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BASIC CONCEPT ABOUT TAX LAWS

a. Types of taxes and distinction between direct and indirect taxes

Tax is an obligatory expense enforced on an individual by the state and central government. It
is one of the government’s most significant sources of income that helps them build a country’s
economy and infrastructure.

Therefore as a responsible citizen, you must pay taxes. However, it is also crucial to know the
different types of taxes in India implemented in the taxation system of India.

The tax structure in India is a three-tier structure: local municipal bodies, state, and central
government. Typically taxation in India is broadly classified into direct tax and indirect tax.
Let us look at these two types of taxes and catch the difference between direct and indirect
taxes.

Direct taxes

Direct tax is levied on the income or profits of people. For example, a taxpayer pays the
government for different purposes, including income tax, personal property tax, FBT,
etc. The burden has to be borne by the person on whom the tax is levied and cannot be passed
on to someone else. Direct tax is governed and administered by the Central Board of Direct
Taxes (CBDT).

Indirect taxes

Conversely, indirect tax is levied by the government on goods and services. Therefore, it
can be shifted from one tax-paying individual to another. E.g. The wholesaler can pass it
on to retailers, who then pass it on to customers. Therefore, customers bear the brunt of
indirect taxes. Indirect taxes are governed and administered by the Central Board of Indirect
Taxes and Customs (CBIC).

Here is the list of major types of Indirect taxes:

• Goods and Service Tax– It is one of the existing indirect taxes imposed on various
goods and services. One significant benefit of GST is that it eliminates the tax-on-tax
or cascading effect of the previous tax regime.

• Excise duty – It is a tax imposed on licensing, sale or production of certain goods

produced within the country.

• Sales Tax - Sales tax is a type of indirect tax in which the seller charges a buyer at the
time of selling or exchanging a taxable good. Then the seller repays the tax to the
government on behalf of that buyer. However, the sales tax generally relies upon the
authority in power and the policies implemented by the authority. Some major sales tax

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 types are manufacturer’s sales tax, wholesale sales tax, use tax, value-added tax, and
retai sales tax.

Here is the list of major types of Direct taxes:

• Income tax – It is a type of tax that is imposed on the profits and income earned during
the year. Income tax is the most common example of direct tax. As the term “income
tax” suggests, it is a tax levied by the Central government on income generated by
individuals and businesses in a particular financial year. However, the amount payable
for your income tax depends on how much money you earn under different heads of
income. Additionally, for the financial year of 2022-2023, income tax is applicable to
those with an annual income exceeding Rs 2.5 lakh p.a.

• Capital Gains Tax: If anyone is making capital gains; they are required to pay tax on those
gains to the government. Capital gains may arise out of land or from investments such as
equities. Based on the duration for which one held the investments, the capital gains tax is
charged as long-term capital gains (LTCG) or short-term capital gains (STCG).

• Securities Transaction Tax (STT): If one is involved in security trading, then they are
required to pay securities transactions tax, irrespective of any gains made out of it or
not. A Comparative Analysis of Direct and Indirect Taxes in the Indian Taxation Context

The Indian taxation system embraces two fundamental modes of revenue collection: direct
taxes and indirect taxes. These categories diverge significantly in their application, impact, and
implications for various stakeholders. This comparative elucidation delves into the nuances of
direct and indirect taxes within the Indian jurisdiction, elucidating their distinctive attributes
and implications.

1. Imposition and Incidence:

• Direct Taxes: Direct taxes are levied directly on individuals and entities, with the
liability attached to their income, wealth, or capital gains. The incidence of these taxes
cannot be shifted onto other parties, and the taxpayers themselves bear the brunt of the
economic impact. The principle of progressiveness underscores direct taxes, wherein
the burden intensifies as the taxpayer's financial capacity escalates.

• Indirect Taxes: Indirect taxes, conversely, target goods and services rather than individuals.
The liability for these taxes can be transmitted through the supply chain, ultimately affecting
end consumers. While the immediate payer of the tax is an intermediary, such as a manufacturer
or retailer, the final economic burden is borne by the consumers, as the taxes are often integrated
into the price of goods and services.

2. Progressivity and Impact:

• Direct Taxes: Direct taxes align with the principle of equity and progressive taxation.
Tax rates are stratified based on income slabs, ensuring that those with higher earnings
contribute proportionally more to public finances. This approach seeks to uphold
fairness and redistribute wealth by mitigating economic disparities.

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 • Indirect Taxes: The regressive nature of indirect taxes warrants scrutiny. These taxes
impose a higher relative burden on lower-income individuals since a larger proportion
of their earnings is allocated to consumption. This structure inadvertently leads to the
potential exacerbation of income inequality, as the marginalized segments of society
bear a disproportionately heavier tax burden.

3. Examples and Collection Mechanisms:

• Direct Taxes: Prominent instances of direct taxes in India encompass income tax,
corporate tax, and wealth tax. Taxpayers are required to submit declarations of their
taxable income and wealth, with taxes collected through periodic assessments and
returns filed directly with tax authorities.

• Indirect Taxes: Notable examples of indirect taxes comprise Goods and Services Tax
(GST), excise duty, and customs duty. These taxes are accrued at various stages of the
production and distribution chain, with intermediaries responsible for their collection
and remittance to the government.

4. Economic Behavior and Administrative Complexity:

• Direct Taxes: Direct taxes possess the potential to influence economic behavior, as
higher tax rates on income or capital gains may lead to altered investment decisions or
reduced consumption. However, the intricate process of assessment, varying
deductions, and exemptions can result in administrative complexities and opportunities
for tax avoidance.

• Indirect Taxes: Indirect taxes, due to their embedment within the cost of goods and
services, may not significantly affect consumer behavior. Yet, their standardized
application streamlines administration and minimizes opportunities for evasion. The
introduction of GST in India exemplifies efforts to rationalize and simplify the previous
complex web of indirect taxes.

In conclusion, the Indian tax landscape comprises direct and indirect taxes, each
characterized by distinct imposition methodologies, economic impacts, and administrative
implications. While direct taxes emphasize progressivity and personal liability, indirect
taxes pivot around consumption-based imposition and cascading effects. A nuanced
comprehension of these tax categories is indispensable for an informed assessment of their
broader socio-economic ramifications.

Advantages and disadvantages of direct tax

Benefits

• Individuals with lower incomes pay lower taxes than people with higher incomes.
Therefore, it is known to be impartial and progressive in nature.

• It curbs inflation and reduces inequalities.

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Drawbacks

• There are many fraudulent practices through which taxpayers often pay lower tax or
avoid taxes.

• The documentation process is sometimes complex and time-consuming, thereby

creating inconvenience. Therefore, it is often considered a burden.

Advantages and disadvantages of indirect tax

Benefits

• It ensures that every individual, including the poor, contributes toward nation-building.

• This payment is more convenient as such taxes are already included in the price when
purchasing any product or service.

Drawbacks

• It can result in an increase in the overall price of goods and services.

• Consumers often lack civic consciousness of the tax they are paying.

• The rich and the poor pay the same tax. Therefore, it known to be regressive in nature.

b. Previous Year and Assessment Year

In the context of the Indian income tax system, "previous year" and "assessment year" are
critical concepts that pertain to the determination and calculation of taxable income for
individuals and entities. These terms are defined under the Income Tax Act, 1961, and they
play a pivotal role in the taxation process. Let's delve into their definitions, examples, and legal
implications.

Legal Implications:

Understanding the distinction between the previous year and assessment year is crucial for
complying with the tax regulations of India. Taxpayers must accurately determine their income
and deductions for the previous year and then report this information in their income tax returns
for the corresponding assessment year. Failure to comply with these timelines and reporting
requirements may lead to penalties and legal consequences.

Importance of Accurate Distinction: Properly identifying the previous year and assessment
year is essential for timely compliance with tax regulations. Taxpayers must meticulously
determine their income, deductions, and liabilities for the previous year and accurately report
these details during the assessment year. Failure to adhere to these timelines and obligations
could lead to penalties and legal repercussions.

Income Tax law defines Previous Year, as defined in section 3 of Income Tax Act, 1961
(hereinafter referred to as “IT Act”). The Previous Year is the Financial Year immediately
preceding the Assessment Year.

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PREVIOUS YEAR UNDER INCOME TAX LAW

The term “Previous year” in the context of the Income Tax Act (sec3) refers to the financial
year immediately preceding the assessment year. In India, the assessment year is the year in
which income tax is calculated and paid for the previous year.

The term "previous year" refers to the financial year immediately preceding the assessment
year. It is the period during which an individual or entity earns income that will be assessed for
taxation in the subsequent assessment year. In simpler terms, it is the fiscal year in which
income is generated, and the tax liability for that income is calculated in the following year.

For example, let’s say we are currently in the assessment year 2023-2024. The previous year
for this assessment year would be the financial year 2022-2023. During the previous year, an
individual or entity earns income and engages in financial transactions that are considered for
income tax purposes in the assessment year.

The Income Tax Act provides provisions and guidelines for the computation, assessment, and
collection of income tax for each previous year. It outlines various income categories,
deductions, exemptions, and tax rates that apply to different taxpayers based on their income
and other relevant factors.

ASSESSMENT YEAR UNDER INCOME TAX LAW

The assessment year (sec2(9)) in the context of income tax law refers to the year immediately
following the financial year for which the income is assessed. In many countries, including
India, the income tax laws follow a system where the assessment of income is done for a
specific financial year and then the tax liability is determined for that year. The assessment
year is the year in which the taxpayer’s income is assessed and tax returns are filed based on
the income earned during the preceding financial year.

The "assessment year" is the fiscal year in which the income earned during the previous year
is evaluated, assessed, and taxed. During this year, taxpayers are required to file their income
tax returns, declaring their income, deductions, and other relevant financial details to the tax
authorities. The income earned during the previous year is subjected to scrutiny and taxation
in the assessment year.

For example, if the financial year is from April 1, 2022, to March 31, 2023, the assessment
year would be the year following this period, which is April 1, 2023, to March 31, 2024. During
the assessment year, individuals and entities are required to file their income tax returns for the
previous financial year, declaring their income, claiming deductions, and paying any taxes due.

DIFFERENCE BETWEEN PREVIOUS YEAR AND ASSESSMENT YEAR

Previous Year

• The previous year, also known as the financial year.

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 • The year in which an individual or entity earns income.

• It is the year preceding the assessment year. For example, if the financial year is from
April 1, 2022, to March 31, 2023, then the previous year would be 2022-2023.

• During the previous year, we earn income from various sources, such as salary,
business, profession, capital gains, etc.

• We are required to maintain proper records and documentation of your income and
expenses during this period.

Assessment Year

• The assessment year is the year following the previous year.

• In which your income earned during the previous year is assessed for taxation
purposes.

• It is the year in which you file your income tax return and your income is assessed by
the tax authorities. For example above, if the previous year is 2022-2023, then the
assessment year would be 2023-2024.

• During the assessment year, we need to compile all the relevant information about our
income, deductions, and investments to compute our taxable income.

• We file our income tax return based on this information, and the tax authorities assess
your income and determine the amount of tax we owe.

IMPORTANCE OF PREVIOUS YEAR

Here are some key reasons why the previous year holds importance:

• Determining the Taxable Income: The previous year is the period during which
income is earned and accrued. It serves as the basis for computing the taxable income
for that year. Income earned in the previous year is subject to tax in the subsequent
assessment year.

• Accounting and Bookkeeping: The previous year is crucial for maintaining proper
accounting records and books of accounts. It helps individuals and businesses
accurately record their income, expenses, assets, and liabilities during the specific
period.

• Compliance and Filing of Returns: The previous year determines the time period for
which an individual or entity needs to file their income tax returns. The assessment year
follows the previous year, and taxpayers are required to file their returns for the income
earned during the previous year within the prescribed due dates.

• Tax Planning and Investments: The previous year plays a vital role in tax planning
strategies. Taxpayers can assess their income and expenses during the previous year to

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 plan their investments, claim deductions, and avail of tax benefits available under the
income tax law.

• Carry-forward of Losses and Set-off: The previous year is important for determining
the treatment of losses incurred by individuals or businesses. Taxpayers can carry
forward certain types of losses from the previous year and set them off against future
profits or incomes, thereby reducing their overall tax liability.

• Assessment and Audit: The income tax authorities conduct assessments and audits to
ensure compliance with tax laws. The previous year’s financial records and returns form
the basis for such assessments, providing a snapshot of the taxpayer’s income,
expenses, deductions, and tax payments during that period.

IMPORTANCE OF ASSESSMENT YEAR

Here are some key reasons why the assessment year holds importance:

• Tax Calculation: The assessment year is used to calculate the tax liability of an
individual or entity. The income earned during a financial year Is assessed and taxed in
the subsequent assessment year based on the prevailing tax rates and rules for that year.

• Filing Income Tax Returns: The assessment year determines the period for which the
income tax return needs to be filed. Taxpayers are required to file their returns for a
specific financial year in the assessment year following that year. For example, income
earned during the financial year 2022-2023 will be assessed and taxed in the assessment
year 2023-2024, and the taxpayer needs to file the tax return for that financial year in
the assessment year.

• Compliance and Deadlines: The assessment year sets the deadlines for various tax-
related activities. It specifies the due dates for filing income tax returns, paying taxes,
claiming deductions, and submitting supporting documents. Taxpayers need to comply
with these deadlines to avoid penalties and ensure smooth tax processing.

• Revisions and Rectifications: The assessment year provides an opportunity for

taxpayers to revise or rectify their tax returns. If any errors or omissions are identified
after filing the return, taxpayers can file a revised return or rectification application
within the prescribed time limit of the assessment year.

• Assessment Proceedings: The tax authorities conduct assessment proceedings during

the assessment year. They scrutinize the tax returns, verify the income, deductions, and
exemptions claimed, and determine the final tax liability. The taxpayer may be required
to provide additional information or evidence during this process.

• Carry Forward of Losses and Set-Offs: The assessment year is crucial for carrying
forward losses and setting them off against future income. If a taxpayer incurs a loss in
a financial year, they can carry it forward to subsequent assessment years and set it off

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 against future profits. The assessment year determines the period within which these
losses can be carried forward and adjusted.

As a normal rule, the income earned during any previous year is assessed or charged to tax in
the immediately succeeding assessment year. However, in the following circumstances the
income is taxed in the same year in which it is earned. Therefore, the assessment year and the
previous year in these exceptional circumstances will be the same. These exceptions
have been provided to safeguard the collection of taxes so that assesses, who may not be
traceable later on, are not allowed to escape the payment of the taxes. The exceptions are as
follows:

1. Shipping Business of Non-Residents [Section 172]:

A non-resident who is carrying on a shipping business and earns income from carrying
passengers/livestock/goods from a port in India, will be charged income tax before the ship is
allowed to leave the Indian port. Therefore, before the ship leaves the Indian port, the master
of the ship is under an obligation to furnish a return of the full amount earned on account
of fare and freight (including the amount paid or payable by way of demurrage charge or
handling charge or any other amount of similar nature) and pay the tax accordingly. In this
case 7.5% of the amount of fare/freight/charge, etc. shall be deemed to be income of such
assessee on which the income-tax will be charged. Therefore, in this case the tax is chargeable
on the income in the same year in which it is earned.

Where the Assessing Officer is satisfied that it is not possible for the master of ship to furnish
the return before the departure of the ship from the port and the master of the ship has made
satisfactory arrangement for the filing of the return and payment of the tax by any other person
on his behalf, he (the Assessing Officer) may, if the return is filed within 30 days of the
departure of the ship, deem the filing of the return by the person so authorised by the master
as sufficient compliance for the purpose of this section.

2. Assessment of Persons Leaving India [Section 174]:

When it appears to the Assessing Officer that any individual may leave India during the
current assessment year or shortly after its expiry, and such individual has no present intention
of returning to India, the total income of such individual, from the expiry of previous year for
that assessment year (i.e. from 1st April of the assessment year) up to the probable date of his
departure from India shall be chargeable to tax in the same assessment year.
Example 1.—R wishes to migrate to USA permanently and plans to leave India on 15.11.2019.
He submitted his return for assessment year 2019-20 on 31.7.2019 the assessment of which
is still pending.

In this case the Assessing Officer will make two assessments:

(a) regular assessment for previous year income of 2018-19 at the rates applicable for
assessment year 2019-20.

(b) assessment of income of the period 1.4.2019 to 15.11.2019 (either actual or estimated
basis) and tax should be levied on such income in the assessment year 2019-20 itself but at
the rates of advance tax for financial year 2019-20 (A.Y. 2020-21) given in part III of First
Schedule of Finance (No. 2) Act, 2019.

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3. Assessment of Association Of Persons (AOP) or Body Of Individuals (BOI) or Artificial
Juridical Person formed for a particular event or purpose [Section 174A]:

Where it appears to the Assessing Officer that any association of persons or a body of
individuals or an artificial juridical person formed or established or incorporated for a
particular event or purpose is likely to be dissolved in the assessment year in which such
association of persons or body of individuals or artificial juridical person was formed or
established or incorporated or immediately after such assessment year, the total income of
such person or body or juridical person, for the period from the expiry of the previous year for
that assessment year up to the date of its dissolution, shall be chargeable to tax in that
assessment year.

E.g. if AOP which is formed in the previous year 2019-20 is going to be dissolved on
16.6.2020 then the income of the period 1.4.2020 to 16.6.2020 shall be charged to income tax
in the assessment year 2020-21 itself although its assessment year should have been
assessment year 2021-22.

4. Assessment of Persons likely to Transfer Property to Avoid Tax [Section 175]:

If it appears to the Assessing Officer during any current assessment year, that any person is
likely to charge, sell, transfer, dispose of or otherwise part with any of his assets with a view
to avoiding any payment of his tax liability, then the total income of such person for the period
from the expiry of the previous year for that assessment year (i.e. from 1st April of that
assessment year) till the date when the assessing officer commences proceedings, shall be
chargeable to tax in the same assessment year. However, in this case also the rate of tax
applicable shall be the rate given in Part III of Schedule I which are applicable for advance
tax also.

5. Discontinued Business [Section 176]:

Where any business or profession is discontinued in any assessment year, the income of the
period from expiry of the previous year for that assessment year up to the date of such
discontinuance may, at the discretion of the assessing officer, be charged to tax in
that assessment year. For example, if a business is discontinued on 16.7.2019 then the income
for the period 1.4.2019 to 16.7.2019 may be assessed in the assessment year 2019-20 itself.
The tax will be charged at the rates in force for advance tax payable during financial year
2019-20. [i.e. rates given in Part III of the First Schedule].

Any person discontinuing any business or profession shall give to Assessing Officer notice of
such discontinuance within 15 days thereof.

It may be noted that in the first four exceptions given above, the Assessing Officer shall charge
the tax on such persons in the same previous year i.e. it is mandatory for the Assessing Officer
to charge the tax in the same previous year. On the other hand, in the fifth exception given
above the Assessing Officer has the discretionary power and as such he may charge in the
same previous year or may wait till the assessment year.
Conclusion: The concepts of "previous year" and "assessment year" underpin the Indian
income tax system, orchestrating the timing of income generation, assessment, and taxation.

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Ensuring a precise understanding of these concepts is imperative for taxpayers, enabling them
to fulfil their legal obligations and avoid potential legal entanglements. As tax laws are subject
to change, consulting the latest provisions and seeking professional advice is recommended for
accurate compliance.

In the Indian legal tax system, the terms "previous year" and "assessment year" hold pivotal
significance in the determination and computation of taxable income. These concepts are
integral to the Income Tax Act, 1961, and elucidate the temporal framework within which
income is earned, evaluated, and taxed.

In sum, the distinction between the previous year and assessment year is pivotal for accurate
tax reporting and compliance. The previous year is the period of income generation, while the
assessment year is when this income is evaluated and taxed. This differentiation ensures the
systematic administration of taxation within the Indian legal framework.

c. Definition of Certain Terms: Persons, Assessee, Income, Application of Income and

Diversion of Income by overriding titles

Person

For the purpose of charging Income-tax, the term ‘person’ has been defined under Section
2(31) of the Income Tax Act, 1961 to include Individuals, Hindu Undivided Families [HUFs],
Association of Persons [AOPs], Body of individuals [BOIs], Firms, LLPs, Companies, Local
authority and any Artificial Juridical Person (AJP).

As per Section 2(31) of Income Tax Act, 1961, unless the context otherwise requires, the term
“person” includes:

(i) an individual,

(ii) a Hindu undivided family,

(iii) a company,

(iv) a firm,

(v) an association of persons or a body of individuals, whether incorporated or not,

(vi) a local authority, and

(vii) every artificial juridical person, not falling within any of the preceding sub-clauses.

Explanation: For the purposes of this clause, an association of persons or a body of individuals
or a local authority or an artificial juridical person shall be deemed to be a person, whether or
not such person or body or authority or juridical person was formed or established or
incorporated with the object of deriving income, profits or gains.

Types of Persons in the Income Tax Act

1. Individuals:

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An individual is a natural person who is a citizen of India or a resident of India. Under the
Income Tax Act, an individual is taxed on his or her income. The income tax rates for
individuals vary depending on their income level.

2. Hindu Undivided Family (HUF):

An HUF is a type of family arrangement that is recognized under Hindu law. An HUF consists
of all persons lineally descended from a common ancestor, including their wives and unmarried
daughters. Under the Income Tax Act, an HUF is taxed as a separate entity from its members.

3. Companies:

A company is a separate legal entity that is registered under the Companies Act, 2013.
Companies are taxed on their income at a flat rate.

4. Firms:

A firm is an association of two or more individuals who come together to carry on a business.
Under the Income Tax Act, a firm is taxed as a separate entity from its partners.

5. Association of Persons (AOP):

An AOP is a group of two or more persons who come together for a common purpose, other
than for profit. An AOP is taxed as a separate entity from its members.

6. Body of Individuals (BOI):

A BOI is a group of two or more individuals who come together for a common purpose, other
than for profit. A BOI is taxed as a separate entity from its members.

Association of Persons (AOP) means a group of persons who come together for achieving a
common objective and have the same mindsets. Members of the AOP can be natural or artificial
persons.

Body of Individuals (BOI) means a group of individuals (natural persons) who join together
for earning income.

An Association of Persons (AOP) and a Body of Individuals (BOI) convey two different
arrangements of people. The fact that both of these expressions at times are used
interchangeably doesn’t justify the restrictive interpretation. We need to stop interchanging the
usage of these words as they represent two different compositions.

There are certain differences between an Association of Persons and Body of Individuals. A
person in AOP could be a company or an individual person. The term person could include any
association, body of individuals or company, irrespective of whether it is incorporated or not.

However, in a BOI, only individuals can join with the intention of earning some income. Hence
we can say, BOI only comprises of individuals, whereas an AOP could include legal entities.

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In a nutshell, it could be said that an AOP (association of persons) has a legal meaning and it
represents a unit having duties and rights. For instance, if a group of people are travelling in a
train, or waiting for a bus at the bus stop, they might be a group of people or in the literal sense
a “body of individuals”. However, they’re not an AOP (association of persons) in a legal sense.

Moreover, an AOP implies a combination of persons which doesn’t mean that any combination
or group of persons is an AOP. It’s only when these individuals associate themselves with any
income-producing activity they can be called an AOP.

When the share of Income of individual members of BOI or AOP wholly or partly is unknown,
tax would be charged on the total Income of the BOI/ AOP at the maximum marginal rate.
In case income of a member of the AOP is chargeable at the rate that is higher than marginal
rate, the former would apply i.e. the higher rate would be levied on total income of the AOP.
Where total income of the member of BOI/ AOP is more than the maximum exemption Limit,
member with the highest income would be charged at maximum marginal rate of 30 percent.

7. Artificial Juridical Person:

An artificial juridical person is a legal entity that is not a natural person. These entities are taxed
on their income at the same rates as individuals.

Taxation of various Persons

The “assessee” under the Income Tax Act, 1961 is a person by whom any tax/ other dues are
payable under the Act, i.e. income-tax is to be paid by a ‘person’. Therefore deciding the ‘type
of person’ under the Income Tax Act is all the more important, as there are different set of tax
rules/ rates which are applicable to respective category. The term ‘person’ as defined under the
Income-tax Act covers in its ambit natural as well as artificial persons, i.e. apart from a natural
person/ individual, any sort of artificial entity will also be liable to pay Income-tax, as explained
above.

In conclusion, the Income Tax Act of 1961 defines the term ‘person’ as a broad category that
encompasses a wide range of entities. The Act recognizes various types of persons, including
individuals, HUFs, companies, firms, AOPs, BOIs, and artificial juridical persons, each with
their own tax obligations and rates.

Certainly, here are examples of different types of persons under the Income Tax Act, 1961,
from an Indian tax law perspective:

1. Individual: Example: Ramesh, a software engineer, earns a salary and interest income.
He is considered an individual taxpayer and is subject to income tax based on the tax
slabs applicable to individuals.

2. HUF (Hindu Undivided Family): Example: The Desai family has ancestral property
that generates rental income. This rental income is taxed separately as income earned
by the HUF entity.

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 3. Company: Example: ABC Pvt. Ltd., a manufacturing company, earns profits from its
operations. The company is subject to corporate tax rates on its income.

4. Firm: Example: Gupta & Associates, a partnership firm of lawyers, earns fees from
legal services. The firm's income is assessed and taxed separately from the individual
partners' incomes.

5. AOP (Association of Persons) and BOI (Body of Individuals): Example: A group of

friends organizes a charity event and generates funds. The income earned is taxed as an
AOP, with its own applicable tax rates.

6. Local Authority: Example: XYZ Municipal Corporation collects property taxes and
charges for municipal services. The municipal corporation is treated as a separate entity
subject to taxation.

7. Trust: Example: ABC Charitable Trust manages an orphanage and earns interest on its
investments. Depending on the type of trust, the income is taxed either in the hands of
the trustees or beneficiaries.

8. Political Party: Example: DEF Political Party receives donations and earns income
from its membership drives. It is considered a person under the Income Tax Act and is
eligible for certain tax exemptions.

9. Co-operative Society: Example: Green Fields Housing Cooperative Society earns

maintenance fees from its members. The society is taxed separately on the income it
generates.

10. Artificial Juridical Person: Example: The Estate of Late Mr. Patel owns properties
that generate rental income. The income from these properties is taxed separately as an
artificial juridical person.

11. AOP/BOI of Individuals: Example: A group of doctors forms an association to

provide free medical camps in rural areas. The income generated from these camps is
treated as income of an AOP for tax purposes.

These examples highlight how different entities are categorized as "persons" under Indian tax
law and are subject to distinct tax provisions and rates based on their legal status and nature of
income. Always consult the Income Tax Act and seek professional advice for accurate and up-
to-date information on taxation matters in India.

Assessee

An income tax assessee is a person who pays tax or any sum of money under the provisions of
the Income Tax Act, 1961.

Furthermore, Section 2(7) of the act defines an income tax assessee as anyone who is required
to pay taxes on any earned income or incurred loss in a single assessment year.

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Normal Assessee

An individual who is liable to pay taxes for the income earned during a financial year is known
as a normal assessee. Every individual who has earned any income earned or losses, incurred
during the previous financial years is liable to pay taxes to the government in the current
financial year.

All individuals who pay interest/penalty or who are supposed to get a refund from the
government are categorised as normal assessees. Say, Mr A is a salaried individual who has
been paying taxes on time over the past 5 years. Then, Mr A can be considered as a normal
assessee under the Income Tax Act, 1961.

Representative Assessee

There may be a case in which a person is liable to pay taxes for the income or losses incurred
by a third party. Such a person is known as a representative assessee.

Representatives come into the picture when the person liable for taxes is a non-resident, minor,
or lunatic. Such people will not be able to file taxes by themselves. The people representing
them can either be an agent or guardian.

Consider the case of Mr. X. He has been residing abroad for the past 7 years. However, he
receives rent for two house properties he owns in India. He takes the help of a relative, Mr. Y,
to file taxes in India. In this case, Mr. Y acts as a representative assessee. If the assessing officer
plans to investigate the tax filing, Mr. Y will be asked to provide the necessary documents as
he is the guardian of the property and represents Mr. X.

Deemed Assessee

An individual might be assigned the responsibility of paying taxes by the legal authorities and
such individuals are called deemed assessees. Deemed assessees can be:

• The eldest son or a legal heir of a deceased person who has expired without writing a
will.

• The executor or a legal heir of the property of a deceased person who has passed on his
property to the executor in writing.

• The guardian of a lunatic, an idiot, or a minor.

• The agent of a non-resident Indian receiving income from India.

For example, Mr P owns a commercial building from which he earns rent income. He has
prepared and signed a will stating the property should be handed over to his niece after his
death. Upon his death, his niece will be considered as the executor of the property, i.e. deemed
assessee. She will be responsible for paying tax on the rental income thereon.

Assessee-in-default

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Assessee-in-default is a person who has failed to fulfil his statutory obligations as per
the income tax act such as not paying taxes to the government or not filing his income tax
return. For example, an employer is supposed to deduct taxes from the salary of his employees
before disbursing the salary. He is, then, required to pay the deducted taxes to the government
by the specified due date. If the employer fails to deposit the tax deducted, he will be considered
as an assessee-in-default.

Roles/Responsibilities and Duties of an Assessee

Assesses must file their returns on time and pay their taxes when they are due. However, an
assessee may frequently fail to file their return on time. In this situation, they may receive a
notice from the IT department or the relevant Assessing Officer requesting information about
why the return was not filed for that particular fiscal year. In this scenario, the assessee must
provide a response to the Assessing Officer explaining why they did not file his returns on
time, and he must also file the returns as soon as he receives the notification.

Let us take a quick look at the various roles and responsibilities of an Assessee upon receiving
a notice:

• As soon as the Assessee receives the notice from the department, they must file their
tax returns for the avoided income for the specific assessment year.

• After filing the returns, they may obtain a copy from the assessing officer that clearly
states the grounds for which the officer issued the notice to them.

• If the Assessee believes that the grounds given in the copy are not valid, and they are
not satisfied with the reasons, they may file an objection and question the legality of
the notice.

• The Assessee must also ensure that they have valid reasons for filing the objection and
that they have properly decided to query the government's notification.

• If the officer rejects the Assessee's allegations, the Assessee may submit a request to
the concerned Assessing Officer, asking him to provide additional explanations.

• The Assessee may choose to contest the legitimacy of the notification much before the
planned assessment or re-assessment is completed by filing a writ petition with the
relevant High Court.

• The Assessee may also choose to challenge the legitimacy of the notice even after the
planned assessment is completed by filing a writ petition with the respective High
Court.

• The Assessee must provide details relevant to their income returns within 30 days of
the date of issuance of the notice, not the date on which the notification was received
by the Assessee. To avoid complications later on, the details relevant to the income for
which tax payment has been avoided, as well as other associated income details, must
be clearly given and filed with the concerned authorities.

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Income

The Income Tax Act, 1961 (India), provides a legal concept and definition of income in Section
2(24) of the Act. This definition is crucial in determining what constitutes taxable income and
how different types of earnings are assessed and taxed. Here is the legal concept and definition
of income as per the Income Tax Act:

Section 2(24) of the Income Tax Act, 1961:

"Income includes—

(i) Profits and gains;

(ii) Dividend;

(iii) Voluntary contributions received by a trust created wholly or partly for charitable or
religious purposes or by an institution established wholly or partly for such purposes not being
contributions made with a specific direction that they shall form part of the corpus of the trust
or institution;

(iv) The value of any perquisite or profit in lieu of salary taxable under sections 15, 17, 18, and
19;

(v) Any special allowance or benefit, granted to the assessee to meet expenses wholly,
necessarily and exclusively for the performance of the duties of an office or employment of
profit;

(va) Any allowance, not being in the nature of perquisite, granted to the assessee either to meet
his personal expenses at the place where the duties of his office or employment of profit are
ordinarily performed by him or at the place where he ordinarily resides or to compensate him
for the increased cost of living;

(vb) Any allowance granted to the assessee to meet the hostel expenditure on his child;

(vi) Any payment due to or received by an assessee from an employer or a former employer or
from a provident or other fund, not being a sum chargeable under the head 'Salaries';

(vii) Any capital gains chargeable under section 45;

(viii) Any winnings from lotteries, crossword puzzles, races including horse races, card games
and other games of any sort or from gambling or betting of any form or nature whatsoever;

(ix) Any sum referred to in clause (va) of section 28;

(x) Any sum referred to in clause (vb) of section 28;

(xi) Any other sum received by the assessee which, due to the nature of the transaction or
arrangement, may be so regarded;"

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This legal definition encompasses a wide array of sources of income, including profits and
gains from various activities, dividends, contributions to charitable trusts, perquisites,
allowances, capital gains, winnings from games of chance, and more. It also includes a catch-
all provision (clause xi) that covers any other sum received by the assessee that, due to the
nature of the transaction or arrangement, can be considered as income.

There are several principles associated with the concept of income that guide its assessment
and taxation. Let's delve into these principles:

1. Comprehensive Inclusion Principle: The comprehensive inclusion principle states that all
forms of economic gain should be included in the concept of income, regardless of their source.
This ensures that taxpayers cannot evade taxes by categorizing income in a way that would
escape taxation. The Income Tax Act, 1961, adheres to this principle by broadly defining
income to encompass various sources and types of earnings.

2. Realization Principle: The realization principle suggests that income is recognized for tax
purposes when it becomes realized or converted into cash or its equivalent. This is particularly
relevant for capital gains, where taxation occurs upon the sale or transfer of a capital asset. The
realization principle helps avoid taxing potential gains that are not yet realized.

3. Accrual Principle: The accrual principle dictates that income should be recognized when it
becomes due and is earned, even if it has not yet been received. This principle is essential for
recognizing income from services provided, interest earned on investments, and other
situations where the income is earned but not yet physically received.

4. Periodic Accounting Principle: This principle stipulates that income should be recognized
and assessed periodically, usually on an annual basis. The income tax system typically follows
the fiscal year as the assessment period, ensuring a regular and predictable cycle for taxpayers
and the tax authorities.

5. Matching Principle: The matching principle requires that expenses related to earning income
should be matched with the income they help generate. This principle helps ensure fairness and
accuracy in determining the net income subject to taxation.

6. Exclusions and Deductions: The concept of income recognizes that not all receipts should
be considered taxable income. Certain receipts, such as gifts from relatives, agricultural
income, and specific allowances, are excluded from taxable income. Deductions and
exemptions are also allowed to account for necessary expenses or specific contributions.

7. Fairness and Equity: The principle of fairness and equity suggests that taxation should be
based on a person's ability to pay. Different sources of income and various categories of
taxpayers may have different tax rates and deductions to achieve a fair distribution of the tax
burden.

8. Avoidance of Double Taxation: The principle of avoiding double taxation ensures that the
same income is not taxed twice by multiple jurisdictions. Tax treaties and provisions for foreign
income taxation are examples of how this principle is implemented.

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9. Economic Substance over Legal Form: Tax authorities look at the economic substance of
transactions rather than just their legal form. This prevents taxpayers from structuring
transactions solely for tax avoidance purposes.

10. Transparency and Disclosure: Taxpayers are required to transparently disclose their
income, deductions, and exemptions. This principle enhances accountability and reduces the
scope for tax evasion.

Understanding and applying these principles help tax authorities ensure that the assessment
and taxation of income are carried out fairly, consistently, and in accordance with the law. It
also aids taxpayers in accurately fulfilling their tax obligations and optimizing their tax
planning strategies within the legal framework.

Application and Diversification of Income

Diversion of income and application of income are two concepts that are recognized under the
Income Tax Act, 1961 in India. These concepts are used to determine the taxability of income
in certain situations where income is diverted or applied by a taxpayer in a manner that may
affect its tax liability. Let's delve into a detailed analysis of these concepts as per the Income
Tax Act, 1961:

1. Diversion of Income:

Diversion of income refers to a situation where income is legally diverted by a taxpayer to a

third party before it reaches the taxpayer, and the diverted income is not considered as the
taxpayer's income for tax purposes. In other words, the income is diverted to another person
before it becomes taxable in the hands of the taxpayer.

Under the Income Tax Act, for a diversion of income to be recognized, the following conditions
must be met:

a) Existence of a legal obligation: There must be a legal obligation on the taxpayer to apply the
income in a particular manner before it accrues or arises to the taxpayer. This legal obligation
can arise from a contract, an agreement, a statute, or any other legal arrangement.

b) Diversion before accrual or arising of income: The income must be legally diverted to a third
party before it accrues or arises to the taxpayer. Once the income accrues or arises to the
taxpayer, it becomes taxable in the hands of the taxpayer unless it satisfies the conditions for
diversion of income.

c) Diversion without the taxpayer's control: The income must be diverted to a third party
without the taxpayer having control over it. The taxpayer must not have any power or control
over the diverted income after it is diverted.

d) Genuine and bona fide transaction: The diversion of income must be a genuine and bona
fide transaction, and it must not be a sham or colorable transaction intended to evade taxes.

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If all these conditions are met, the diverted income will not be treated as the taxpayer's income
for tax purposes, and it will be taxable in the hands of the third party to whom it is diverted.

2. Application of Income:

Application of income refers to a situation where income is applied by a taxpayer for a specific
purpose or utilized in a particular manner, and such application or utilization is considered as
a taxable event. In other words, the income is applied or utilized by the taxpayer for a particular
purpose, and it is treated as the taxpayer's income for tax purposes.

Under the Income Tax Act, the concept of application of income is primarily used in cases
where income is accumulated or set apart for the benefit of a specific person, such as a trust or
a fund. In such cases, the income is considered as the taxpayer's income and is taxable in the
hands of the person for whose benefit it is accumulated or set apart.

Diversion Of Income v/s Application Of Income

The Supreme Court decision in case of CIT v. Sitaldas Tirthdas (1961) is the authority for the
proposition that where by an obligation, income is diverted before it reaches the assessee, it is
deductible from his income as for all practical purposes it is not his income at all (as it is
diversion of income by overriding title). But where the income is required to be applied to
discharge an obligation after it reaches the assessee, it is not deductible (as it is called as
application of income). Thus, there is the difference between the diversion of income by an
overriding title and application of income as the former is deductible while the latter is not.

Thus, when management of a company is taken over by another person from the existing team
in consideration of percentage of future profit to the latter, in computing the business income
of the former, such percentage of profits is diversion of income and hence, deductible [CIT v.
Travancore Sugars and Chemicals Ltd. (1973)].

Example of Application of Income: Mr. A is liable to pay Rs. 2,000/- per month to Ms. B (his ex-
wife) as an alimony sum. Mr. A being an employee of Mr. C, instructs him to pay Rs. 2,000/- per month
out of his salary and disburse the remaining salary to him. Whether this amount of Rs. 2,000/- per month
be included in the Total Income of Mr. A or is it a case of diversion of income of Mr. A and not taxable
in his hands?

This is a case of Application of Income by Mr. A and not diversion of Income and hence it will
be included in the Total Income of Mr. A. This is because this amount of Rs. 2,000/- per month
is an obligation of Mr. A to pay to Ms. B out of his income and not an income in which Ms. B
had over riding entitlement from Mr. C before being earned by Mr. A. In other words, this is
an Income of Mr. A, which is applied by him to fulfill an obligation and hence included in his
Total Income and a mere arrangement to make Mr. C make such payments directly to Ms. B
won’t make it a case of Diversion of Income.

Example of Diversion of Income: M/s ABC is a partnership firm in which A and his two sons B &
C are partners. The partnership deed provides that after the death of Mr. A, B & C shall continue the
business of the firm subject to a condition that 20% of profit of the firm shall be given to Mrs. D (Wife
of Mr. A/ Mother of B & C). After the death of Mr. A, whether this 20% amount of profit be included

19
in the Total Income of Firm M/s ABC or is a case of diversion of income of M/s ABC and not taxable
in its hands?

This is a case if Diversion of Income and the said 20% amount shall not be included in the
Total Income of M/s ABC, i.e., it is deductible from its Total Income. This is because the clause
mentioned in partnership deed has given an overriding title of 20% profit to Mrs. D and such
income is a precondition for the firm to continue its business. In other words, this 20% profit
reaches Mrs. D before it becomes income of the firm and hence it is a case of diversion of
Income.

In conclusion, diversion of income and application of income are important concepts under the
Income Tax Act, 1961 in India, which are used to determine the taxability of income in certain
situations where income is diverted or applied by a taxpayer. It's crucial for taxpayers to
understand these concepts and ensure that their transactions are in compliance with the legal
provisions to avoid any potential tax implications. Consulting with a tax professional or seeking
legal advice may be helpful in navigating the complexities of these concepts and ensuring
compliance with the tax laws.

Egs: 1) Mr. Chatur Singh, a CEO of a multinational firm asks one of his employees Buddhu
Singh, to pay $2 million per month to another employee Halagu Khan out of his (Chatur
Singh’s) salary and disburse the remaining salary back to him. This is a case of application of
income by Chatur Singh because the salary is first generated in his name.

Once he has earned it in his account, only then Buddhu Singh can pay $2 million out of it to
Halagu Khan. A mere arrangement to make one employee pay the other won’t make it a case
of Diversion of Income.

2) M/s CBP is a partnership firm in which Chittu and his two sons Bittu and Pintu are partners.

The partnership deed provides that after Chittu’s death, Bittu and Pintu shall continue the
business of the firm subject to a condition that 20% of the profit of the firm shall be given to
Mrs. Battisi (wife of Mr. Chittu and mother of Bittu and Pintu). Will it be an application or
diversion of income?

It is a case of diversion of income at the source itself. After the death of Mr. Chittu, the 20%
amount of profit shall not be included in the total income of M/s CBP i.e. it is deductible from
its total income.

This is because the clause mentioned in the partnership deed has given an overriding title of
the 20% profit to Mrs. Battisi and such income is a precondition for the firm to continue its
business.

In other words, this 20% profit reaches Mrs. Battisi before it becomes the income of the firm
and hence it is a case of diversion of Income.

Eg: Sridhar is a partner in a trading firm ‘William and Sons Partnership’. Sridhar’s share is
25% in the said trading firm.

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By a settlement deed, he had created a trust, assigning 50 percent out of his 25 percent right,
title, and interest (excluding capital), as a partner in the trading, and a sum of Rs. 25,000 out of
his capital in the firm in favor of the said trust.

Sridhar thereafter, claimed that 50 percent of the income attributable to his share from the firm
stood transferred to the trust resulting in the diversion of income at source and the same could
not be included in his total income for the purpose of his Income Tax assessment. Is Sridhar
right?

No. it is a case of application of income because Sridhar being a partner in the trading firm, the
capital, or profit on account of his share is first generated in his name.

Also, in the present case, the said trust does not become entitled to receive the amount (50 %
of the income attributable to his share from the firm) under an obligation of an assessee even
before he could lay a claim to receive it as his income.

The assignee gets no interest or right in the main partnership except the right to receive the part
of the profit assigned to him under the said settlement deed between her and Sridhar.

Further, the assignee entering the said trust does not get any special interest in the main trading
firm by overriding any title of Sridhar.

It just has a right to receive the part of the profit i.e. 50% of the income attributable to his share
from the firm assigned to Sridhar under the settlement deed.

Assessment under Income Tax Act 1961

Every taxpayer has to furnish the details of his income to the Income-tax Department. These details are
to be furnished by filing up his return of income. Once the return of income is filed up by the taxpayer,
the next step is the processing of the return of income by the Income Tax Department. The Income Tax
Department examines the return of income for its correctness. The process of examining the return of
income by the Income Tax department is called as “Assessment”. Assessment also includes re-
assessment and best judgment assessment under section 144. Under the Income-tax Law, there are four
major assessments given below:

• Assessment under section 143(1), i.e., Summary assessment without calling the assessee.

• Assessment under section 143(3), i.e., Scrutiny assessment.

• Assessment under section 144, i.e., Best judgment assessment.

• Assessment under section 147, i.e., Income escaping assessment.

Assessment under section 143(1) This is a preliminary assessment and is referred to as summary
assessment without calling the assessee (i.e., taxpayer).

1. Self Assessment

The assessee himself determines the income tax payable. The tax department has made
available various forms for filing income tax return. The assessee consolidates his income from

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various sources and adjusts the same against losses or deductions or various exemptions if any,
available to him during the year. The total income of the assessee is then arrived at. The
assessee reduces the TDS and Advance Tax from that amount to determine the tax payable on
such income. Tax, if still payable by him, is called self assessment tax and must be paid by him
before he files his return of income. This process is known as Self Assessment. The assessee
himself determines the income tax payable while filing the return of income. Before filing the
return of income assessee is supposed to find whether he is liable to pay any tax, for this
purpose this section has been introduced in the income tax act. This process is generally known
as self-assessment.

2. Summary Assessment

It is a type of assessment carried out without any human intervention. In this type of assessment,
the information submitted by the assessee in his return of income is cross-checked against the
information that the income tax department has access to. In the process, the reasonableness
and correctness of the return are verified by the department. The return gets processed online,
and adjustment for arithmetical errors, incorrect claims, and disallowances are automatically
done.

Example, credit for TDS claimed by the taxpayer is found to be higher than what is available
against his PAN as per department records. Making an adjustment in this regard can increase
the tax liability of the taxpayer. After making the aforementioned adjustments, if the assessee
is required to pay tax, he will be sent an intimation under Section 143(1). The assessee must
respond to this intimation accordingly. Assessment under section 143(1) is like preliminary
checking of the return of income. At this stage, no detailed scrutiny of the return of income is
carried out.

3. Regular Assessment

The income tax department authorizes the Assessing Officer or Income Tax authority, not
below the rank of an income tax officer, to conduct this assessment. The purpose is to ensure
that the assessee has neither understated his income or overstated any expense or loss or
underpaid any tax. The CBDT has set certain parameters based on which a taxpayer’s case gets
picked for a scrutiny assessment.
a. If an assessee is subject to a scrutiny assessment, the Department will send a notice well in
advance. However, such notice cannot be served after the expiry of 6 months from the end of
the Financial year, in which return is filed.
b. The assessee will be asked to produce the books of accounts, and other evidence to validate
the income he has stated in his return. After verifying all the details available, the assessing
officer passes an order either confirming the return of income filed or makes additions. This
raises an income tax demand, which the assessee must respond to accordingly.

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4. Scrutiny Assessment

After submitting an income tax return, an Income Tax Officer may be assigned by the Income
Tax Department to assess the tax filing. The taxpayer is informed of this through an Income
Tax Notice under Section 143(2). The officer may request information, documents, and books
of accounts for scrutiny assessment, which will be thoroughly examined. The officer then
calculates the income tax payable by the taxpayer, and if there is a mismatch between the
income and the tax due, the taxpayer can either pay the extra amount or receive a refund.

If the taxpayer is not satisfied with the assessment, they can apply for recitation under Section
154 or submit a revision application under Section 263 or Section 264. If the Scrutiny
Assessment order is still considered invalid, the taxpayer can appeal to higher authorities such
as CIT (A), ITAT, High Court, and The Supreme Court, in that order. This is a detailed
assessment and is referred to as a scrutiny assessment. At this stage, detailed scrutiny of the
return of income will be carried out to confirm the correctness and genuineness of various
claims, deductions, etc., made by the taxpayer in the return of income. The objective of scrutiny
assessment is to confirm that the taxpayer has not understated the income or has not computed
excessive loss or has not underpaid the tax in any manner. To confirm the above, the Assessing
Officer carries out detailed scrutiny of the return of income and will satisfy himself regarding
various claims, deductions, etc., made by the taxpayer in the return of income. To carry out an
assessment under section 143(3), the Assessing Officer shall serve such notice in accordance
with provisions of section 143(2). In a case where the return of income is not filed by the
taxpayer, then notice under section 142 (1) is issued by the assessing officer for filing the return
of income after the time allowed under sub-section (1) of section 139 for filing the return has
expired, but the return of income is already filed by the taxpayer then the assessing officer
directly issued a notice under section 143 (2) to carry out an assessment under section 143(3).

5. Best Judgement Assessment

This assessment gets invoked in the following scenarios:

a. If the assessee fails to respond to a notice issued by the department instructs him to produce
certain information or books of accounts
b. If he/she fails to comply with a Special Audit ordered by the Income tax authorities
c. The assessee fails to file the return within due date or such extended time limit as allowed
by the CBDT
d. The assessee fails to comply with the terms as contained in the notice issued under Summary
Assessment After providing an opportunity to hear the assessee’s argument, the assessing
officer passes an order based on all the relevant materials and evidence available to him. This
is known as Best Judgement Assessment. This is an assessment carried out as per the best
judgment of the Assessing Officer on the basis of all relevant material he has gathered. This
assessment is carried out in cases where the taxpayer fails to comply with the requirements
specified in section 144. As per section 144, the Assessing Officer is under an obligation to
make an assessment to the best of his judgment in the following cases. If the taxpayer fails to
file the return required within the due date prescribed under section 139(1) or a belated return

23
under section 139(4) or a revised return under section 139(5), or an updated return under section
139(8A). If the taxpayer fails to comply with all the terms of a notice issued under section
142(1). The Assessing Officer can issue the notice under section 142(1) asking the taxpayer to
file the return of income if he has not filed the return of income or to produce or cause to be
produced such accounts or documents as he may require and to furnish in writing and verified
in the prescribed manner information in such form.

6. Income Escaping Assessment

When the assessing officer has sufficient reasons to believe that any taxable income has
escaped assessment, he has the authority to assess or reassess the assessee’s income. The time
limit for issuing a notice to reopen an assessment is 4 years from the end of the relevant
assessment Year.

Some scenarios where reassessment gets triggered are given below.

a. The assessee has taxable income but has not yet filed his return.
b. The assessee, after filing the income tax return, is found to have either understated his income
or claimed excess allowances or deductions.
c. The assessee has failed to furnish reports on international transactions, where he is required
to do so. Assessment could close quickly for some taxpayers, while it could prove to be quite
gruelling for others. If you are not comfortable dealing with income tax officers, it is suggested
that you take the help of a Chartered Accountant to help you with your case.

If any income of an assessee has escaped assessment for any assessment year, the Assessing
Officer may, subject to the new provisions of sections 148 to 153, assess or reassess such
income and also any other income which has escaped assessment and which comes to his notice
subsequently in the course of the proceedings, or recomputed the loss or the depreciation
allowance or any other allowance, as the case may be, for the such assessment year. The
Assessing Officer shall serve on the assessee a notice under Section 148 along with a copy of
the order passed under clause (d) of section 148A, requiring him to furnish within 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.

e. Capital Receipt and Revenue Receipt

Capital receipts are cash inflow in business arising from financial (capital) activities and not
the operating activities of the business. These are receipts resulting from activities which are
occasional or not of routine nature. Capital Receipts are not the regular or main source of
income for an organization. Thus it either creates a liability or reduces the assets for the
business entity. And, because of its capital nature such receipts are shown in the balance sheet
of a company and not the income statement or Profit and Loss account.
These receipts are recorded on an accrual basis (means recording an income for which you
have got the rights to receive but the actual receipt has not yet occurred). Also, since capital

24
receipts are non-recurring in nature, they can not be used for the distribution of profit, unlike
revenue receipts.

Types of Capital Receipts

Capital receipts are divided into three groups-

1. Borrowings

2. Recovery of Loans and

3. Other Capital Receipts

1. Borrowings: It includes the funds raised from outside to meet the expenditure incurred
in the company. It is considered as the capital receipts because it creates liability for the
company.

2. Recovery of Loans: Sometimes the company separates a part of the asset to recover
the loans in future, as a result, it decreases the assets of the company.

3. Other Capital receipts: Under this category of Capital Receipts, Disinvestment and
Small Savings are covered.

Examples of Capital Receipts

• Cash received from the sale of fixed assets

• Amount received from Shareholders and debenture holders

• Borrowings which includes loans, disinvestment, insurance claims etc.

Revenue receipts are money earned by a business through its day to day operational activities.
These are recurring in nature and directly affects the profit and loss of the business. Thus, the
disclosure of revenue receipts are required to be made in the income statement of the company
or organization.
In general terms, we can say that revenue receipts do not create any liability for the business
nor does it reduces the assets. It simply suggests that goods or services have been delivered to
the clients and in return, income has been received. Ultimately it is a source of cash inflow
which leads to an increase in the total revenue of a company.

Examples of Revenue Receipts

Some examples of receipts which are of routine nature i.e. revenue receipts in an organization
are,

• Money received for services provided to customers

• Rent received

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 • Discount received from suppliers, vendors or creditors

• Dividend received

• Interest earned

• Commission received

• Bad-debts recovered(if any)

• Revenue earned by the sale of scrap material or waste etc

Some Important features of Revenue Receipts

• Benefits from revenue receipts can be taken for a short period of time i.e one accounting
or financial year

• As benefits from revenue receipts are for a short period of time, thus another feature
comes that it is recurring in nature

• Revenue receipts come directly from the operational activities of a business

• It directly affects the profit and loss of business. As when revenue is received by a
company it will either increase the profit or will contribute towards loss.

• Disclosure is made under Trading and Profit or Loss account and not in the Balance
Sheet.

Immaterial Considerations

In deciding whether a particular receipt is of a capital or revenue type, the following

considerations are considered to be immaterial and not going to decide or change the character
or nature of the receipt.

1. Receipt in lump sum or in Instalments. Whether any income is received in lump sum
or in instalments, it will not make any difference as regards its nature, e.g., an employee
is to get a salary of 1,000 p.m. Instead of this he enters into an agreement to get a sum
of 36,000 in lump sum to serve for a period of three years. The receipt where it is
monthly remuneration or lump sum for 3 years is a revenue receipt. It has been decided
in so many court cases that a lump sum receipt may be an item of revenue nature and
an annual receipt recurring over few years may be a capital receipt. Thus, whether a
receipt is a periodic receipt or a single receipt is immaterial for the purposes of
determining its nature. [Rajah Manyain Meenak and Shamma v. C.I. T. (1956) 30 1.
T.R. 286].

2. Nature of receipt in the hands of recipient. Whether a receipt is capital or revenue

will be determined in the hands of the persons receiving such income. No attention will

26
 be paid towards the source from which the amount is coming. Salary even if paid out
of capital by a new business will be it revenue receipt in the hands of employee.

3. Magnitude of receipt. The magnitude of the receipt, whether big or small, cannot
decide the nature of the receipt although the size of a receipt in a transaction is not an
entirely irrelevant consideration. A receipt of 10,000 may be of revenue nature whereas
a receipt of only ‘ 1,000 may be a capital receipt. Supreme Court has ruled in a case
Divencha v. C.I. T. (48 1. T.R. 222), that the magnitude of a receipt is immaterial for
the purpose of determining its nature.

4. Name given by parties and treatment in books of accounts. What name the recipient
or payer of the receipt has given in the books of accounts or with what name he has
called a particular transaction, all such considerations are immaterial to decide the
nature of the receipt. A capital payment by a dealer may be a revenue receipt in the
hands of the recipient. The character of the receipt shall be decided by considerations
other than by what name the parties call it. [Divencha v. C.I. T.]. The nature of the
receipt will be determined in the hands of the person receiving such income.

5. Payment made out of capital. No attention will be paid towards the source from which
amount is coming. Salary even paid out of capital by a new business will be a revenue
receipt in the hands of the employee. It was also decided in a case that if a receipt is
made out of capital, the receipt may also be a capital receipt. If a recipient is beneficially
entitled not only to the income but also to the capital, payments given to him by his
trustees out of the corpus would be capital receipts. [Brodie’s Trustees v. I.R. 25 T.C.
13, 16].

6. Time of receipt. The nature of the receipt has to be determined at the time when it is
received and not afterwards when it has been appropriated by the recipient.

7. Quality of receipt. Whether the income is received voluntarily or under a legal

obligation, it will not make any difference as regards its nature.

Distinguishing Tests

It is very difficult to draw a line of demarcation between capital receipts and revenue receipts.
Even the courts have found it difficult to lay down some points of distinction on the basis of
which a capital receipt may be distinguished from a revenue receipt. Some tests, however, can
be applied in particular cases. These tests are

1. On the basis of nature of assets. If a receipt is referable to fixed asset, it is capital receipt
and if it is referable to circulating asset it is revenue receipt.

o Fixed asset is that with the help of which owner earns profits by keeping it in
his possession, e.g., plant, machinery, building or factory, etc.

o Circulating asset is that with the help of which owners earn profit by parting
with it and letting others to become its owner, e.g., stock-in-trade.

27
 o Circulating asset is asset which is turned over and while being turned over yields
profit or loss whereas fixed asset is one on which the owner earns profit by
keeping it in his own possession.

o Profit on the sale of motor car used in business by an assessee is capital receipt
whereas the profit earned by an automobile dealer, dealing in cars, by selling a
car is his revenue receipt.

2. Termination of source of income. Any sum received in compensation for the

termination of source of income is capital receipt, e.g., compensation received by an
employee from its employer on termination of his services is capital receipt.

3. Amount received in substitution of income. Any sum received in substitution of income

is revenue receipt, e.g., ‘A’ company purchased the right to produce a film from its
earlier producer with the condition that no other producer will be given these rights.
Afterwards it is found that the rights for producing this film had already been sold. The
‘A’ company claimed damages and was awarded 40,000. It was held that damages
received are the compensation for the profits which were to be earned. Hence this is
revenue receipt.

4. Compensation received on termination of lease. Where a sum is received as

compensation for termination of a lease, it is capital receipt because it is termination of
source of income.

5. Compensation on surrender of a right. Any amount received as compensation on

surrendering a right is capital receipt whereas any amount received for loss of future
income is a revenue receipt. An author gives up his right to publish a book and receives
1,00,000 as compensation. It is capital receipt but if he receives it as advance royalty
for 5 years it is revenue receipt.

6. Tests as to the purpose of keeping an article. If a person purchases a piece of sculpture

to keep as decoration piece in his house, if sold later on, will bring causal receipt but if
the same sculpture is sold by an art dealer it will be his revenue receipt.

7. If an article is acquired for the purpose of trade, the profit arising from it is revenue
receipt.

Example :

State , giving reasons, whether the following are Capital or Revenue Receipts :

1. Compensation received for compulsory vacation of place of business.

1. Bonus shares received by a dealer of shares.

2. Money received by a Tyre Manufacturing company for sale of technical know-how

regarding manufacture of tyre.

3. Dividend and interest for investment.

Solutions :

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 1. Revenue receipt as it is in compensation of assessee’s profit which it would have
earned.

2. If the assessee has also converted the bonus shars into stock in trade then it is a revenue
receipt otherwise it is an accretion in the capital assets.

3. Revenue Receipt but in case the sale of technical know-how results into substantial
reduction in value of the tyre company or company closes down its business in that
particular line then the receipt would be a Capital Receipt.

Assessee gets the income of dividend and interest regularly and form a define source and it is
a return for the use of his asset by somebody else and so it is a revenue receipt.

f. Rates of Income Tax: Proportional & Progressive Rate of Taxation

The tax is levied on the income of individuals and businesses, and the rate of tax depends on
the amount of income earned. Considering the relation between the tax rate and the tax base
(income), there can be four types of taxation, viz.: (i) Proportional taxes, (ii) Progressive taxes,
(iii) Regressive taxes and (iv) Digressive taxes.

In India, there are two types of rates of income tax – proportional and progressive.

Income tax is one of the primary sources of revenue for governments around the world. It is a
direct tax levied on the income of individuals, companies, and other entities. The rates of
income tax can be levied through two methods – a proportional rate of taxation or a progressive
rate of taxation. This research paper aims to analyze the two methods of taxation, their
advantages and disadvantages, and their impact on government revenue, fairness, and
incentives to work harder and earn more.

Income tax is an important source of revenue for the Indian government. The tax is levied on
the income of individuals and businesses, and the rate of tax depends on the amount of income
earned. In India, there are two types of rates of income tax – proportional and
progressive. (John, 2021)

Proportional Rate of Taxation:

A proportional rate of taxation, also known as a flat tax, means that every individual pays the
same percentage of tax regardless of their income. For example, if the flat tax rate is 10%, then
a person earning $20,000 per year will pay $2,000 in taxes, while a person earning $200,000
per year will pay $20,000 in taxes.

A proportional rate of taxation, also known as a flat tax, is a tax where the rate of tax is the
same for all levels of income. In India, a proportional rate of taxation is applied to companies,
with a flat rate of tax of 25% on their income

Advantages of Proportional Rate of Taxation:

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One of the primary advantages of a proportional rate of taxation is that it is simple and easy to
understand. A flat tax also encourages people to work harder and earn more because they will
not be penalized with a higher tax rate. This is because a flat tax does not discourage work or
investment, which is beneficial for economic growth.

Another advantage of a flat tax is that it reduces the administrative burden of tax collection. A
flat tax simplifies the tax system, making it easier to administer and reducing the need for
complex tax regulations.

Disadvantages of Proportional Rate of Taxation:

One of the biggest disadvantages of a proportional rate of taxation is that it is regressive. A flat
tax places a higher burden on low-income earners as they have to pay the same percentage of
tax as high-income earners. This means that a low-income earner will have to pay a higher
percentage of their income in tax compared to a high-income earner. This reduces the fairness
of the tax system as low-income earners are taxed at the same rate as high-income earners.

Another disadvantage of a flat tax is that it reduces government revenue. High-income earners
will pay less tax compared to the progressive rate of taxation, reducing the government’s ability
to fund public expenditure.

Progressive Rate of Taxation:

A progressive rate of taxation is a tax where the rate of tax increases with the level of income.
In India, a progressive rate of taxation is applied to individuals, with different tax rates for
different levels of income.

A progressive rate of taxation means that individuals with higher incomes pay a higher
percentage of their income in taxes. The progressive rate of taxation is based on the principle
of the ability to pay. The more an individual earns, the higher their ability to pay taxes. Under
a progressive tax system, the tax rate increases as income increases. For example, if the tax rate
is 10% for income up to $50,000 and 20% for income above $50,000, then a person earning
$60,000 will pay $5,000 in taxes (10% on the first $50,000 and 20% on the remaining $10,000).

Advantages of Progressive Rate of Taxation:

One of the primary advantages of a progressive rate of taxation is that it is fairer than a flat tax.
A progressive tax system places a higher burden on high-income earners, who have a greater
ability to pay taxes. This means that the tax system is more equitable and progressive as it
reduces the income gap between low-income and high-income earners.

Another advantage of a progressive tax system is that it provides the government with a stable
source of revenue. High-income earners pay a higher percentage of their income in taxes, which
means that the government has a more consistent and reliable source of revenue.

Disadvantages of Progressive Rate of Taxation:

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One of the biggest disadvantages of a progressive rate of taxation is that it can reduce the
incentive to work harder and earn more. High-income earners may feel discouraged from
working harder if they know that they will be taxed at a higher rate for their increased income.
This can lead to a reduction in economic growth as people may not have the same motivation
to work harder and increase their income.

Another disadvantage of a progressive rate of taxation is that it can lead to tax evasion and
avoidance. High-income earners may try to find ways to reduce their taxable income or hide
their assets to avoid paying higher taxes. This can reduce government revenue and increase the
burden on low-income earners. (Kakkar, 2016)

Comparison of Proportional and Progressive Rate of Taxation:

The choice between a proportional rate of taxation and a progressive rate of taxation ultimately
depends on the priorities of the government and the society it serves. A flat tax may be more
beneficial for countries with a small and homogeneous population, as it simplifies the tax
system and encourages economic growth. However, for countries with high levels of income
inequality, a progressive tax system may be more appropriate as it reduces the income gap
between low-income and high-income earners.

A flat tax may also be suitable for countries with a low level of government expenditure, as it
reduces the administrative burden of tax collection and provides a stable source of revenue.
However, for countries with high levels of government expenditure, a progressive tax system
may be more effective in providing a sufficient source of revenue.

In India, the choice between a proportional rate of taxation and a progressive rate of taxation
ultimately depends on the priorities of the government and the society it serves. A flat tax may
be more beneficial for India, as it simplifies the tax system and encourages economic growth.
However, for a country with high levels of income inequality like India, a progressive tax
system may be more appropriate as it reduces the income gap between low-income and high-
income earners.

India currently follows a progressive tax system, with different tax rates for different levels of
income. The tax rates range from 0% to 30%, with the highest rate of tax applicable to
individuals earning over INR 10 million per annum. However, there have been proposals to
introduce a flat tax in India, which would simplify the tax system and reduce the administrative
burden of tax collection.

Let’s outline the key differences between progressive and proportional taxation:

1. Tax Rate Structure:

• Progressive Taxation: In a progressive tax system, the tax rate increases as an

individual's income increases. Higher income individuals pay a higher percentage of
their income in taxes. This approach is designed to distribute the tax burden more
equitably and reduce income inequality.

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 • Proportional Taxation: In a proportional tax system (also known as a flat tax), all
individuals, regardless of their income, pay the same fixed percentage of their income
in taxes. This means that the tax rate remains constant across income levels.

2. Tax Burden:

• Progressive Taxation: Progressive taxation places a relatively heavier tax burden on

individuals with higher incomes. The idea is that those who can afford to contribute
more should do so, aiming to achieve greater social equity.

• Proportional Taxation: Proportional taxation imposes an equal tax burden on all

individuals, regardless of their income. While this can appear fair on the surface, critics
argue that it may disproportionately affect low-income individuals by consuming a
larger portion of their disposable income.

3. Income Redistribution:

• Progressive Taxation: One of the main goals of progressive taxation is to redistribute

wealth and income from higher-income individuals to lower-income individuals. This
is done through the mechanism of taxing higher incomes at higher rates and using the
tax revenue for social welfare programs.

• Proportional Taxation: Proportional taxation doesn't inherently focus on income

redistribution. It tends to keep the tax burden equal for all individuals, which can lead
to less wealth redistribution compared to a progressive system.

4. Impact on Economic Behavior:

• Progressive Taxation: Critics argue that progressive taxation can discourage high-
income earners from working harder or earning more because a larger portion of their
additional income is taxed at higher rates. This potential disincentive to earn more
income is known as the "income effect."

• Proportional Taxation: Proportional taxation is generally considered to have less

impact on economic behavior, as the tax rate remains the same regardless of income
levels. This could provide less disincentive for high-income individuals to earn more.

5. Administrative Complexity:

• Progressive Taxation: A progressive tax system requires multiple tax brackets and
rates, which can make it administratively more complex to manage and implement.

• Proportional Taxation: Proportional taxation is simpler to administer because there is

only one tax rate that applies to all income levels.

In summary, progressive taxation seeks to address income inequality and social equity by
taxing higher incomes more heavily and redistributing wealth. Proportional taxation, on the
other hand, applies the same tax rate to all individuals regardless of income, potentially

32
resulting in a simpler tax system but potentially impacting income equality. Both approaches
have their advantages and disadvantages and are subject to ongoing debate and policy
considerations.

g. Agricultural Income

As per section 10(1), agricultural income earned by the taxpayer in India is exempt from tax.
Agricultural income is defined under section 2(1A) of the Income-tax Act. As per section
2(1A), agricultural income generally means:

(a) Any rent or revenue derived from land which is situated in India and is used for agricultural
purposes.

(b) Any income derived from such land by agriculture operations including processing of
agricultural produce so as to render it fit for the market or sale of such produce.

(c) Any income attributable to a farm house subject to satisfaction of certain conditions
specified in this regard in section 2(1A). Any income derived from saplings or seedlings grown
in a nursery shall be deemed to be agricultural income.

(d) Income earned from commercial use of agricultural use

**Income from a farmhouse is exempt from tax if it meets certain criteria defined in section
2(1A) of the Income Tax Act:

• - The farmhouse should be situated on or near the agricultural land, and

• - The agricultural land should not fall within the specified area, which is:

Aerial distance from municipality Population

Within 2 km 10,000 to 1,00,000

Within 6 km 1,00,000 to 10,00,000

Within 8 km > INR 10,00,000

How much agricultural income is exempt from income tax?

There is a complete tax rebate on agriculture income in these cases

1. If your total agricultural income is less than Rs. 5,000 p.a.;

2. If the income from agricultural land is your only source of income, i.e., no other income;

33
 3. Where you have both agricultural income and other income and if the total income
excluding such agricultural income is less than the basic exemption limit.

But, in case, your agricultural income exceeds Rs. 5,000 and you have other sources of income
too, then the tax liability for that year is to be calculated as:

1. Compute income tax on the aggregate income (i.e. agricultural income + other income)
as per the prevailing income tax rates.

2. Compute income tax on the sum of the amount of basic exemption limit plus
agricultural income as per the prevailing income tax rates.

3. Now, Compute (1) – (2) to arrive at the tax liability for the year.

What are some exclusions to this income?

Few exclusion that not considered as agricultural income:

• Income from processed agricultural products without direct agricultural activities

• Income from highly processed products of agricultural origin

• Income from selling trees as timber

Income from agricultural should be produced by a cultivator or a rent receiver of that produce
in-kind, which can be fit to take that into the market.

The income should be derived from the sale by a cultivator or a rent receiver of that product
which is produced or received by him, no process can be performed other than the process to
render it fit for the market.

Income which is derived from the building should follow some conditions:

1. The building should be situated in India;

2. It should be occupied by a cultivator or a receiver of rent-in-kind.

3. In the connection of the land of a cultivator or a rent receiver, the building required to
be as a dwelling-house, store-house or other outbuildings.

Agricultural Income has been exempted from Income Tax under Sec. 10(1) of the Income Tax
Act, where it has been given that, in computing, the total income of a previous year of a person
whose source of income is agriculture will not fall under the category of total income. The
burden of proof that an income fall under this category is on the assessee.

Sri Ranganatha Enterprises v. CIT [1998] 232 ITR 568 (kar.)

In this case, the Court held that the burden lies on the assessee to prove that the income derived
by him is the agricultural income for which he is claiming an exemption under Sec. 10(1) of
the Income Tax Act.

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Necessary conditions for income to be Agricultural income

There are some necessary conditions which are required for income to be Agricultural income
–

• Income should be derived from land

The very first requirement is the income should be derived from land not from any other assets.
Land can be owned or occupied by a cultivator who produces on that land, or a rent receiver of
that produce. Land can be farming land or a building that should be occupied or owned by a
cultivator or a rent receiver. That building or farmhouse should be on the same land and used
as a dwelling-house, store-house or other outbuildings.

Income should be in the form of rent or revenue,

Rent is payment, it can be in cash or in-kind, by one person to another in respect of a grant of
right to use that land.

Revenue is used in a broader sense, In the case of Durga Narain Singh v. CIT [ (1947) 15 ITR
235]

“Revenue” covers income other than rent. Mutation fees extracted from tenants upon their
succeeding to occupancy holding are revenue derived from land.

Revenue can be derived from land only if lands are an effective and immediate source of
income and not the indirect and secondary source of income. Where income derived from
indirect source then it will not be considered income derived from land.

We can understand this with the help of the case Bacha F. Guzdar v. CIT,

In this case, a dividend paid by a company out of its agricultural income is not revenue derived
from land, as an effective and immediate source of income is shareholding and not the land.

Let’s discuss this situation with some illustrations-

1. If a person X owns the land and give it to Mr.Y for rent for agricultural purpose. Mr.Y
uses that land for growing wheat. Is it taxable or not?

No, it is not taxable because here income derived by a cultivator and a rent receiver is as per
the condition.

• If a person X owns a building and give it to Mr.Y on rent for Agricultural Purpose. But
Mr.Y uses that building for the non-agricultural purpose. What will be the result?

This will be taxable because the income derived here is other than the agricultural purpose.

• Land must be situated in India

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Another condition is the land must be situated in India, whether situated in urban areas or rural
areas. The areas are also mentioned in Sec. 2(1A) of the Income Tax Act. The area where land
revenue can be collected by officers of the government:

1. If it is situated in an area which comes within the jurisdiction of the municipality or

cantonment board where the population is not less than ten thousand.

2. Any area within the distance,

3. Not being more than two kilometers from the local limits of any municipality or
cantonment board and which has a population of more than ten thousand but not
exceeding one lakh.

4. Not being more than six kilometers from the local limits of any municipality or
cantonment board and which has a population of more than one lakh but not exceeding
ten lakh.

5. Not being more than eight kilometers from the local limits of any municipality or
cantonment board and which has a population of more than ten lakh.

Agricultural income from foreign countries will be considered as income from other sources
and it will not be exempted under Agricultural income.

E.g.- A person owns the land in Africa and give it to Mr. A on rent for the Agricultural purpose.
Now, the income which is earned by that person will consider being an income from other
sources and will include in the total income.

• Land must be used for basic operations of Agriculture

For exemption under agricultural income, the operation must be related to agricultural. That
means land should be used for the agricultural purpose.

Now, what can be understood by the term ‘Agricultural Purpose’. In the case of CIT v. Raja
Benoy Kumar Suhas Roy [1957] 32 ITR 466, the Supreme Court laid down the principles in
regard to the term ‘Agriculture’ and ‘Agricultural Purposes’.

SC divided operations into two types-

• Basic operation.- Basic operation includes the expenditure of human skill and labor
upon the land itself, merely having an agricultural land will not constitute agricultural
purposes. Some operations like tilling of land, sowing of the seeds, planting, etc.

• Subsequent operation.- Subsequent operations are performed after the produce sprouts
from the land. Like weeding (removal of wild plants), digging the soil around the
growth, removal of undesirable undergrowths, removal of the crop from insects and
pests, cutting, harvesting, rendering the produce fit for the market etc.. Subsequent
operation must be in continuation of basic operations, mere performance of these
activities on the land will not constitute agricultural operation.

36
If this integrated activity is done on the land then it can be said to be “Agricultural purposes”
and the income derived from these activities said to be “Agricultural income”.

Agricultural Activity does not merely include the production of foods and grains. It includes
all products from the performance of basic and subsequent operations on land. We can not
confine it to the production of food and grains for human consumption, it can also include
products for trade and commercial assets like cotton, flax, jute, indigo, etc. and it would also
include forest products like timber, sal, tendu leaves, and all those forest products which are
used for commercial purpose.

In support of the Agricultural operation, there is another case K. Lakshmanan Co. v.

CIT [1999] 239 ITR 597 (SC),

In this case, SC held that Sec. 2(1A)(b) of the Act does not contemplate the sale of commodity
different from what is cultivated and processed and where the assessee is growing mulberry
leaves, feeding them to silkworms and obtaining silk cocoons, income from the sale of silk
cocoons is not an agricultural income.

• Income from a Nursery

Income from a nursery is always exempted from total income.

H.H. Maharaja Vibhuti Narain Singh v. State of Uttar Pradesh [1967] 65 ITR 364 (All.)

In this case, the Hon’ble Allahabad High Court held that income from a nursery is not an
agricultural income unless maintained by a farmer as an aid or necessary adjunct to the primary
process of agriculture, for example, paddy nursery, nursery of tomato plants. Here assessee
used the nursery for ornamental plants which can not be considered an adjunct to the primary
agricultural process.

In the case of CIT v. Saundarya Nursery [2000] 241 ITR 530 (Mad.), the Madras High Court
held that nursing activities involve carrying out of several operations on land before the sapling
were transplanted in a particular pot and then put them in shades for further operation and
growth. Therefore, the income from the nursery will consider being an agricultural income.

Rent or Revenue from Land

Rent or Revenue is a kind of income derived from agricultural income by the landlord or the
owner of the land.

Rent can be in cash or in-kind. E.g.- if a person owns the land and gives it to another person on
rent for agricultural purposes @ Rs. 5,000, then this amount of income considered to be rent
from land in cash which is a part of agricultural income.

Another example of rent from land is,

A person owns the land and gives it to Mr.B on rent for agriculture, a tenant will give 1/3rd
part of the whole wheat grown to the landlord, this is rent from land in-kind.

37
Revenue is a kind of profit received from the land. Let’s say, a landowner asks a farmer to
grow wheat and 50% of its profit will be credited to the landlord. This profit is revenue from
land.

Rent or revenue derived from land should fulfill three essential conditions

1. Rent or revenue should be earned from land.- To receive rent or revenue, the most
important point is that it should be earned from land. Rent or revenue received from
assets other than land will not be considered as income derived from land.

Revenue which is received by the landlord should be from the direct and immediate source. If
the land is an indirect and secondary source then revenue will not be considered to be
agricultural income. In the support of the statement, there is a case-

Pratap Singh v. Province of Bihar [1949] 17 ITR 202 (pat.)

In this case, the Malikana allowance paid by the government under a legal obligation to an
owner, dispossessed of his land, is not revenue derived from land, as the immediate source of
income is the government’s legal obligation to pay compensation and not the land.

• Land should be situated in India .- The Second essential condition is to be land should
be situated in India, otherwise, it will be considered to be income from other sources
and will not include in agricultural income. Land can either be in a rural or urban
area. Some conditions are given under Sec. 2(1A)(c) of the Income Tax Act in regards
to the Area which is considered to be land.

• Land should be used for agricultural purposes.- The land should be used for
Agricultural purposes. We have discussed earlier the meaning of the term “Agricultural
Purpose” with the help of case:

CIT v. Raja Benoy Kumar Suhas Roy [1957] 32 ITR 466, where SC laid down the principles
of basic operation and subsequent operation.

Mere connection with land will not be sufficient for Agricultural Purpose. There should be
activities in connection with agriculture. Activities like dairy farming, poultry farming, cheese
and butter making, etc. are not considered to be agricultural activities.

Illustrations –

1. A landowner receives rent in-kind from a tenant who grows wheat on that land, now
the landowner sells it in the market @ Rs. 20000. This income is derived from
agricultural operation.

2. A landowner receives the rent of 1/3rd of whole wheat grown in his land. And he uses
that wheat in making biscuits and sells it in the market. Here, this activity is not
considered to be an agricultural operation because that income is business income.

Income derived from Agricultural produce and marketing processes

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Any income derived by a cultivator or receiver of rent-in-kind from agriculture by the sale of
agricultural produce on which necessary operations( maybe or may not be needed)are carried
on to render the produce fit for consumption and taking it to market is called as agricultural
income. Such income is exempt from taxation. However in case of operations performed are
not in nature as mentioned above, income has to be separated so as to compute tax on non-
agricultural income. The operations mentioned above are called as agricultural or marketing
operations.

There are two conditions which must be satisfied for marketing operation;

1. The agricultural process must be performed by a person employed by a cultivator or a

receiver of rent-in-kind.

2. That product should be fit to be taken to market.

There are some ordinary process employed to render the produce fit to be taken to market like-
thrashing, winnowing, cleaning, drying, crushing, boiling and decanting, etc. if the income
derived from these marketing process will be considered as agricultural income.

If the marketing process is performed on products that can be sold in the market in its raw form
without performing any operation which makes it fit for marketing, then that income will be
considered as partly agricultural and partly from a business.

Brihan Maharashtra Sugar Syndicate Ltd. v. CIT [1946] 14 ITR 611 (Bom.)

In this case, assessee carries the business in the manufacture and sale of sugar, and then he
owns a sugarcane farm and utilized this in the production of sugar. The court, in this case, held
that the process of converting sugarcane into sugar would not be agricultural process and the
income derived from this would not be agricultural income.

Income from Farm building

Income from farm building which is derived from Agricultural operation is exempted from tax.
But to satisfy that property is used for agricultural purposes there are some essential
requirements that need to be fulfilled. Those conditions are:

1. The building must be occupied by the cultivator or the receiver of rent-in-kind;

2. The land must be situated in India and used for agricultural purposes;

3. The building which is used for agricultural operations by the cultivator or the rent
receiver must be as a dwelling house, storehouse.

4. The land is assessed to land revenue or local rates or land is situated in rural areas.

Rural Areas for the above purpose are given under Sec.2(1A)(c)(ii) of the Act, any area not
situated:

39
 1. within the jurisdiction of municipality or cantonment board and where the population
is not more than ten thousand.

2. within 2km from the local limits of municipality or cantonment board, where the
population is more than 10000 but less than 1 lakh.

3. Within 6km from the local limits of municipality or cantonment board, where the
population is more than 1 lakh but less than 10 lakh.

4. Within 8km from the local limits of municipality or cantonment board, where the
population is more than 10 lakh.

The use of the building other than farming activity will not be exempted under Income
Tax. E.g.- If an owner gives that building on rent for residential purpose then income derived
from that building will not be exempted.

Illustrations

1. Mr. W owns farmland and there is a building attached to that land. Mr. W gives it on
rent to Mr. H @ rs.4000(rs. 3500 for land and rs. 500 for a house). Income received by
Mr.W will be exempted here because the land is used for an agricultural purpose and
the building is attached to the land and used by cultivator as a dwelling house.

2. A person owns a building in a particular city and gives it on rent to Mr. X who is a
farmer. Mr. X uses it as a dwelling house. Is it taxable or not? In this case, income is
taxable because the building is not attached to any land, so it is not an agricultural
income and taxable.

3. Mr. D owns the land and gives it to Mr. A for Agricultural operation. Mr. A uses that
land for Dairy Farming. Agricultural income will not be exempted because dairy
farming is not an agricultural activity.

Partly Agricultural and Partly Non-agricultural Income

Sometimes, income comprises of both agricultural as well as non-agricultural income. Such a

situation arises in case of certain ‘Agro based industries where agricultural produce is used as
raw material and it (i.e., raw material) is produced by the same person (i.e., industrialist) who
manufactures industrial product by using such raw material. Such industries (i.e., persons),
earn income by selling the industrial product manufactured from self grown agricultural raw
material.

For example :

Mr. X is the owner of agricultural land in India and produces sugarcane by spending Rs.
2,00,000. Further, X set up an industrial undertaking to manufacture sugar from sugarcane so
produced. Accordingly, he uses the whole quantity of sugarcane for producing sugar and

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spends Rs, 2,50,000 as industrial expenses. He ultimately sells the sugar so produced for Rs.
7,00,000.

In this case, the total income of Mr. X shall be calculated as follows :

Total Income = Sale proceeds of sugar - Cost of cultivation - Industrial expenses

= Rs. (7,00,000 - 2,00,000 - 2,50,000) = Rs. 2,50,000

The above total income of Mr. X is the composite income comprising of agricultural income and non-
agricultural income. The income attributable to agricultural operations (i.e., raising of sugarcane) is
agricultural income and the income attributable to industrial operations (i.e., manufacturing sugar
from sugarcane) is non-agricultural income.

In such a situation, it becomes necessary to disintegrate (bifurcate) the two incomes because
agricultural income is exempt from tax and non-agricultural income is taxable.

Rules 7, 7A, 7B and 8 of Income Tax Rules, 1962 provide the method of segregating the two
incomes. These rules deal with calculation of agricultural income and non-agricultural income
in such cases of composite income.

(A) Income from Growing and Manufacturing of any product other than Tea [Rule 7]

An assessee may have composite business income which is partially agricultural and partially
non-agricultural, for example, where XYZ Ltd. grows potatoes and further processes its
produce to sell them as wafers. In this case the company has composite income i.e. from
agriculture and from business. The composite income has to be disintegrated and for computing
business income the market value of any agricultural produce raised by the assessee or received
by him as rent in kind and utilised as raw material in his business is deducted. No further
deduction is permissible in respect of any expenditure incurred by the assessee as a cultivator
or receiver of rent in kind. For computing agricultural income the market value of agricultural
produce will be total agricultural receipt on account of potatoes. From such agricultural
receipts, expenses such as cultivation expenses etc. incurred in connection with such receipt
will be deducted and balance will be agricultural income which will be exempt.

For example, in the above case, if the market value of the potatoes grown by the company,
which have been used for the purpose of making its own wafers, is Rs. 5 lakhs and the cost of
cultivation of such potatoes is Rs. 4 lakhs, the agricultural income shall be Rs. 1 lakh (5 lakhs
- 4 lakhs). This agricultural income of Rs. 1 lakh shall be exempt. Further for the purpose of
computing business income from the sale of wafers produced from such potatoes, the company
shall be allowed deduction of `5 lakhs as the cost of potatoes, being the market value of potatoes
grown by it.

(B) Income from Growing and Manufacturing of Rubber [Rule 7A]

1. Income derived from the sale of centrifuged latex or cenex or latex based crepes (such
as pale latex crepe) or brown crepes (such as estate brown crepe, re-milled crepe,
smoked blanket crepe or flat bark crepe) or technically specified block rubbers
manufactured or processed from field latex or coagulum obtained from rubber plants

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 grown by the seller in India shall be computed as if it were income derived from
business, and 35% of such income shall be deemed to be income liable to tax.

2. In computing such income, an allowance shall be made in respect of the cost of planting
rubber plants in replacement of plants that have died or become permanently useless in
an area already planted, if such area has not previously been abandoned, and for the
purpose of determining such cost, no deduction shall be made in respect of the amount
of any subsidy which, under the provisions of section 10(31), is not includible in the
total income.

(C) Income from Growing and Manufacturing of Coffee [Rule 7B]

a. Income derived from the sale of coffee grown and cured by the seller in India, shall be
computed as if it were income derived from business, and 25% of such income shall be
deemed to be income liable to tax.

b. Income derived from the sale of coffee grown, cured, roasted and grounded by the seller
in India, with or without mixing chicory or other flavouring ingredients shall be
computed as if it were income derived from business, and 40% of such income shall be
deemed to be income liable to tax.

(D) Income from Growing and Manufacturing of Tea [Rule 8]

Where the assessee has a business of growing tea leaves and then processing it (or
manufacturing the same), the procedure adopted to disintegrate is as under:

Step 1: Compute the income of growing as well as manufacturing tea under the head
'profits and gains of business or profession' after claiming the deductions available under that
head.

Step 2: 60% of the income computed in Step 1 will be treated as net agricultural income
and 40% of such income, so arrived at, is treated as business income.

Tax on Non-Agricultural Income if the Assessee has both Agricultural & Non-Agricultural
Income

As already discussed, there is no tax on agricultural income but if an assessee has non-
agricultural income as well as agricultural income, such agricultural income is included in his
Total Income for the purpose of computation of Income-tax on non-agricultural income. This
is also known as partial integration of agricultural income with non-agricultural income or
indirect way of taxing agricultural income.

Such partial integration is done only in the case of:

i. individual;

ii. HUF;

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 iii. AOP/BOI;

iv. Artificial juridical person.

It is not done in the case of:

i. firm;

ii. company;

iii. co-operative society;

iv. local authority.

The partial integration is done to compute the tax on non-agricultural income only when the
following two conditions are satisfied:

1. non-agricultural income of the assessee exceeds the maximum exemption limit which
is Rs. 2,50,000 in the case of an individual (other than individual of the age of 60 years
or above) and HUF, etc.; and

2. the Net Agricultural Income exceeds Rs. 5,000.

Computation of tax where there is agricultural income also:

The following steps should be followed to calculate the tax:

Step 1: Add agricultural income and non-agricultural income and calculate tax on the aggregate
as if such aggregate income is the Total Income.

Step 2: Add agricultural income to the maximum exemption limit available in the case of the
assessee and compute tax on such amount as if it is the Total Income.

Step 3: Deduct the amount of income-tax as computed under Step 2 from the tax computed
under Step 1.The amount so arrived at shall be total Income-tax payable by the assessee.

Step 4: Claim rebate under section 87A if applicable.

Step 5: Add surcharge if applicable + education cess and SHEC @ 3%

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