Capital gains on distribution of assets by companies in liquidation.

(1) Notwithsatnding anything contained in section 45, where the assets of the
company are distributed to its shareholders on its liquidation, such distribution
shall not be regarded as transfer by the company for the purposes of section 45.

(2) Where the shareholder on the liquidation of the company receives any money
or assets from the company, he shall be chargeable to income – tax under the head
“Capital Gains” in respect of the money so received or the market value of the
other assets on the date of distribution , as reduced by the amount assessed as
dividends , and the sum so arrived at shall be deemed to be the full value of the
consideration .

Section 47. Transactions not regarded as transfer.

(viii) Any transfer of agricultural land in India effected before the 1st day of
March , 1970.

Section 48. Mode of Computation.

The income chargeable under the head “Capital Gains” shall be computed by
deducting from the full value of the consideration received or accruing as a result
of the transfer of the capital asset namely ;
(i) expenditure incurred wholly and exclusively in connection with such transfer.
(ii) the cost of acquisition of an the asset and cost of improvement thereto.

Section 147. Income escaping assessment.-

If the Assessing Officer has reason to believe that any income chargeable to tax
has escaped assessment for any assessment year, he may, assess or reassess such
income and also any other income chargeable to tax which has escaped
assessment and which comes to his notice subsequently in the course of the
proceedings , or recompute the loss or the depreciation allowance or any other
allowance, as the case may be, for the relevant assessment year:

148. Issue of notice where income has escaped assessment.-

(1) Before making the assessment, reassessment or recomputation under section

147, the Assessing Officer shall serve on the assessee a notice requiring him to
furnish within such period, as may be specified in the notice, a return of his
income or the income of any other person in respect of which he is assessable
under this Act during the previous year corresponding to the relevant assessment
year, in the prescribed form and verified in the prescribed manner and setting
forth such other particulars as may be prescribed.
(2) The Assessing Officer shall, before issuing any notice under this section,
record his reasons for doing so.

Facts.
The assessee appellants are sisters. They were share holders in M/s. Palkulam
Estate (Private) Ltd., Nagercoil. The company went into liquidation in
1964.Pursuant to a compromise decree dated 22nd December 1969 in litigation
between the assessees and their brother (who was also a share holder in the
company), and the company represented by the liquidator, the assets of the
company which included agricultural lands were distributed to the appellants and
eight others. The appellants thereby received 479.89 acres of the agricultural
lands prior to the end of the relevant accounting year that was 31.3.70. The
assessment in respect of the year 1970- 71 had been completed on 27.2.71. The
Income Tax Officer reopened the assessments under the relevant provisions of
the Income Tax Act. The appellants filed their returns in respect of the two notices
under the relevant provisions for reassessment. The assessing officer did not
acccept the contention of the assessee appellants that in terms of the definition
of ‘assets’ in section 2(14), agricultural lands were entitled to be excluded while
computing capital gains on assets received by the shareholder from a company in
liquidation under section 46(2) .
According to the assessing officer, section 46(2) refers only to money received
on liquidation or the market value of the assets on the date of distribution and it
was immaterial whether the asset was agricultural lands or otherwise. The value
of the share of agricultural lands transferred to each appellant was, therefore,
included as income subject to capital gains and subjected to tax. The assessees’
appeals before the Commissioner of Income Tax (Appeals) were allowed by
holding that the scope of section 46(2) would have to be read in the light of the
definition of the word ‘capital asset’ in section 2(14) and that “having exempted
agricultural lands from capital gains under the general provision , it was difficult
to interpret section 46(2) as including agricultural land.” The action of the Income
Tax Officer in charging the income of the distribution of agricultural lands as
capital gains under section 46(2) of the Act was accordingly set aside. The
revenue appealed before the tribunal. The tribunal dismissing the revenue’s
appeal held that : On a combined reading of section 45, 46(2) and 48 it will be
clear, according to our opinion, that assets mentioned in section 46(2) would
mean capital assets. In as much as section 47(viii) exempts transfer of agricultural
land from capital gain tax under section 45, we agree with the Commissioner of
Income Tax (Appeals) in coming to the conclusion that it is difficult to interpret
section 46(2) as including agricultural lands which is outside the scope of the
Income Tax. At the instance of the CIT , the Tribunal referred the following
question for the consideration of the High Court.
“Whether on the facts and in the circumstances of the case, the appellate tribunal
is right in law in holding that the assets mentioned in section 46(2) would mean
‘capital asset’ as defined in section 2(14) and that consequently, the value of
agricultural lands received by the assessee on the liquidation of Palkulam Estate
(P) Ltd. cannot be charged to be tax under section 46(2) of the Income Tax Act,
1961?”
The High Court answered the question against the assessees and in favour of the
revenue. The High Court construed the provisions of section 46(2) and held,
reversing the decision of the CIT(A) and the tribunal, that the definition of ‘capital
assets’ under section 2(14) of the Act is not of any relevance for the purpose of
construing section 46(2) of the Act, and the fact that agricultural lands to the
extent provided in section 2(14)(iii) of the Act are excluded from the definition
did not have any impact on the taxability of the market value of the agricultural
land received by the assessee on the distribution of the assets of a company in
liquidation. Against this the assessees have come in appeal to the Supreme Court
. “Whether the word ‘assets’ in section 46(2) of the Income Tax Act, 1961 must
be understood and construed according to the definition of the word ‘capital
assets’ in section 2(14) of the Act.”
Reasoning of the Court
Before considering the correctness of the decision of the High Court the context
in which section 46(2) came to be part of the Income Tax Act needs to be
considered. Section 12-B of the Income Tax Act, 1922 provided for payment of
tax under capital gains “in respect of any profits or gains whatsoever from the
sale, exchange, relinquishment or transfer of a capital asset effected after 31st day
of March 1956, and such profits and gains shall be deemed to be income of the
previous year in which the sale, exchange, relinquishment or transfer took place.”
In Commissioner of Income Tax, Madras v. Madurai Mills Co. Ltd. [1973 (89)
ITR 45] Construing section 12-B of the Income Tax Act, 1922, the Supreme Court
in had held that: When a shareholder receives money representing his share on
distribution of the net assets of the company in liquidation, he receives that money
in satisfaction of the right which belonged to him by virtue of his holding the
shares and not by operation of any transaction which amounts to sale, exchange,
relinquishment or transfer within the meaning of section 12-B of the Act. Section
45(1) of the 1961 Act which substantially corresponds with section 12-B of the
1922 Act provides that: “Any profits or gains arising from the transfer of a capital
asset effected in the previous year shall be chargeable to income tax under the
head ‘capital gains,’ and shall be deemed to be the income of the previous year in
which the transfer took place.”
The words ‘capital assets’ has been defined in section 2(14) of the Act which
provides that:
(14) ‘Capital assets’ means property of any kind held by an assessee, whether or
not connected with his business or profession, but does not include
(iii) agricultural land in India.
It has been held by the Supreme Court that the principle of Madurai Mills that a
distribution of assets of a company in liquidation does not amount to a transfer
continues to apply to the 1961 Act. The view in Madurai Mills Co. Ltd. has also
been statutorily affirmed in Section 46(1) which provides: “46.(1)
Notwithstanding anything contained in section 45, where the assets of a company
are distributed to its shareholders on its liquidation, such distribution shall not be
regarded as a transfer by the company for the purposes of section 45.” In other
words, a distinction is drawn between a “transfer” of assets and a distribution of
assets of the company on liquidation. Where there is “transfer” of assets and not
a “distribution” on liquidation then having regard to section 47(viii) which
provides that:
“Nothing contained in section 45 shall apply to the following transfers:
(viii) any transfer of agricultural land in India effected before the 1st day of March
1970”
it may have been argued at least on behalf of the company that the ‘transfer’
having been concluded in 1969 was exempt from capital gains.
This argument, however, is not available to the shareholders who receive assets
from the company on distribution consequent upon liquidation because of section
46(2) which was introduced to make the receipts of assets from a company
liquidation by its share holders a taxable event for the first time.
Section 46(2) provides:
“46(2). Where a shareholder on the liquidation of a company receives any money
or other assets from the company, he shall be chargeable to income tax under the
head ‘capital gains’ in respect of the money so received or the market value of
the other assets on the date of distribution, as reduced by the amount assessed as
dividend and the sum so arrived at shall be deemed to be the full value of the
consideration.
The question is “does the words ‘assets’ in section 46(2) mean ‘capital assets’ as
defined in section 2(14) of the Act?”
If it does then, it is conceded by the revenue, there is no question of subjecting
the agricultural lands received by the assessees from the company in liquidation
to capital gains. Indisputably, the object in introducing section 46(2) was to
overcome the reasoning in Madurai Mills by broadening the base of the incidence
of capital gains and expressly providing for receipt of assets of a company in
liquidation by a shareholder as a taxable event. Section 46(2) is in terms of an
independent charging section.
It also provides for a distinct method of calculation of capital gains. It was
mentioned in C.I.T. v. R.M. Amin that:
Section 46 (2) , was enacted both with a view to make shareholders liable for
payment of tax on capital gains as well as to prescribe the mode of calculating the
capital gains to the shareholders on the distribution of assets by a company in
liquidation. But for that sub-section , it would have been difficult to levy tax on
capital gains to the shareholders on distribution of assets by a company in
liquidation. However Section 46 (2) does not make any reference to capital assets
either in connection with the imposition of capital gains tax nor its computation.
Having referred to ‘capital asset’ in section 45(1), 47 and 48, the Parliament
appears to have deliberately chosen to use the word ‘asset’ in section 46(1) and
(2), the ostensible intention being to bring assets of all kinds within the scope of
the charge. It is not necessary to refer to a dictionary to hold that capital
assets are a species of the genus ‘assets.’ If the words ‘capital assets’ and ‘assets’
as used in sections 45(1) and 46 respectively did not overlap then there was no
need to provide for a non obstante clause in section 46(1) with reference to section
45.
Therefore the High Court correctly held that , agricultural land would have been
a ‘capital asset’ but for the exclusion from the definition of ‘capital asset’ and
what is not a capital asset may yet be an asset for the purposes of section 46(2).
Therefore, to the extent that a shareholder assessee receives assets whether capital
or any other from the company in liquidation, the assessee is liable to pay tax on
the market value of the assets as on the date of the distribution as provided under
section 46(2). That appears to be the plain meaning of the section and there is no
reason to construe it in any other fashion. The invocation of section 2(14) of the
Act which defines “capital asset” is as such unnecessary for the purpose of
construing section 46(2).

The appeals are accordingly dismissed.

 INCOME
FROM
OTHER
SOURCES
INCOME FROM OTHER SOURCES.

LEADING CASE.

1.C.I.T. V. RAJENDRA PRASAD MODY(1978) 115 I.T.R. 519 (SC)

Facts:

The assessee had borrowed monies for the purpose of making investment in
shares of certain companies and during the assessment year 1965-66 for which
the relevant accounting year ended on 10th April 1965, the assessee paid interest
on the monies borrowed but did not receive any dividend on the shares purchased
with those monies. The two assessee made a claim for deduction of the amount
of interest paid on the borrowed monies but this claim was negatived by the ITO
and Appelate Assistant Commissioner . The ground for rejection of assessee’s
claim was that during the relevant assessment year the shares did not yield any
dividend and, therefore, interest paid on the borrowed monies could not be
regarded as expenditure laid out or expended wholly and exclusively for the
purpose of making or earning income chargeable under the head “Income from
other sources” so as to be allowable as a permissible deduction under s. 57(iii).
The Tribunal, however, on further appeal, disagreed with the view taken by the
taxing authorities and upheld the claim of the assessee for deduction under s.
57(iii).
On an application by the Revenue , the Tribunal referred the following question
of law, to the Supreme Court namely:
“Whether interest on moneys borrowed for investment in shares is allowable
expenditure under s. 57(iii) when the shares have not yielded any return in the
shape of dividend during the relevant assessment year.”
Statutory Provision: Section : 57. Deductions.-
The income chargeable under the head “Income from other sources” shall be
computed after making the following deductions, namely :—
(iii) Any other expenditure (not being in the nature of capital expenditure) laid
out or expended wholly and exclusively for the purpose of making or earning
such income;
Question For Consideration:
What is the true interpretation of section 57 of the Income Tax Act.
S. 57(iii) occurs in a bunch of sections under the heading, “Income from other
sources.”
S. 56, which is the first in this group of sections, enacts in sub-s. (1) that income
of every kind which is not chargeable to tax under any of the heads specified in
Section . 14, shall be chargeable to tax under the head “Income from other
sources”. Section 56 (2) includes in such income various items, one of which is
“dividends.” Dividend on shares is thus income chargeable under the head
“Income from other sources.”
S. 57 provides for certain deductions to be made in computing the income
chargeable under the head “Income from other sources” and one of such
deductions is that set out in cl. (iii), which reads as follows:
Any other expenditure (not being in the nature of capital expenditure) laid out or
expended, wholly and exclusively for the purpose of making or earning such
income.
The expenditure to be deductible under s. 57(iii) must be laid out or expended
wholly and exclusively for the purpose of making or earning such income. The
Revenue contends that unless the expenditure sought to be deducted resulted in
the making or earning of income, it could not be said to be laid out or expended
for the purpose of making or earning such income. The making or earning of
income, is essential for the admissibility of the expenditure under Section . 57(iii)
and, therefore, if in a particular assessment year there was no income, the
expenditure would not be deductible under that section. The Revenue stated that
the legislature had deliberately used words of narrower import in granting the
deduction under Section . 57(iii). Deductions under Section 37 and Section 57 are
different. The Revenue pointed out that S. 37(1) provided for deduction of
expenditure laid out or expended wholly and exclusively for the purpose of the
business or profession in computing the income chargeable under the head
“Profits or gains of business or profession.”
The language used in s. 37(1) was “laid out or expended – for purpose of the
business or profession” and not “laid out or expended – for the purpose of making
or earning such income” as set out in s. 57(iii).
The revenue contended the words in s. 57(iii) being narrower,, they cannot be
given the same wide meaning as the words in s. 37(1) and hence no deduction of
expenditure could be claimed under s. 57(iii) unless it was productive of income
in the assessment year in question.
Reasoning of the Court:
What s. 57(iii) requires is that the expenditure must be laid out or expended
wholly and exclusively for the purpose of making or earning income. It is the
purpose of the expenditure that is relevant in determining the applicability of s.
57(iii) and that purpose must be making or earning of income. S. 57(iii) does not
require that this purpose must be fulfilled in order to qualify the expenditure for
deduction. It does not say that the expenditure shall be deductible only if any
income is made or earned. There is in fact nothing in the language of s. 57(iii) to
suggest that the purpose for which the expenditure is made should fructify into
any benefit by way of return in the shape of income. The plain natural
construction of the language of Section 57(iii) irresistibly leads to the conclusion
that to bring a case within the section, it is not necessary that any income should
in fact have been earned as a result of expenditure.
An identical view was taken by the Supreme Court in Eastern Investments Ltd.
v. CIT [(1951) 20 ITR 1, 4 (SC)]. In Eastern Investment case , interpreting the
corresponding provision in Section 12(2) of the Indian I.T. Act, 1922, which is
in the same terms as Section 57(iii), It was observed that:“It is not necessary to
show that the expenditure was a profitable one or that in fact any profit was
earned.”
Therefore there is no scope for any controversy as regards interpretation of
Section 57 (iii) i.e. to bring a case under this section it is not necessary that any
income should in fact have been earned as a result of expenditure.
According to the revenue, the expenditure would disqualify for deduction only if
no income results from such expenditure in a particular assessment year. However
if there is some income, howsoever small or meagre, the expenditure would be
eligible for deduction. This means that in a case where the expenditure is Rs. 1000,
if there is income of even Re. 1, the expenditure would be deductible and there
would be resulting loss of Rs. 999 under the head “Income from other sources.”
But if there is no income, then, on the argument of the revenue, the expenditure
would have to be ignored as it would not be liable to be deducted. This would
indeed be a strange and highly anomalous result and it is difficult to believe that
the legislature could have ever intended to produce such illogical situation.
Moreover when a profit and loss account is cast in respect of any source of
income, what is allowed by the statute as proper expenditure would be debited as
an outgoing and income would be credited as a receipt and the resulting income
or loss would be determined. It would make no difference to this process whether
the expenditure is X or Y or nil; whatever is the proper expenditure allowed by
the statute would be debited.
Equally, it would make no difference whether there is any income. Since
whatever is the income be it , X or Y or nil, it would be credited. And the ultimate
income or loss would be found.
It is very difficult to accept the contention that expenditure which is otherwise a
proper expenditure can cease to be such merely because there is no receipt of
income. Whatever is a proper outgoing by way of expenditure must be debited
irrespective of whether there is receipt of income or not.
That is the plain requirement of proper accounting and the interpretation of s.
57(iii) cannot be different. The deduction of the expenditure cannot, in the
circumstances, be held to be conditional upon the making or earning of the
income. It is true that the language of s. 37(1) is a little wider than that of s. 57(iii),
but that cannot make any difference to the true interpretation of s. 57(iii).
The language of s. 57(iii) is clear and unambiguous and it has to be construed
according to its plain natural meaning and merely because a slightly wider
phraseology is employed in another section which may take in something more,
it does not mean that s. 57(iii) should be given a narrow and constricted meaning
nor warranted by the language of the section and, in fact, contrary to such
language.
This view is clearly supported by the observations in Hughes v. Bank of New
Zealand [(1938) 6 ITR 636, 644 (HL)], where it was stated that : “Expenditure in
course of the trade which is unremunerative is none the less a proper deduction,
if wholly and exclusively made for the purposes of the trade. It does not require
the presence of a receipt on the credit side to justify the deduction of an expense.”
This view is eminently correct as it is not only justified by the language of s.
57(iii) but it also accords with the principles of commercial accounting. Therefore
the question referred is decided in favour of the assessee and against the revenue.
CLUBBING
OF
INCOME
Clubbing of Income.

Leading Cases.

1.J.M. Mokashi v. Commissioner of Income-Tax (1994) 207 ITR

252 (Bom)

Facts.

The assessee is a practising physician and cardiologist. His wife had passed first
year Arts of the Bombay University and was employed by him as a receptionist-
cum-accountant.
During the relevant to the assessment year , the assessee paid a sum of Rs.
8,100 to her by way of salary. This amount was included by the Income-tax
Officer in the income of the assessee by applying the provisions of section
64(1)(ii) of the Act.
Before the Income-tax Appellate Tribunal, the orders of the Income-tax Officer
were challenged on various grounds.
Contentions of the Assessee.
The first contention of the assessee was that the word "concern" appearing in
section 64(1)(ii) did not include "profession", as distinguished from "business"
and, as such, the provisions of the above section were not applicable.
The second contention was that the expression "substantial interest" appearing
in section 64(1)(ii) read with Explanation 2(ii) referred only to a proportion of
the whole interest and not the "whole interest", and as such, section 64(1)(ii)
had no application to a proprietary concern in which the assessee has 100 per
cent interest.
The third contention of the assessee was that possession of "technical or
professional qualifications" by the spouse of the assessee does not mean that she
must hold a degree of a competent authority or university in a particular
technical or professional subject. It is sufficient if the spouse concerned
possesses necessary technical or professional knowledge and experience which
might enable her to perform her duties.
Another argument of the assessee was that the word "and" appearing twice in
the proviso to section 64(1)(ii) should be interpreted as "or" and, consequently,
the proviso should be held applicable if any of the two requirements, viz., the
spouse possesses technical or professional qualifications or the income as
attributable to her technical or professional knowledge exists.

The Tribunal rejected all the above contentions of the assessee and held as
follows:
"(i) Section 64(1)(ii) applies, inter alia, to individual assessees, who are
proprietors;
(ii) "concern" means business as well as a professional concern;
(iii) a concern in which the individual has a substantial interest would include a
concern in which the individual has a cent per cent interest;
(iv) "professional qualifications" means fitness to do a job or undertake an
occupation or vocation requiring intellectual skill or requiring manual skill as
controlled by intellectual skill and which is such that a person should be able to
eke out a living therefrom independently though the salary does not cease to be
the product of professional skill merely because a particular employment is
accepted;
(v) the term "technical" implies specialised knowledge generally of a
mechanical or scientific subject or any particular subject;
(vi) the word "and" appearing twice in the proviso to section 64(1)(ii) means
"and" and not "or"; and
(vii) "experience" as appearing in the proviso to section 64(1)(ii) includes
experience acquired in the course of acquiring technical or professional
qualifications."

Since the spouse in this case did not possess any technical or professional
qualification or that the salary paid to her was attributable to any technical or
professional knowledge and experience of hers, her income is liable to be
clubbed with the income of the assesse.
However the Tribunal referred the following question of law to the High
Court for opinion: "Whether, on facts and in the circumstances of the case, the
Income-tax Appellate Tribunal has rightly held that the income of the assessee's
wife is includible in the income of the assessee under section 64(1)(ii) of the
Income-tax Act, 1961 ?"

Contentions of the Revenue.

Neither the expression "concern" can be equated to "business establishment" nor
the words "technical or professional qualifications" be equated to educational
qualifications. These words have their special meaning and they have to be
interpreted accordingly.
The use of the word "experience" with technical and professional qualification
in the latter part of the proviso is intended to restrict the scope and ambit thereof
and not to enlarge it.
The definition of "substantial interest" is intended to specify the lowest limit of
the interest of the assessee in the concern which will attract the provisions of
section 64(1)(ii). It cannot be interpreted to mean that interest higher than the
lowest limit specified in the definition will not amount to "substantial interest".
Such an interpretation will be most unnatural and will go counter to the very
object and scheme of section 64(1)(ii).

From a plain reading of section 64(1)(ii) of the Act, it is clear that this section
lays down various circumstances under which income of certain family
members specified therein, namely, spouse, minor child, son's wife and son's
minor child is clubbed with the income of the assessee.

Reasoning of the Court.

Section 64 (1) (ii) provides that the income derived by the spouse of an
individual by way of remuneration, etc., from a concern in which the individual
has substantial interest shall be included in the income of the said individual.
The only exception is contained in the proviso to clause (ii) which provides that
the said clause shall not apply where the spouse possesses technical or
professional qualifications and the remuneration can be solely attributed to the
application of such technical or professional knowledge and experience of the
spouse.

The scope and ambit of the expression "concern".

According to the assessee, the expression "concern" refers only to business
establishments as contrasted with professional organisations which depend on
the personal skill and knowledge of the person concerned. Establishments of
professionals like doctors, according to the assessee, do not fall within the
ambit of the expression "concern", and as such, section 64(1)(ii) has no
application to payments made by an individual, who is a professional, to the
spouse of such individual.
The word "concern" is a word of wide import. It has various shades of
meanings. According to the dictionaries, it means "something which pertains to
a person; business affairs;". It also means "a matter that engages a person's
attention, interest or care or that affects his welfare or happiness".
In Black's Law Dictionary , it has been defined as: "Concern. To pertain, relate
or belong to; be of interest or importance to; have connection with; to have
reference to; to involve; to affect the interest of."
From the above definitions, it is evident that the word "concern" is a word of
wide import and it conveys different ideas and meanings depending upon the
context and setting in which it appears. In the context of section 64(1)(ii) of the
Act read with Explanation 2 thereto, it is clear that "concern" includes any
company, firm, individual or any other entity carrying on business or
professional activity. It cannot be given any restricted meaning to take out of its
ambit professional organisations or organisations run as proprietary
establishments. It covers all establishments or organisations - whether engaged
in business activities or professional activities. This is so also because the word
"business" itself is a word of wide import and has been broadly interpreted to
include "professions, vocations and callings".
It is in this context that in Barendra Prasad Ray v. ITO [(1981) 129 ITR 295],
the Supreme Court, while interpreting the expression "business connection"
appearing in section 9(1) of the Act, held as follows
"The word 'business' is one of wide import and it means an activity carried on
continuously and systematically by a person by the application of his labour or
skill with a view to earning an income. We are of the view that in the context in
which the expression 'business connection' is used in section 9(1) of the Act,
there is no warrant for giving a restricted meaning to it excluding 'professional
connections' from its scope."
Therefore the expression "concern" appearing in section 64(1)(ii) of the Act is a
word of wide import and takes within its sweep and ambit all organisations or
establishments engaged in business or profession, whether owned by a
company, partnership or individual or any other entity.

Substantial Interest

Assessee contends that section 64(1)(ii) only applies to concerns in which the
assessee has a substantial interest within the meaning of Explanation 2 thereto, a
proprietary concern in which the individual has cent per cent interest does not
fall within the purview thereof.
There is no force in this contention. Explanation 2 is a deeming provision which
provides that in a case where the concern is a company, the assessee shall be
deemed to have substantial interest therein if he holds not less than twenty per
cent of its shares and in other cases, if he is entitled to not less than twenty per
cent of the profits of such concern.
The object of this Explanation is to create a legal fiction to extend the
application of section 64(1)(ii) to concerns in which the interest of individual
concerned exceeds the limits specified therein. It sets out the lowest limit of
interest of the individual in the concern for the purpose of applicability of
section 64(1)(ii). Its object is to widen the net of the section - not to restrict it.
No outer limit of interest of the individual has, therefore, been specified. It will
be a most unreasonable and unnatural interpretation of Explanation 2 to hold
that though persons having "not less than twenty per cent of the profits of the
concern" shall be deemed to have substantial interest in the concern, persons
having cent per cent interest will not be deemed so.
Therefore an individual entitled to cent per cent of the profits of a concern is a
person having substantial interest within the ordinary meaning of the expression
itself.
Interpretaion of provisio to section 64(1)(ii).
Section 64(1)(ii) provides for clubbing with the income of an individual, the
income of the spouse of such individual by way of salary, commission,
remuneration, etc., derived from a concern in which the individual has
substantial interest. The only exception is contained in the proviso thereto.
If the spouse possesses technical or professional qualification, any income
derived by such spouse even from a concern falling in section 64(1)(ii) read
with Explanation 2 thereto will not be liable to be clubbed with the income of
the spouse provided the "income" too fulfils the requirement of the second part
of the proviso.
The requirements of the proviso to section 64(1)(ii) are as follows :
"(i) The spouse possesses 'technical or professional qualifications'; and
(ii) the income is solely attributable to the application of his or her technical or
professional knowledge and experience."
In order to claim the benefit of the proviso to avoid clubbing of income under
section 64(1)(ii) of the Act, both the conditions specified in the proviso must be
satisfied. The first condition relates to the spouse of the individual who must
possess "technical or professional qualifications". If this condition is not
satisfied, the proviso will not apply and reference to the second requirement will
be unnecessary.
If the first condition in regard to the qualification of the spouse is satisfied, it
will be necessary to refer to the second condition which pertains to the income
that will not be clubbed.
It may be pertinent to mention that even in the case of a spouse possessing
technical or professional qualification, only the income arising to such spouse
which is solely attributable to the application of his or her technical or
professional knowledge and experience will be out of the purview of section
64(1)(ii) and not the whole of the income of such spouse.
It is in this context that the words "technical or professional knowledge and
experience" have been used in the latter part of the proviso in contradistinction
to "technical or professional qualifications" used in the earlier part. Thus, two
different expressions have been used by Parliament in the very same proviso,
not inadvertently, but with a deliberate purpose.
The word "qualification" simpliciter is a word of very wide import and, in the
absence of any qualifying words or expression, conveys the idea of any quality
which makes a man fit for any job or any activity in life.
The word "qualification" has been defined in " Black's Law Dictionary as:
"Qualification. - The possession by an individual of the qualities, properties, or
circumstances, natural or adventitious, which are inherently or legally necessary
to render him eligible to fill an office or to perform public duty or office. ..... "
However the word "qualification" in the proviso to section 64(1)(ii) is qualified
by the words "technical or professional".

Therefore true meaning of "technical qualifications" or "professional

qualifications" needs to be ascertained.
“Technical” according to Black's Law Dictionary, means “belonging or
peculiar to an art or profession”. Similarly, “profession” means a vocation or
occupation requiring special, usually advanced education, knowledge, and skill,
e.g., law or medical profession.
Halsbury's Laws of England describes “profession” as follows: “. ... A
profession involves an idea of an occupation requiring either purely intellectual
skill, or if any manual skill is involved, as in painting, sculpture, or surgery,
skill controlled by the operator's intellectual skill, as distinguished from an
occupation which is substantially a production or sale or arrangement for the
production or sale of commodities. The word 'profession' is certainly wider than
the old definition of the learned professions - the church, medicine and law. A
company cannot carry on a profession.”
Though the word profession now has a broader and more comprehensive
meaning than formerly was accorded to it and its signification now extends far
beyond the well-known classical professions of earlier days and as the
applications of science and learning are extended to other departments or affairs
other vocations also receive the same treatment, persons engaged in executive
and clerical aspects of business organisations, brokers, insurance agents, etc.,
are not held to be engaged in the practice of a profession. ( Corpus Juris
Secundum, ).
The word "profession" still retains its distinct character and does not take within
its ambit any and every activity or employment undertaken by a person for his
livelihood. If we read the expression "technical or professional qualification"
used in the proviso to section 64(1)(ii) in the light of the above definitions of
"technical" and "professional", it becomes clear that the "qualification"
mentioned therein must be such which makes a person eligible for technical or
professional work.
 A person can, therefore, be said to be in possession of requisite technical
qualification when by virtue thereof, he is eligible to perform that function.
Similarly, professional qualification must mean qualification which is necessary
for carrying on the particular profession.
Take, for example, the legal profession. The requisite qualifications for
carrying on the legal profession have been laid down by the statute. In such a
case, a person possessing such qualification alone can be said to be in
possession of professional qualification, because such qualification is a must for
carrying on the profession. Knowledge of law or experience is not relevant for
that purpose. Similarly, a person cannot carry on medical profession unless he
possesses the requisite degree. Similarly, there are technical jobs which require
degrees and diplomas - whereas, there are a few others where university degree
or diploma is not necessary. Adequate training and evidence thereof might be
sufficient. Thus, the nature of professional qualification will vary from
profession to profession.
Similarly, the nature of technical qualification will also vary depending on the
nature of the technical job. What is technical or professional qualification,
therefore, will have to be decided in each case depending upon the nature of the
profession or the technical work.
But one thing is certain that it is not any and every qualification, academic or
otherwise, which can bring a spouse within the scope and ambit of the proviso
to take the income out of the clubbing provision. It is the possession of only
technical or professional qualification necessary for undertaking the particular
technical job or carrying on the profession to which the income is attributed that
will meet the requirement of the first part of the proviso "knowledge and
experience" will not be relevant for that purpose.
A spouse, well-versed in law and experienced in the working of the legal
profession, cannot be said to be in possession of professional qualification for
carrying on the legal profession if he or she does not possess the requisite
degree or diploma. Payments made to the spouse in such a case for any legal
services cannot be brought within the purview of the proviso by reference to the
words "knowledge and experience" occurring in the latter part thereof.
The second requirement of the proviso, in fact, refers to the income of the
spouse from a concern falling under section 64(1)(ii) and restricts the benefit of
the proviso even in the case of an eligible spouse only to that part of the income
which can be "solely attributed to the application of his or her technical or
professional knowledge and experience". This provision makes it clear that the
possession of technical or professional qualification is a condition precedent on
fulfillment of which that part of the income which falls in the second part of the
proviso is excluded from the operation of the clubbing provision.
Take, for example, the case of the wife of an individual who is a qualified legal
practitioner. Her professional services are utilized by the assessee and
remuneration paid to her by way of salary, fees, etc. In such a case, she fulfils
the first requirement of the proviso and she is, therefore, entitled to the benefit
of the proviso. But, the benefit is again hedged in with certain conditions and is
limited to the extent indicated in the proviso. In that context, her "knowledge
and experience" will assume significance.
Take for example, the case of the wife of the individual who has just passed the
LL. B. examination and enrolled herself as an advocate or having passed the
LL.B. examination, did not practice law for long but has started doing so just a
year or two back. Her professional services as a lawyer are utilized in the
concern of her husband and she is paid remuneration therefor. In such a case,
when the assessee claims the benefit of the proviso to avoid clubbing of such
income of his wife with his own income, he will be required to satisfy that the
remuneration so paid to her for her legal services was "solely attributable to the
application of her professional knowledge and experience" as a lawyer.
If the taxing authorities find that the remuneration paid for the legal services
was excessive or high having regard to her limited professional knowledge and
experience, he may determine the amount of remuneration which can be solely
attributed to the application of her professional knowledge and experience and
exclude only that part of her income from the clubbing provision contained in
section 64(1)(ii).
Thus, the object of the second part of the proviso is to restrict the benefit of the
proviso only to reasonable payments for professional services and to put a check
on diversion of income to the spouses possessing technical or professional
qualifications in the guise of salary, fees, etc., for professional or technical
services with a view to reduce the incidence of tax.

Therefore the two conditions mentioned in the proviso are cumulative and not
alternative. They deal with two different aspects - one pertains to the eligibility
of the spouse to claim benefit of the proviso, the other to the income which
would qualify for exclusion from clubbing. Both are relevant and equally
important. There is no scope for mixing up the two and diluting the first
condition relating to qualification of the spouse by reference to the expression
"knowledge and experience" in the second condition.
Any attempt to do so will go counter to the clear language, scheme and object
of the proviso and the well-accepted rule of interpretation that one part of a
section or clause should not be construed in such a manner as to render the other
part redundant. It is a cardinal rule of interpretation of statutes that a
construction which would leave without effect any part of the statute should
normally be rejected.
Therefore there is no conflict between the two requirements of the proviso, each
deals with a different aspect and both of them must be satisfied, though the
second comes into operation only on fulfillment of the first condition, not
otherwise.
In the present case, the spouse of the assessee neither possessed any technical
or professional qualification nor was she paid for any technical or professional
services rendered by her. Admittedly, she had passed first year Arts of the
Bombay University and that was her only qualification. She was employed by
her husband, the assessee in this case, as receptionist-cum-accountant and paid a
salary for that employment.
In such a case, it is not only difficult but impossible to hold that she possessed
any “technical or professional qualification” which is necessary to bring her
within the proviso. That being so, the proviso to section 64(1)(ii) is not
applicable to her and, as such, the assessee is not entitled to get the benefit
thereof to bring her income out of the purview of the clubbing provision
contained in section 64(1)(ii).
Therefore the question referred is decided in favour of the Revenue and against
the assessee.
2. MOHINI THAPAR V. C.I.T. (1972) 4 SCC 493

Facts:
Late Karam Chand Thapar made certain cash gifts to his wife Mohini Thapar.
From out of those gifts, she purchased certain shares and the balance amount she
invested. The shares earned dividends and the investments yielded interest. The
interest realised and the dividends earned were included in the income of Karam
Chand Thapar for the purpose of assessment . The assessee objected to the
inclusion of that amount in his income. The question is whether the department
was entitled to include the dividends and interest in question in computing the
taxable income of the assessee. The Income-tax Officer held that they were liable
to be included in the income of the assessee. That decision was upheld by the
Appellate Assistant Commissioner. On a further appeal, taken by the assessee to
the Tribunal, the Tribunal upheld the order of the Assistant Commissioner. The
High Court on further appeal decided in favour of the revenue. Against this the
assessee has come in appeal to the Supreme court with the following question for
cosidearation.
“Whether on the facts and in the circumstances of the case, the income derived
from deposits and shares held by the assessee’s wife, Smt Mohini Devi Thapar,
was income from assets directly or indirectly transferred by the assessee to his
wife within the meaning of Section 16(3) of the Income-tax Act.”
Section 16(3)(a)(iii) of the Income Tax Act, 1922( the corresponding provision
is Section 64 of the Income Tax Act, 1961.)
The provision relevant for the purpose of these appeals is :
Section 16(3). In computing the. total income of any individual for the purpose
of assessment, there shall be included –
(a) so much of the income of a wife or minor child of such individual as arises
directly or indirectly -
(iii) from assets transferred directly or indirectly to the wife by the husband
otherwise than for adequate consideration or in connection with-an agreement to
live apart,
The assets transferred in this case is the gift of cash amounts made by the assessee
to his wife. The transfers in question are direct transfers. But those assets, as
mentioned earlier, were invested either in shares or otherwise.
The Revenue contends that : the incomes realised either as dividends from shares
or as interest from deposits are income indirectly received in respect of the
transfer of cash directly made. That is the position which clearly emerges from
the plain language of the section. The assessee contends that: There is no nexus
between the income earned and the transfer of the assets. Before an income can
come within Section 16(3)(a)(iii) it must be an income directly arising from the
assets transferred. Therefore only such income which can be said to have directly
sprung from the assets transferred can come within the scope of Section
16(3)(a)(iii).
Reasoning of the Court:
The contention of the assessee that only such income which directly springs from
the assets transferred can come within the scope of Section 16(3)(a)(iii), is not
correct. If that would have been the case then, the expression ‘as arises directly
or indirectly’ in Section 16(3)(a) would become redundant. The net cast by
Section 16(3)(a)(iii) includes not merely the income that arises directly from the
assets transferred but also that arises indirectly from the assets transferred.
Though the court accepts the contention of the assessee that the income that can
be brought to tax under Section 16(3)(a)(iii) must have a nexus with the assets
transferred directly or indirectly. There is no dispute that the income with which
we are concerned , in the present case has a nexus with the assets transferred. The
assessee has relied on the decision in C.I.T. v. Prem Bhat Parakh [(1970) 1 SCC
784].
But the facts of the Parakh case are different freom the present case , so the
decision in Parakh’s case can be of no help. The facts of Prem Bhat Parakh case
are as follows: The assessee, who was a partner in a firm , retired from the firm.
Thereafter, he gifted Rs 75,000 to each of his four sons, three of whom were
minors. There was a reconstitution of the firm with effect from July 2, 1954,
whereby the major son became a partner and the minor sons were admitted to the
benefits of partnership in the firm.
The question in Parakh’s case was “Whether the income arising to the minors by
virtue of their admission to the benefits of partnership in the firm could be
included in the total income of the assessee under Section 16(3)(a)(iii) .” The
Tribunal found that the capital invested by the minors in the firm came from the
gift made in their favour by their father, the assessee. Therefore the connection
between the gifts made by the assessee and the income of the minors from the
firm is direct and such income should be clubbed with the income of the assesse
under the provisions of section 16 (3) (a) (iii) . However on appeal , the Supreme
Court overruled the contention of the revenue that the income earned from the
firm by minors, as a result of gift by the assessee is direct income from the assets
transferred and it must be included in the income of the assessee. The Court came
to the conclusion that the connection between the gifts made by the assessee and
the income of the minors from the firm was a remote one and it could not be said
that the income arose directly or indirectly from assets transferred. Hence the
income arising to the three minor sons of the assessee by virtue of their admission
to the benefits of partnership in the firm could not be included in the total income
of the assessee. The Court observed in that case:
“The connection between the gifts mentioned earlier and the income in question
is a remote one. The income of the minors arose as a result of their admission to
the benefits of the partnership. It is true that they were admitted to the benefits
of the partnership because of the contribution made by them. But there is no nexus
between the transfer of the assets and the income in question.
It cannot be said that that income arose directly or indirectly from the transfer of
the assets referred to earlier.
Section 16(3) of the Act created an artificial income. That section must receive
strict construction as observed held by the Supreme Court in C.I.T. v. Keshavlal
Lallubhai Patt [(1965) 55 ITR 637]. Therefore before an income can be held to
come within the ambit of Section 16(3), it must be proved to have arisen - directly
or indirectly - from a transfer of assets made by the assessee in favour of his wife
or minor children.
The connection between the transfer of assets and the income must be proximate.
The income in question must arise as a result of the transfer of asset , whether
directly or indirectly and not in some manner connected with it. The ratio of the
decision in In Parakh’s case, where there was no nexus between the transfer of
asset and income earned , cannot be applied to the facts of the present case. In
the present case cash transfer was made by the assessee to his wife. From that
cash, the wife purchased some shares and invested some money on interest. The
dividend earned from those shares and interest from investment has proximity
with the income earned as the section talks about earnings from transfer of assets
, whether directly or indirectly.
If the dividend income earned from direct transfer of shares to the wife can be
included in the income of the husband , under the provisions of section 16 (3) (a)
(iii) , similarly dividend income from shares purchased from transfer of cash or
interest earned from cash investment , by the spouse would come within the
purview of Section 16 (3) (a) (iii) .
It would make no difference whether dividend income comes from shares
transferred directly or from the shares purchased from cash transfer by the
assessee. To bring a case under the provisions of Section 16 (3) (a ) (iii) , what
needs to be established is nexus between transfer of asset and earning . Since
the nexus has been established in the present case , the appeal of the assessee is
dismissed.

3. PHILIP JOHN PLASKET THOMAS V. C.I.T. (1964) 2 SCR 480

Statutory Provisions:
The case has been decided under provisions of Income Tax Act, 1922. The
relevant section is Section 16 of 1922 Act. The corresponding section in the
Income Tax Act , 1961 is Section 64. The concerned section i.e section 16 in the
1922 Act and Section 64 in the 1961 Act deals with Income of spouse and minor
children for purpose of assessment.

Section 64. Income of individual to include income of spouse, minor child, etc.-

(1) In computing the total income of any individual, there shall be included all
such income as arises directly or indirectly—
(ii) to the spouse of such individual by way of salary, commission, fees or any
other form of remuneration whether in cash or in kind from a concern in which
such individual has a substantial interest :
Provided that nothing in this clause shall apply in relation to any income arising
to the spouse where the spouse possesses technical or professional qualifications
and the income is solely attributable to the application of his or her technical or
professional knowledge and experience.
(iv) to the spouse of such individual from assets transferred directly or indirectly
to the spouse by such individual otherwise than for adequate consideration or in
connection with an agreement to live apart .
Section 16. Income Tax Act , 1922.
Exemptions and exclusions in determining the total income.-
(3) In computing the total income of any individual for this purpose of
assessment, there shall be included.
(a) so much of the income of a wife or minor child of such individual as arises
directly or indirectly….
(i) from the membership of the wife in a firm of which her husband is a partner;
(ii) from the admission of the minor to the benefits of partnership in a firm of
which such individual is a partner;
(iii) from assets transferred directly or indirectly to the wife by the husband
otherwise than for adequate consideration or in connection with an agreement, to
live apart; or
(iv) from assets transferred directly or indirectly to the minor child, not being a
married daughter, by such individual (otherwise than for adequate
consideration).”

FACTS

The assessee P.J.P. Thomas held 750 ‘A’ shares in J. Thomas & Co. Ltd. The
assessee entered into an engagement to marry one Mrs Judith Knight, stated to be
a divorcee, and the engagement was announced in certain newspapers on
September 3, 1947. On December 10, 1947 the assessee and Mrs Knight
presented to the Company an application to transfer the said 750 ‘A’ shares to
Mrs Judith Knight. The transfer deed stated that : “I, Philip John Plasket Thomas
of 8, Mission Row, Calcutta, in consideration of my forthcoming marriage with
Judith Knight of 35, Ridgeway, Kingsbury, London (hereinafter called the said
transferee) do hereby transfer to the said transferee the 750 ‘A’ shares numbered
1-750 standing in my name in the books of J. Thomas & Co. Ltd. to hold to the
said transferee.… Executors, administrators and assigns, subject to the several
conditions on which I hold the name at the time of the execution thereof. And I
the said transferee do hereby agree to take the said shares subject to the same
conditions.” On December 15, 1947 the Company transferred the shares to Mrs
Judith Knight and registered her as the owner of the shares. On December 18,
1947 the marriage was solemnised. On January 26, 1948 the fact of marriage was
communicated to the Company and the name of the shareholder was changed in
the books of the Company to Mrs Judith Thomas. It is undisputed that during the
relevant periods the shares stood registered in the name of the assessee’s wife and
when the income in question arose to her she was the wife of the assesee. The
four accounting years with which the assessments were concerned were 1948,
1949, 1950 and 1951. For the years 1948 and 1949 assessments of P.J.P. Thomas
which had by then been already completed , were reopened and the dividends
paid to Mrs Judith Thomas during the accounting years 1948 and 1949 were
reassessed in the hands of P.J.P. Thomas. For accounting years 1950 and 1951 ,
the dividends paid by the Company to Mrs Judith Thomas were held by the
Income Tax Officer to be includible in the total income of P.J.P. Thomas.
Accordingly orders were passed for including the grossed up dividends for the
two years respectively in the total income of P.J.P. Thomas. Against the said
assessment orders the assessee preferred appeals to the Appellate Assistant
Commissioner. The Appellate Assistant Commissioner confirmed the orders of
the Income Tax Officer holding that not only the provisions of Section 16(3)(b)
but also the provisions of Section l6(3)(a)(iii) of the Act applied in these cases.
Against the order of the Appellate Assistant Commissioner the assessee preferred
appeal to the Appellate Tribunal and contended: (1) that he transferred the shares
to Mrs Judith Knight when she was not his wife, (2) that the transfer of shares
was absolute at the time when it was made and no condition was attached to the
transfer, and (3) that the transfer was for adequate consideration. On these
grounds the assessee contended that the provisions of Section l6(3) of the Act
were not attracted to the cases in question. The Appellate Tribunal disagreed with
the view of the Income Tax Officer and the Appellate Assistant Commissioner
that the provisions of Section l6(3)(b) applied. But it held that the cases fell
within Section l6(3)(a)(iii) of the Act, because the transfer became effective only
after the marriage. It further held that the transfer could also be construed as a
revokable transfer within the meaning of Section 16(1)(c) of the Act. Therefore
the Appellate Tribunal dismissed the appeal. The High Court also agreed with
the reasoning of the Tribunal and rejected the appeal. Against this , assessee then
came in appeal to the Supreme Court with the following question :
1. In the facts and circumstances of these cases, whether the dividends paid by J.
Thomas & Co. Ltd, to Mrs Judith Thomas, respectively for the four years in
question could be included in the income of Mr P.J.P. Thomas and be taxed in his
hands under the provisions of Section 16(3)(a)(iii) of the Indian Income Tax Act?
Reasoning of the Court
The answer to the question depends on the determination of two points:
(1) what on its proper interpretation is the true scope and effect of Section
l6(3)(a)(iii) of the Act,
(2) whether the transfer made by the assesses in favour of Mrs Knight took effect
only from the date of the marriage between the assessee and Mrs Knight.
Section 16 . Income tax Act , 1922.
Exemptions and exclusions in determining the total income.-
(3) In computing the total income of any individual for this purpose of
assessment, there shall be included.
(a) so much of the income of a wife or minor child of such individual as arises
directly or indirectly….
(iii) from assets transferred directly or indirectly to the wife by the husband
otherwise than for adequate consideration or in connection with an agreement, to
live apart.
Under the provisions of section 16 (3)(a)(iii) the income arising from assets
transferred by an individual to his wife has to be included in the transferor’s total
income.
There are two exceptions to this Rule.
(1) where the transfer is for adequate consideration, or
(2) where it is in connection with an agreement to live apart.
The first and principal point contended by the appellant in the present case is that
: At the time the transfer of shares was made by the assessee to Mrs Judith Knight
she was not the wife of the assessee and therefore clause (a)(iii) which talks of
“assets transferred directly or indirectly to the wife by the husband” has no
application. Similar contention was advanced by the appellant before the High
Court also. The High Court held that : “In order to determine whether particular
case came under clause (a)(iii) or not, the relevant point of time was the time of
computation of the total income of the individual for the purpose of assessment
and the section did not limit any particular time as to when the transfer of assets
should take place.”
“ As the addition of the wife’s income to the husband’s income under this sub-
section is made, the relevant time of the relationship between husband and wife
which has to be considered by the taxing authorities is the time of computing of
the total income of the individual for the purpose of assessment.”
“The material consideration under Section l6(3)(a)(iii) was whether the transferee
was actually the wife of the assessee during the relevant accounting period when
the income from the assets transferred to her accrued.
“For the application of clause (a)(iii) it was not necessary that the relationship of
husband and wife must subsist at the time when the transfer of the assets is made
but the crucial date to determine the relationship is the date when the taxing
authorities are computing the total income of the husband and the crucial time is
the time when the income accrues to the wife.”
“On a true construction of Section l6(3)(a)(iii) the time when the relationship has
to be construed is the time when the computation of the total income of the
husband is made.”
On a plain reading of sub-section (3) of Section l6 it seems clear that at the time
when the income accrues, it must be the income of the wife of that individual
whose total income is to be computed for the purpose of assessment: this seems
to follow clearly from clause (a) of sub-section (3). Therefore in a sense it is right
to say that the relationship of husband and wife must subsist at the time of the
accural of the income; otherwise the income will not be the income of the wife,
for the word “wife” predicates a marital relationship. Moreover Section 16 (a)
(iii) further provides that only so much of the income of the wife, as arises
directly or indirectly from assets transferred directly or indirectly to the wife by
the husband shall be included in the total income of the husband. Therefore, sub-
clause (iii) predicates a further condition, the condition being that the income
must be from such assets as have been transferred directly or indirectly to the wife
by the husband. This condition must be fulfilled before sub-clause (iii) is attracted
to a case. It is clear that all income of the wife from all her assets is not includible
in the income of the husband. Thus on a proper reading of Section 16(3)(a)(iii)
it seems clear enough that the relationship of husband and wife must also subsist
when the transfer of assets is made in order to fulfil the condition that the transfer
is “directly or indirectly to the wife by the husband”.
However the Revenue contended that
(i) the transfer mentioned in Section l6(3)(a)(iii) need not necessarily be post-
nuptial
(ii) that the main object of the provision is the principle of aggregation, that is,
the inclusion of the income of the wife in the income of the husband, because of
the influence which the husband exercises over the wife.
(iii) the word “wife” is merely descriptive and means the woman referred to in
clause (a) and the word “husband” has reference merely to the individual whose
total income is to be computed for the purpose of assessment.
Rejecting the contentions, the Court held that: There is no reason to construe the
words “husband” and “wife” in the archaic sense .We are dealing here with a
statute and the statute must be construed in a manner which carries out the
intention of the legislature. The intention of the legislature must be gathered from
the words of the statute itself. If the words are unambiguous or plain, they will
indicate the intention with which the statute was passed and the object to be
obtained by it. There is nothing in Section 16 (3) which would indicate that the
word “wife” or the word “husband” must not be taken in their primary sense
which is clearly indicative of a marital relationship. It cannot be said that the
object of the legislature is just the principle of aggregation. Section 16 (3) clearly
aims at foiling an individual’s attempt to avoid or reduce the incidence of tax by
transferring his assets to the wife or minor child . This object does not require that
the word “wife” or the word “husband” should be interpreted in an archaic or
secondary sense. I n Vestey v. Commissioners of Inland Revenue [31 Tax Cases
1], the question for consideration was whether “wife” included a “widow”, for
the purpose of English Income Tax Act. It was held in Inland Revenue v. Gaunt
[24 Tax Cases 69] that the word “wife “ included the “widow” also. But
overruling the decision in Gaunt case , it was held in Vestey’s case that the word
“wife” did not include a “widow”. The English decisions proceeded on the footing
that in England it is a principle of income tax law that for income tax purposes
husband and wife living together are one.
The treatment of husband and wife by the legislature for income tax purposes
rests on the view that any income enjoyed by one spouse is a benefit to the other
spouse. It is not surprising, therefore, that a benefit to the wife of the assessee is
treated as being a benefit to the asssessee , but it is unlikely that this principle is
being extended to the widow of the assessee. But the treatment of husband and
wife under the Indian Income Tax Act, differs from the English Law. It does not
rest on the view that any income enjoyed by one spouse is a benefit to the other
spouse.
Section l6 (3) makes it quite clear that all income enjoyed by the wife is not to
be included in the income of the husband and only such of the wife’s income nas
comes within the sub-section is to be included in the income of the husband.
Therefore the English decisions , based on English law have no relaevance under
the Indian Income Tax Act.
In such circumstances , there are no reasons why the word “wife” or the word
“husband” should not be given its true natural meaning.
Now the second question, namely, whether the transfer of shares made by the
assessee in favour of Mrs Judith Knight on December 10, 1947 was to take effect
only from the date of their marriage, has to be considered. It is admitted that on
December 10, 1947 the assessee and Mrs Knight were not married. It is also
admitted that they were engaged to be married and the engagement was
announced on September 3, 1947. The transfer deed contained no words of
postponement. On the contrary, it contained words which indicated that the
transfer took effect immediately.
The revenue has rightly pointed out that the expression in the transfer deed “in
consideration of my forthcoming marriage” can have very little meaning as a real
consideration, because on September 3, 1947 the parties had mutually promised
to marry each other; therefore the promise to marry had been made earlier than
December 10, 1947. The transfer of shares was really a gift made to Mrs Knight
in contemplation of the forthcoming marriage and the gift was subject to a
condition subsequent, namely, that of marriage which if not performed would put
an end to the gift. This does not however advance the case of the revenue in any
way. A gift may be made subject to conditions, either precedent or subsequent.
A condition precedent is one to be performed before the gift takes effect; a
condition subsequent is one to be performed after the gift had taken effect, and,
if the condition is unfulfilled will put an end to the gift. But if the gift had already
taken effect on December 10, 1947 and the condition subsequent has been later
fulfilled, then the gift is effective as from December 10, 1947 when the assessee
and Mrs Knight were not husband and wife. That being the position, sub-clause
(iii) of Section 16(3)(a) will not be attracted to the case as the transfer of the
shares was not made by the husband to his wife. From whatever point of view
we look at the transfer of shares in the present case, whether it be in
consideration of a promise to marry or be a gift subject to the subsequent
condition of marriage, the transfer takes effect immediately and is not postponed
to the date of marriage. If that be the true position, then sub-clause (iii) of Section
l6(3)(a) is not attracted to the facts of the present case. Therefore the appeal is
allowed and answer in favour of the assessee.