Direct Taxation

10.01.2011

CIT v. GRK

During 1974-75, he participated in a race and came first. Objectives of race were endurance, driving
and reliability of the automobile. GRK said it was a contest and not a race. His winnings was
considered to be income even though the winnings did not fall under the ambit of section 2(24)(9)
because the nature of winnings was such that it amounted to income.

Capital Receipts v. Revenue Receipts

All capital receipts are exempted unless expressly taxable but all revenue receipts are taxable unless
expressly exempted.

Long term capital gain is exempted in case of shares. Normally, Long Term capital gain is also
taxable.

Gift of Money is a capital receipt but is taxable. There are some exceptions but generally it is taxable.

What is Capital Receipt?

Source of income is capital. Income is a fruit of capital. There is no hard and fast definition. Circular
No.4 of 2007 clarified investment and business income for FII’s. FII’s investments are capital assets
and not trading assets. Business income is only taxable only if there is permanent establishment in
India.

Treatment of Income

Capital Sales v. Business Sales- If receipt is under capital account, than the transaction merely
amounts to a charge on the account.

Fixed Capital v. Circulating Capital- If a receipt can be referred to fixed capital, it is Capital Receipt.

CIT v. Wajir Sultan and Sons- 1959 36 ITR 175 SC

This firm was appointed as a sole selling agent for cigarettes. The agency was extended to sell
cigarettes outside the state. There was another agreement which again confined them.
Compensation was given for the loss of agency. Agency is a capital of the firm and compensation
would fall under the category of Capital Receipt. But, current position is different.

Vishnu Data v. CIT- 1970 78 ITR 58 SC

Treatment in the hands of receiver is important and not the payer.

Lump sum payment- Capital receipt, Recurring payment- Revenue Receipt

Accounting System is only important in case of Business Sources and other Sources- Section 155

Two books of accounts are to be prepared, one for taxation purposes and the other for business
purposes.
Purpose of Compensation important in considering whether it is income or not.

CIT v. AMSS- 1963 48 ITR 59 SC

If you receive anything on part of estate of a deceased person, it is capital receipt.

Payment in lieu of Alimony

Right to get maintenance is a capital asset. So, any lump sum payment received is a capital receipt.
But, monthly payment would be revenue receipt.

11.01.2011

Section 4 is the Charging Section under Income Tax Act.

Capital Receipts/Revenue Receipts/Voluntary Receipts

Things that do not matter

 Whether the amount received is lump sum?

 Magnitude of the Payment
 What the parties term it as?
 Payments made out of capital

Anything lost on account of source of income would be a capital receipt.

Anything lost on account of income would be a revenue receipt.

Adventure in the nature of trade would be a Revenue receipt.

Section 2(13) defines business. It is inclusive and wide in nature.

Onus would lie upon the department to show adventure in the nature of trade.

A single transaction would not be a trading venture unless it bears an indica of trade- Supreme Court

IPR would constitute as Capital Asset. But Royalty is taxable under Income Tax Act. It would
constitute as Business Income.

Amount received in lieu of Salary- Pension would be capital in nature since it is a matter of right.
Amount received in lieu of Salary would be revenue in nature.

12.01.2011

Treatment of Agricultural Income

Section 2(1A) - Any income derived from agriculture.

1. Any rent or revenue derived from agricultural land which is situated in India and is used for
agricultural purposes.
2. Land must be the effective and immediate source of income.
3. Agricultural Purpose is more important than Agricultural Land.
 4. CIT v. Raja Binay Kumar Sahas Roy- 1957 32 ITR 466 SC- Agricultural Purpose
a. Basic Operation on the land- Prior to germination some basic operation is necessary.
It would involve expenditure of Human skill and labour on the land.
b. Subsequent Operation on the land- When the produce sprouts from the land.
Whatever is done for making the produce fit for the market?
c. Land must be situated inside India.
5. Any income derived from such product by agricultural operation so as to render it fit for the
market. The process must be ordinarily employed.
6. K.A. Laxmannan and Co. v. CIT- 1998 9 SCC 537- Millbury leaves used for producing silk. Not
an ordinarily employed process. Used for selling silk cocoons.
7. Brihan Maharashtra Sugar Syndicate Ltd. V. CIT- 1946 14 ITR 611- Sugarcane into Jaggery.
Not an ordinarily employed process.
8. Baccha and Gujjar v. CIT- AIR 1955 SC 74- Land must be the immediate and effective source
of income.
9. Kamakhaya Narain Singh v. CIT- Any rent or revenue derived from land is agricultural income
but receiving interest from rent on that land will not constitute as Agricultural Income.

13.01.2011

Cases of Partial Integration (When person has agricultural and non- agricultural income, both)

1. Indian
2. HUF
3. AoP/BoI
4. Artificial Juridical Person

If net agriculture income exceeds Rs.5000, then there will be partial integration and it shall be
taxable.

E.g. Salary- 300,000

NAI- 200,000

Step I- 200,000 + 300,000 = Total Taxable Income = 500,000

Step II- Maximum Exemption Limit= NAI + 160,000 (By virtue of IT act) = 360,000

Step III- 34000 -20000 = 14000 (10% till 500,000)

Net Agriculture Income- If income is from rent/revenue, and then income would be from other
sources. So after deduction whatever is left would be the Net Agricultural Income.

Income from Business- After deduction, whatever is left would be NAI.

Income from House Property- After deduction, whatever is left would be NAI.

Under DTC (Direct Tax Code), agricultural income would mean

1. Any profits or gains derived from agricultural land.

2. Any rent derived from agricultural land.
 3. Any rent derived from farm house

Agricultural Land means any land which is situated in India and is used for agricultural purposes.

Residential Status and Tax Liability

1. Ordinary Resident
2. Non- Ordinary Resident
3. Non- Resident

For Individual and HUF, all these three categories are there but in cases of company one first and
third classification exists.

Five Categories

1. Individual
2. Firm/AoP/BoI
3. HUF
4. Company
5. Every Other Person

Section 5,6,7,8 and 9 of the IT Act.

Section 5 - incidence of tax.

Section 6 - determination of status.

Section 7 - Income deemed to be received

Section 8 - Divided Income

Section 9 – Income deemed to be arise in India

14.01.2011

There are two types of residents:

1. Resident
2. Non-Resident

In Individual and HUF,

1. Ordinary Resident
2. Not Ordinary Resident- Refer Section 6(6), only in case of Individual. Section 6(6)(b) for HUF.
3. Non- Resident

Section 6:

1. Individual- If he
a. Is in India for that period or period amounting to 182 days or more in the previous
year.
 b. Resided for a total of 365 days in the four years preceding that previous year
amounting to 365 days or more and including 60 days in the previous year.
i. Being a citizen of India who leaves India on an Indian ship. (Only Condition a
applicable)
ii. Being a citizen of India who leaves India for the purpose of employment.
(Only Condition a applicable)
iii. Being a citizen of a person of Indian Origin who being outside India comes
for visiting purpose. (Only Condition a applicable)
2. HUF/Firm/AoP/BoI- They are said to be resident of India except when during that year the
control and management of its affairs is situated wholly outside of India.
3. Company- A company is said to be resident of India if
a. It is an Indian Company
b. During that year the control and management of its affairs is situated wholly in India.
4. Every other person (Local authorities and Artificial Juridical Person)

Section 6(5) says that if a person is resident for one source of income, than he shall be deemed to be
resident for all sources of income.

Control and Management- Where is the head and brain of the company situated? De Jure Control is
not important.

V.V. Subaiyah Chettiyar v. CIT, 1951 19 ITR 168 SC- Test of Control and Management- It is a question
of fact and it is the duty of the assesse to present all the facts in front of the department. Burden is
on the person to prove that he is a resident or not a resident. In case of Individual and company, this
burden lies upon the department.

Erin Estate v. CIT- 34 ITR 1 SC- Control and Management of Business is situated where head and
brain of the company is subjected. Control of a business does not necessarily means the carrying of a
business. The place where actual physical activity is going on is not necessarily the place where the
control and management is. Situated here implies functioning of such power from a particular place
with a degree of permanence. Present position is that permanence is not a requirement.

CIT v. Nand Lal Gand Lal- 40 ITR 7 SC- The control and management means De Facto control and
management and not the De Jure control and management.

OECD Commentary- It depends upon facts and circumstances of each case whether there is effective
management or not.

Under DTA (Direct Tax Agreements), residence is more important than other factors. In case of
active income, source of the income is important. There is no clear cut rule regarding this. In case of
immovable properties, the resident country has superior right than the source country.

Force of Attraction Rule and Attribution Rule- Refer Book.

In case of Section 6(4), every other person is said to be resident of India except in the case where
there control and management is wholly outside India.
Section 5- Incidence of Tax- Scope of Total Income- Subject to DTA agreement, the total income of
any previous year of a person who is a resident includes income:

1. Received or deemed to be received in India

2. Accrue or arise to him or deemed to be accrued in India
3. Accrue or arise outside India

In case of Not Ordinary Resident

1. Received or deemed to be received in India

2. Accrue or arise to him or deemed to be accrued in India
3. Accrue or arise to him outside India from a business or professional setup in India

Non Resident

1. Received or deemed to be received in India

2. Accrue or arise to him or deemed to be accrued in India

Changes Proposed in Direct Tax Code

 Accrue or deemed to accrue to him in India

 Accrue outside India
 Received or deemed to be received by him or on his behalf
 Received by him or on his behalf outside India during the year

CIT v. Oglae Glassworks- 1954 25 ITR 29- If there is receipt through Post, than the place of delivery is
the post office and it will be treated as an agent of the assesse. When the check is delivered, it is
deemed to be received. (In case of resident)

Tax will be calculated on receipt or accrual whichever comes first- Provided in the act itself.

Section 9- Income deemed to accrue or arise in India- A provision is not unconstitutional merely
because it has extra territorial jurisdiction provided it has sufficient nexus.

CIT v. R.D. Agrawal-

1. Question that there is business connection is a mixed question of fact and law.
2. It is a wide term.
3. It must have close and intimate relationship.
4. There must be continuity.

Ahmad Bhai Umed Bhai Case- Only operation carried out in India shall be taxed.

B.P. Roy v. ITO- Business connection includes professional connection. But there must be proper
continuity. It was criticized on the ground that professional connection should be differentiated from
business connection. Continuity Test not a conclusive test.

Section 160- Representative Assesse

Vodafone case- An entity situated in Netherlands wanted to take over Hutchinson Essar in India.
There was a wholly owned subsidiary in Cayman Islands which owned Indian Hutchinson Essar.
Vodafone purchased the holding company, Hutchinson Essar. Thus, the subsidiary automatically
transferred to Vodafone. The main contention was whether there was a transfer of capital asset or
not. High Court said there is not transfer of capital asset. Controlling Interest does not amount to
capital asset. Another thing was that the court said there was a colourable device and all the facts
were not disclosed, hence it amounted to Tax Evasion and not Tax Avoidance.

Section 9(1)(7)- Payable by Non-resident- Only if amount is paid and is used to utilization in India for
business purpose.

Ishika Wajma Case- Two requirements Section 9(1)(7)(c)-

1. Utilization
2. Services have to be rendered in India

Jindal Thermal Case Power- Resident was never a problem, the problem was rendering.

Change in Direct Tax Code- Income of resident will also be taxable in India even if it is received
outside India.

There are number of deeming provisions in the Income Tax Act. Deemed Income, Deemed Accrued,
Deemed Received etc. Section 41 talks about deemed profit. Deemed profit is also deemed received.

Change in Direct Tax Code - Directly or indirectly through or from the capital asset

There are certain incomes which are not taxable under Section 9

1. Non Resident exporter selling goods from abroad to Indian Importer

2. Non Resident Company selling goods from abroad to its subsidiary company
3. Non Resident Person purchasing goods in India
4. Operation confined to collection of news and views

Under Section, we have Agency- Business Connection. Any person who has authority to enter into
contract on behalf of the non-resident, then there will be business connection.

Independent and Dependant Agents- Permanent Establishment also implies Business Connection.

Provided where agent works wholly or mainly on behalf of the NRI.

Section 9(2) - any pension payable outside India to a person residing permanently outside India
shall not be deemed to accrue or arise in India except in some cases.

Section 9(1)(iii) - Income chargeable under the head "Salaries" payable by the Government to a
citizen of India for service outside India is taxable

Income payable by way of interest by government is taxable.

Interest payable by a person who is a resident, it will be taxable except in two situations
mentioned in Section 9.

Income by way of royalty payable by the government is taxable.

20.01.2011

Heads of Income- Section 14

a. Income from salary- Section 15 to 17

b. Income from house property- Section 22 to 27
c. Profit and gains from business or profession- Section 28 to 44
d. Capital gain- Section 45 to 55
e. Income from other sources- Section 56 to 59

Each head is mutually exclusive of each other because of the concept of total income.

Section 15- The following income shall be chargeable to income-tax under the head "Salaries" :-
(a) Any salary due from an employer 377 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.

What is important is Employer-Employee Relationship. There must be this relationship between the
payer and recipient. Test for Employer-Employee Relationship.

CIT v. Lakshmipati- 92 ITR 598 SC- No payment can called to be taxed under this section unless
there is employer and employee relationship.

Tuticorin Alcali Chemical and Fertilizers Ltd. V. CIT- 1997 227 ITR 172 SC- Each head is mutually
exclusive of each other.

Section 17 defines “salary” as

For the purposes of sections 15 and 16 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, to the extent to which it is chargeable to tax under rule 6 of Part A of the Fourth
Schedule; and

(vii) The aggregate of all sums that are comprised in the transferred balance as referred to in sub-
rule (2) of rule 11 of Part A of the Fourth Schedule of an employee participating in a recognised
provident fund, to the extent to which it is chargeable to tax under sub-rule (4) thereof;

Section 2(36) defines profession. Profession includes vocation.

Ram Prasad v. CIT- 1972 86 ITR 122 SC- Deliberated upon difference between Employment and
Profession. It is services rendered by the professionals or merely incidental to the practicing of the
profession and professional is free to offer services to others. Then, his income cannot be
considered to be salary income or income from employment.

CIT v. Durga Khote- 1952 21 ITR 22 Bom- Even a film actress entering into a contract with more
than one film company would not mean that she is an employee.

CIT v. Nawaz bhai Tata- It will depend upon the contract whether the person is an employee or
professional.

Devki Nandan Agrawal v. Union of India- 2006 237 ITR 872 SC- Judges are employees.

Tax Free Salary- Applicable in some cases only.

Regional Insurance v. Popular Employess- 1997 SC Case- Even during subsistence, salary received
in taxable because it is received during the employer-employee relationship.

Also, if salary is received in foreign currency, it shall be converted into INR and taxed.

Retirement Benefits-

1. Gratuity

a. Government Employees- Fully exempted

b. Payment of Gratuity Act, 1972- Partly exempted and partly taxable.

c. Other cases- Partly exempted and partly taxable (whichever is lower)

i. Half Month Salary*Length of Service

ii. 350000

iii. Actual Receipt

d. Gratuity is exempted on following basis (whichever is lower)

i. 15 days salary * length of service

ii. Maximum Limit of Rs.350000.

iii. Gratuity actually received by person.

2. Pension

3. Provident Fund
These retirement benefits come within the ambit of salary only tax purposes.

Allowances are also a type of salary.

1. Fully Exempted

2. Partly Exempted and Partly Taxable

3. Fully Taxable

Perquisites- These are also a type of salary.

15 Days Salary= Last Drawn Salary *15/26

Tax Treatment of Income

1. Fully exempted if received from UNO.

2. HC/SC Judges

3. Army Pension(Under some conditions) also exempted

4. Family Pension in other cases is taxable (Section 56)

5. Pension under notified Scheme (Only for Central Govt. Employees who have joined after 1
Jan. 2004)

Two Types of Pension

1. Commuted Pension- Received Lump sum amount

2. Uncommitted Pension- Received on a Monthly Basis

Section 10(10AA)- Leave Salary

During the employment, leave encashment is always taxable. For the government employees, it is
exempted. For non-government, it is partly taxable.

There are various types of leaves.

Partly Taxable (whichever is lower)

1. Period of earned leave * Avg. salary

2. 10* Avg. Monthly salary

3. 300000

4. Actual Record

Section 10 (10B) - Retrenchment Compensation

It is taxable as salary but is partly exempted and partly taxable.

Section 10 (10C) - Voluntary Retirement Scheme- Golden Handshake Scheme