Basic Concept | Income Tax | Study Notes | Bachelor of Commerce | 3rd Semester CBCS (Honours) | Dibrugarh University

Basic Concept | Income Tax | Study Notes | Bachelor of Commerce | 3rd Semester CBCS (Honours) | Dibrugarh University

INCOME TAX

BASIC CONCEPT

What is an assessment year [Sec. 2(9)]? 

-> Assessment year means a period of 12 months commencing from 1st April every year and its ends on 31st March. It is the following year in which this income is assessed and taxed. Assessment year always comes after financial year.

What is a previous year [Sec. 3]?

-> As per the income tax law the income earned in current year is taxable in the next year. The year in which income is earned is known as the previous year. In layman language the current financial year is known as the previous year. The financial year starts from 1st April and end on 31st March of the next year.

Who are included in “person” [Sec. 2(31]?

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

  1. an Individual;
  2. a Hindu Undivided Family (HUF) ;
  3. a Company;
  4. a Firm;
  5. an association of persons or a body of individuals, whether incorporated or not;
  6. a local authority; and
  7. every artificial juridical person not falling within any of the preceding sub-clauses.
  8. Association of Persons or Body of Individuals or a Local authority or Artificial Juridical Persons shall be deemed to be a person whether or not, such persons are formed or established or incorporated with the object of deriving profits or gains or income.

The word person is a very wide term and embraces in itself the following :

  1. Individual- It refers to a natural human being whether male or female, minor or major.
  2. Hindu Undivided Family- It is a relationship created due to operation of Hindu Law. The manager of HUF is called “Karta” and its members are called ‘Coparceners’.
  3. Company- It is an artificial person registered under Indian Companies Act 1956 or any other law.
  4. Firm- It is an entity which comes into existence as a result of partnership agreement between persons to share profits of the business carried on by all or any one of them. Though, a partnership firm does not have a separate legal entity, yet it has been regarded as a separate entity under Income Tax Act. Under Income Tax Act, 1961, a partnership firm can be of the following two types
    1. a firm which fulfill the conditions prescribed u/s 184.
    2. A firm which does not fulfill the conditions prescribed u/s 184.

It is important to note that for Income Tax purposes, a limited liability partnership (LLP) constituted under the LLP Act, 2008 is also treated as a firm.

5. Association of Persons or Body of Individuals- Co-operative societies, MARKFED, NAFED etc. is the examples of such persons. When persons combine together to carry on a joint enterprise and they do not constitute partnership under the ambit of law, they are assessable as an association of persons. Receiving income jointly is not the only feature of an association of persons. There must be common purpose, and common action to achieve common purpose i.e. to earn income. An AOP can have firms, companies, associations and individuals as its members.

A body of individuals (BOl) cannot have non-individuals as its members. Only natural human beings can be members of a body of individuals.

Whether a particular group is AOP or BOl is a question of fact to be decided in each case separately.

6. Local Authority- Municipality, Panchayat, Cantonment Board, Port Trust etc. are called local authorities.

7. Artificial Juridical Person- A public corporation established under special Act of legislature and a body having juristic personality of its own is known to be Artificial Juridical Persons. Universities are an important example of this category.

Who is regarded as Assessee [Sec. 2(7)]?

-> As per S. 2(7) of the Income Tax Act, 1961, unless the context otherwise requires, the term “assessee” means a person by whom any tax or any other sum of money is payable under this Act, and includes,-

(a) every person in respect of whom any proceeding under this Act has been taken for the assessment of his income or assessment of fringe benefits or of the income of any other person in respect of which he is assessable, or of the loss sustained by him or by such other person, or of the amount of refund due to him or to such other person;

(b) every person who is deemed to be an assessee under any provision of this Act;

(c) every person who is deemed to be an assessee in default under any provision of this Act.

From above definition, we can construe that normally the term ‘Assessee’ is considered as one who is supposed to pay tax under the Income Tax Act, however for better understanding of the term ‘assessee’, we need to understand the following as well:

1. Normal Assessee 

i) any person against whom proceedings under Income Tax Act are going on, irrespective of the fact whether any tax or other amount is payable by him or not;

ii) any person who has sustained loss and filed return of loss u/s 139(3);

iii) any person by whom some amount of interest, tax or penalty is payable under this Act;

iv) any person who is entitled to refund of tax under this Act.

2. Representative Assessee 

A person may not be liable only for his own income or loss but he may also be liable for the income or loss of other persons e.g. agent of a non-resident, guardian of minor or lunatic etc. In such cases, the person responsible for the assessment of income of such person is called representative assesses. Such person is deemed to be an assessee.

3. Deemed Assessee 

i) In case of a deceased person who dies after writing his will the executors of the property of deceased are deemed as assessee.

ii) In case a person dies intestate (without writing his will) his eldest son or other legal heirs are deemed as assessee.

iii) In case of a minor, lunatic or idiot having income taxable under Income-tax Act, their guardian is deemed as assessee.

iv) In case of a non-resident having income in India, any person acting on his behalf is deemed as assessee.

4. Assessee-in-default 

A person is deemed to be an assessee-in-default if he fails to fulfill his statutory obligations. For example, an assessee who fails to pay the demand u/s 156 within 30 days, in full, shall be deemed to be an ‘Assessee in Default’, except in circumstances where he has obtained Order staying the demand in due course. An assessee in default will continue to be so, unless he has cleared the demand/ obligations in full.

Further, In case of an employer paying salary or a person who is paying interest, it is their duty to deduct tax at source and deposit the amount of tax so collected in Government treasury. If he fails to deduct tax at source or deducts tax but does not deposit it in the treasury, he is known as assessee-in-default.

How to Charge Tax on Income?

-> To know the procedure for charging tax on income, one should be familiar with the following:

1. Annual tax- Income-tax is an annual tax on income.

2. Tax rate of assessment year- Income of previous year is chargeable to tax in the following assessment year at the tax rates applicable for the assessment year. This rule is, however, subject to some exemptions.

3.  Rates fixed by Finance Act- Tax rates are fixed by the annual Finance Act not by the Income-tax Act. For instance, tax rates for the assessment year 2018-19 are fixed by the Finance Act, 2018. If, however, on the first day of April of the assessment year, the new Finance Bill has not been placed on the statue book, the provisions in force in the preceding assessment year or the provisions proposed in the Finance Bill before Parliament, whichever is more beneficial to the assessee, will apply until the new provisions become effective.

4. Tax on person- Tax is charged on every person.

5. Tax on Total income- Tax is levied on the “total income” of every assessee computed in accordance with the provisions of the Act. 

6. Provisions as on April 1 of the assessment year applicable for computing income for the assessment year- Total income are calculated in accordance with the provisions of the Income-tax, as they stand on the first day of April of the assessment year. For calculating taxable income for the assessment year 2019-20, the provisions of the Income-tax Act as on April 1, 2019 are applicable. If an amendment is made with effect from April 2, 2019, it is irrelevant for calculating income for the assessment year 2019-20. Likewise, the law existing during the previous year 2018-10 has no relevance for determining the total income for the assessment year 2019-20.

The above rule is applicable only for the purpose of computing taxable income and tax liability. If, however, an amendment is made in procedural law, then it is applicable from the date of amendment. 

What is regarded as “Income” under the Income Tax Act?

-> Income includes:

  1. Profits and gains
  2. Dividend
  3. Voluntary Contributions received by a trust. Voluntary contributions received by a trust are included in the definition of income. As such contributions received by following types of trusts, funds, associations, bodies etc. are included in the income of such bodies.
    1. Contributions received by a trust created wholly or partly for charitable or religious purposes.
    2. Contributions received by a scientific research association.
    3. Contributions received by a fund or institution set up for charitable purposes and notified u/s 10(23c)(iv)(v).
    4. Contribution received by any university or other educational institution, hospital referred in section 10(23c).
  4.  The value of any perquisite or profit in lieu of salary taxable under section 17(2)(3)
  5.  Any special allowance or benefit, other than perquisite included under sub-clause (iii), specifically granted to the assessee to meet expenses wholly, necessarily and exclusively for the performance of the duties of an office or employment of profit
  6.  Any allowance 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 a place where he ordinarily resides or to compensate him for the increased cost of living
  7.  Value of any benefit or amenity, whether convertible into money or not, obtained by a representative assessee or by any person on whose behalf such benefit is received by representative assessee and sum paid by representative assessee in respect of any obligation which hut for such payment would have been payable by the person on whose behalf representative assessee has made such payments
  8. The profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members;
  1. The value of any benefits or perquisites, whether convertible into money or not, obtained from a company either by a director or by a person, who has a substantial interest in the company, or by a relative of a director of such person, and any sum paid by such company in respect of any obligation but for which, such payment would have been payable by the director or other person aforesaid
  2. Any sum chargeable to income-tax under section 28(u) and (iii) or section 41 or section 59;
  3. Any sum chargeable to tax u/s 28 (iiia)
  4. Any sum chargeable to tax u/s 28(iiib)
  5. Any sum chargeable to tax u/s 28 (iiic) , –
  6. The value of any benefit or perquisite taxable under section 28 (iv)
  7. Any capital gain taxable under section 45
  8. Any sum whether received or receivable in cash or in kind under an agreement for—not carrying out any activity in relation to any business ; or not sharing any know-how, patent, copyright, trade-mark, license, franchise or any other business or commercial right of similar nature or information or technique likely to assist in the manufacture or processing of goods or provision of services
  9. The profit and gains of any business of insurance carried on by a mutual insurance company or by a co-operative society, computed in accordance with section 44 or any surplus taken to be such profits and gains by virtue of provisions contained in the first schedule
  10. 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
  11. Any sum received by the assessee as his employers’ contributions to any provident fund or superannuation fund or any fund set up under the provisions of the Employee’s State Insurance Act, 1948 or any other fund for the welfare of’ such employees
  12. Any sum received under a key man insurance policy including the sum allocated by way of bonus on such policy
  13. Any sum received by an individual or HUF from any person during 2013-14
    1. in cash or by issue of cheque overdraft or by any other mode or by way of credit
    2. otherwise than by way of consideration for goods or services but does not include
  14. An aggregate amount of gift or gifts received (whether in cash or in the form of property) exceeding Rs. 50,000 in a previous year by an individual or Hindu undivided family from non-relatives shall be treated as income which will be taxable in the hands of the recipient. (For details, please refer to chapter on Other Sources)
  15. Gifts received by a firm or closely held company as provided in Section 56(2)(viia).
  16. Any consideration for issue of shares by a closely held company as exceeds the fair market value of shares as provided in Section 56(2)(viib) [w.e.f. Assessment year 2013-14].
  1. The definition of term ‘Income’ as given above does not explain what income is? It only tells that the above mentioned receipts are also included in the meaning of term income. The definition given u/s 2(24) is inclusive and not exhaustive. According to English dictionary, the term income means “periodical receipts from one‘s business, land, work, investments etc.”
  2. The term income simply means something which comes in. It is a periodical return with regularity or expected regularity. It’s nowhere mentioned that income refers to only monetary return. It includes value of benefits and perquisites. Anything which can reasonably and properly be described as income is taxable under this Act unless specifically exempted under the various provisions of this Act.
  3. The term income includes not only what is received by using the property but also the amount saved by using it himself. Anything which is convertible into income can be regarded as source of accrual of income.

What is Gross Total Income?

-> Gross income for an individual also known as gross pay when it’s on a paycheck is the individual’s total pay from his or her employer before taxes or other deductions. This includes income from all sources and is not limited to income received in cash; it also includes property or services received. Gross annual income is the amount of money a person earns in one year before taxes and includes income from all sources.

As the name suggests Gross Total Income is the aggregate of all the income earned by you during a specified period. According to Section 14 of the Income Tax Act 1961, the income of a person or an assessee can be categorized under these five heads,

  • Income from Salaries
  • Income from House Property
  • Profits and Gains of Business and Profession
  • Capital Gains
  • Income from Other Sources

And, Gross Total income is arrived at when your earnings from all these five heads of income are taken together.

The computation of gross total income is vital because

  • It is the amount required to be disclosed while filing Income Tax Return
  • Deductions under Chapter VI A are required to be deducted from GTI to arrive at the taxable or total income

Gross Total Income shall not include:

While calculating gross total income one must sum up all of their income without reducing the amount for any tax saving investments made under Section 80C to 80U under Income Tax Act 1961.

Apart from adding earnings from all five heads of income following shall also be added to calculate your gross total income

  • Income to be added as per the clubbing provisions under the Income Tax Act
  • Adjustments for set off and carry forward of losses
  • Unexplained Tax Credit under section 68 of the Income Tax Act 1961, received whether in cash or credit. Which means receipt of any amount of which you do not have sufficient or valid explanation describing the source of receipt of such income. These categories of income are added to your Gross Total Income.
  • Unexplained Investments i.e. the investments which you have made but you are unable to give satisfactory explanation about the source or improper disclosures have been made on your part. In all these situations your investments will be termed as unexplained investments as per the purview of section 69 of the Income Tax Act. also, it shall be added to your Gross Total Income (GTI)
  • Assets and other money under Section 69A, valuables like money, jewellery etc for which no proper explanation is available with the assessee will be added to the Gross Total Income of the person.
  • Undisclosed or lower disclosed income is added to the Gross Total Income as per the provisions of Section 69B of the Income Tax Act 1961. This relates to all those income and assets which you have not reported or made a lower disclosure then the actual funds.
  • Unexplained expenditures under section 69C. In case you have made some expenses and no proper explanation regarding the same available then it would be added to your Gross Total Income and henceforth charged to taxes accordingly.
  • Hundi amount borrowed or repaid. In case you have borrowed or repaid some amount on Hundi then it shall be added to your Gross Total income or GI as per the provisions of section 69D of the income tax act.

Although we have obtained an understanding on the above income and assets or expenditures which are added to the gross total income. But, these additions or nature of additions are not generally witnessed in routine.

Calculation for Gross Total Income:-

In the case of an individual, gross income is calculated as the total income before any deductions and taxes. For a salaried employee, it is calculated as annual salary/12. 

In the case of a person carrying on any business, it is calculated as the revenue which is earned from the sale of goods or rendering of services – the cost of goods sold (excluding the applicable taxes). Let us understand the same with the help of an example:

A company XYZ Limited was in the business of selling fans and their total revenue was Rs. 10, 00,000. Below are the costs incurred by the company:

  1. Raw materials purchased: Rs. 5,00,000
  2. Labor charges Rs. 2,50,000
  3. Packing charges: Rs. 2,00,000

The cost of goods sold will be calculated as below:

COGS = 5, 00,000+2, 50,000+2, 00,000 = 9, 50,000

Gross income = gross revenue – the cost of goods sold

                       = 10, 00,000 – 9, 50,000 = Rs. 50,000 

What is Total Income and how is it computed? 

-> Total Income is defined under Section 2(45) with the scope defined by Section 5 of the Income Tax Act, 1961

  • If you are an Indian resident in the previous year, any income received, accrued or deemed to be received by you will be accounted for
  • If you are not ordinarily resident in the previous year, incomes arising out of India will be included only if they are from a business controlled or performed from India
  • In the case of non-residents (NRI), only incomes arising or accruing in India will be counted
  • Total Income is arrived by deducting all eligible deductions from “Gross Total Income”

Total Income can be calculated by-

The resultant amount is Total Income.


For better understanding, find below the tabular presentation of how to compute total income.

ParticularsAmount
RsRsRs
1. Income from salaries
Income from salaryxx




xxx














xxxx
Income by way of allowancesxx
Taxable value of perquisitesxx
Gross salary
Less:   Deduction under Section 16xxx
Entertainment allowancexxx
    Professional taxxxx
INCOME TAXABLE UNDER THE HEAD SALARIES
2. Income from House Property
Adjusted net annual value  xx



xxxx
Less: Deduction under section 24xx
INCOME TAXABLE UNDER THE HEAD HOUSE PROPERTY
3. Income from Business or Profession
Net profit as per profit and loss accountxx













xxxx
Add: Amounts which are debited to P&l a/c but are not allowed as a deduction under the actxx
Less: Expenditure which are not debited to P&L a/c but are allowed as a deduction under the actxx
Less: Income which are credited to P&L a/c but  are exempt under section 10xx
Add: Income which are not credited to P&L a/c but are taxable under this headxx
PROFIT & GAINS TAXABLE UNDER THE HEAD BUSINESS & PROFESSION
4. Income from Capital Gains
Amount of capital gainsxx




xxxx
Less: Amount exempt under sections 54, 54B,54D,54EC,54F, 54G, 54GA, 54GB, and 54Hxx
INCOME TAXABLE UNDER THE HEAD CAPITAL GAINS
5. Income from other sources
Gross incomexx



xxxx
Less: Deduction under section 57xx
INCOME TAXABLE UNDER THE HEAD OTHER SOURCES

Total [i.e., (1) +(2) +(3) +(4) +(5)]

XXX
Less: Adjustment on account of set-off and carry forward of lossesXXX
Gross total incomeXXXX
Less: DeductionsXXXX

Total Income or Net income

XXXX

What is agricultural income?

-> Agricultural income refers to the income earned or revenue generated from sources essentially premised on agricultural activities. These sources of income include farming land, buildings on or identified with agricultural land as well as commercial produce from a horticultural land. 

Section 2(1A) of the Income Tax Act, 1961, lays down the definition of ‘agricultural income’ under the following three activities:

  • Rent or revenue derived from agricultural land situated in India and used for agricultural purposes.
  • Income earned from agricultural land through the commercial sale of produce gained from this land.
  • Revenue derived from renting or leasing of buildings in or around agricultural land. However, this criterion is subject to the following conditions: 
  • This building should be occupied by a farmer or cultivator through revenue or rent.
  • It is used as a residential space, warehouse/storeroom or outhouse.
  • The land on which this building is located is assessed for land revenue or a local rate evaluated and collected by government officers. 

Categorising a particular amount earned as agricultural income takes into account several other factors, such as:

  • Existence of land: The income earned should be from an existing piece of land. 
  • Utilisation of land for agricultural purposes: Rent or revenue from the agricultural land and income earned by a cultivator through the sale of produce should be based on agricultural operations on a piece of land. Alongside income from agricultural operations, the ambit of agricultural income also includes operations undertaken to make produce marketable. 
  • Cultivation of land is mandatory: The income should be generated by way of cultivation of land. Agricultural income covers all land produce such as grain, fruits, commercial crops, etc. However, it does not include using a piece of land for poultry farming, breeding of livestock, dairy farming, and the like. 
  • Ownership of land is optional: In the case of agricultural operations, the law does not necessitate the cultivator to be the owner of the land in question. However, in the case of rent or revenue, it is essential that an individual possesses an interest in the land, either as an owner or a mortgagee. 

Types of Agricultural Income

The table below summarizes the different types of agricultural income: 

Basis of DifferentiationTypes of Agricultural Income
Source of income Rent or revenue generated from a piece of land.Income derived from agricultural operations.Income from a building attached to agricultural land.
Example of agricultural incomeRent received by an owner of the land from the cultivator in cash or in-kind. Income earned by a cultivator by way of sale of his/her produce.Rent received on a building used as a warehouse by a cultivator. 

Agricultural Income in Income Tax

Under Section 10(1) of the ITA, 1961, agricultural income is exempt from taxation. This exemption implies that the Central Government does not impose or levy any tax on agricultural income. 

However, agricultural income tax persists at the state level. The legislature uses a method called partial integration of agricultural income with non-agricultural income to tax such earnings. This method is applicable when the conditions mentioned below are met by an individual:

  • Net agricultural income was more than Rs. 5,000 in the previous financial year.
  • Total income, minus this net agricultural income, is higher than the exemption limit of Rs. 2,50,000 for individuals below 60 years of age, Rs. 3,00,000 for senior citizens and Rs. 5,00,000 for super senior citizens.

Calculation of Agricultural Income Tax

When the aforementioned criteria are met by an individual, his/her tax on agricultural income is computed using in a three-step calculation:

Step 1: Evaluating tax on non-agricultural income + net agricultural income.

Step 2: Calculation of tax on net agricultural income + maximum exemption limit as per slab rates.

Step 3: Calculation of the final tax as a difference of the figures derived in Step 1 and 2. This step derives the following – 

  • Deduction of a rebate, if available.
  • Addition of surcharge, if applicable.
  • Addition of Health and Education Cess. 

The example discussed below provides a detailed explanation of this process –

An individual taxpayer aged 50 years earns Rs. 3,00,000 in agricultural income. Her non-agricultural income is worth Rs. 5,00,000. Therefore, her agriculture income tax for FY 2020-21 is calculated as follows:

Step 1: Evaluating tax on non-agricultural income + net agricultural income, i.e., Rs. 8,00,000 (Rs. 3,00,000 + Rs. 5,00,000) Tax on the first Rs. 2,50,000 = Nil Tax on the second Rs. 2,50,000 = Rs. 2,50,000 x 5% = Rs. 12,500Tax on balance Rs. 3,00,000 = Rs. 3,00,000 x 20% = Rs. 60,000So, the total tax on non-agricultural income + net agricultural income is Rs. 72,500. (1)
Step 2: Calculation of tax on net agricultural income + maximum exemption limit as per slab rates, i.e., Rs. 5,50,000 (Rs. 3,00,000 + Rs. 2,50,000)Tax on the first Rs. 2,50,000 = NilTax on next Rs. 2,50,000 = Rs. 2,50,000 x 5% = Rs. 12,500Tax on balance Rs. 50,000 = Rs. 50,000 x 10% = Rs. 10,000So, the total tax here stands as Rs. 22,500. (2)
Step 3: Calculation of the final tax as a difference of the figures derived in Step 1 and 2. The difference between (1) and (2) is Rs. 50,000 (Rs. 72,500 – Rs. 22,500).So, final tax = Rs. 50,000(+) Health and Education cess @ 4% = Rs. 2000Therefore, her total tax liability amounts to Rs. 52,000

The agricultural sector is of paramount importance to the Indian economy. In fact, it was the only sector that recorded a real GVA growth of 4% in 2019-2020, on account of record food grain production. The government, therefore, aims to promote the country’s agricultural sector by way of extending such tax exemptions to agricultural income.

What is difference between Exemption and Deduction? 

-> Tax deduction


Tax deduction refers to the amount of money that is reduced from your total taxable income. The final tax payable is calculated depending on the balance ‘taxable income’. Tax deductions aim to promote the culture of savings and investments among the general public.


However, it is good to know that tax deduction is only allowed on specific investments or expenses incurred by the taxpayer. This includes medical fees, transportation charges, donations made to charities, investments made in specific avenues such as Equity Linked Saving Scheme funds (ELSS), Public Provident Fund (PPF) and National Pension Scheme (NPS).


The Income Tax Act sections between 80C and 80U deal with all the deductions available to taxpayers.



Tax Exemption


In the world of taxation, the word ‘exemption’ means exclusion. So, if a particular income is exempt from tax, it will not be included in the total revenue for tax purposes. This reduces the total taxable income of a taxpayer. All exemptions are dealt with under Section 10 of the Income Tax Act.
While certain incomes such as agricultural income are completely exempt from taxation, there are other incomes that are partially exempted from tax. This means only the portion of income that exceeds the exemption is subject to tax. This includes:
a) House Rent Allowance (HRA)


b) Leave Travel Allowance (LTA)


c) Entertainment Allowance


d) Special allowances to meet personal expenses


e) Long-term capital gains on equity funds


Tax deduction vs tax exemption


Tax exemption applies to all taxpayers in the country. For instance, the amount paid to a salaried employee as HRA is not taxable. However, tax deduction applies only to those who qualify for the specific criteria. For instance, Section 80D of the Income Tax Act can be used to claim deductions on premiums paid for medical insurance policies.
Even though Income Tax is a mandatory responsibility to be paid by every citizen, based on his or her paying capacity, age, and gender, taxpayers can obtain relief through the various provisions to reduce their overall tax financial obligation.
Understanding the difference between exemption and deduction in income tax can help in making smarter decisions before the annual tax planning process commences.

The major differences deduction and exemption are indicated below:

  1. Deduction means subtraction i.e. an amount that is eligible to reduce taxable income. Exemption means exclusion, i.e. if certain income is exempt from tax then it will not contribute to the total income of a person.
  2. The deduction is a concession, but Exemption is relaxation.
  3. The deduction applies to tax deductible income, whereas only tax-free income is eligible for tax exemption.
  4. The deduction is allowed to specific persons that qualify the particular criteria. On the other hand, the exemption is allowed to all the persons.
  5. The deduction is conditional, i.e. it is allowed only to those who qualify the eligibility criteria. Conversely, the exemption is unconditional.
  6. The objective of providing deduction is to encourage savings and investments in certain instruments while the exemption is to help the weaker section of society.
  7. Section 80C to 80U of Income-tax Act, 1961 deals with deduction whereas exemptions are provided in Section 10.
  8. Deductions are first added to GTI and then deducted from it. Unlike, Exemptions do not form part of total income.

What are Capital and Revenue Receipts?

-> Capital Receipts

Capital receipts are those receipts which either create liability or reduce an asset. Capital Receipts, as mentioned above, are non-recurring in nature. And these sorts of receipts are also not received every now and then.

From the above definition, it’s clear that a receipt can be called capital receipt if it adheres to at least one of the following conditions –

  • It must create a liability. For example, if a company takes a loan from a bank or a financial institution, then it would create a liability. That’s why it is a capital receipt in nature. But if a company received a commission for using its expertise in producing a special type of product for another company, it would not be called a capital receipt because it didn’t create any liability.
  • It must reduce the assets of the company. For example, if a company sells out its shares to the public, it would help reduce the asset, which could create more money in the future. That means it should be treated as a capital receipt.

Types of Capital Receipts

Capital Receipts can be classified into three types.

  1. Borrowing funds

When a company takes loans from banks or financial institutions, then it would be called borrowing funds. Borrowing funds from a financial institution is one of three forms of capital receipts.

  1. Recovery of loans

To recover loans, often, the company needs to set aside one part of assets, which reduces the value of assets. This is the second type of capital receipts.

  1. Other Capital Receipts

There’s a third type of receipts that we call “other capital receipts.” Under this, we include disinvestment and small savings. Disinvestment means selling off one part of the business. Disinvestment is called capital receipt because it reduced the asset of the company. Small savings are called capital receipts because they create a liability for the business.

Examples of Capital Receipts

Let’s now look at six examples of capital receipts. We will explain each of them and find out why they can be called capital receipts.

Capital Receipts Example: 1 – The money received from the shareholders

When a company needs more money, it can go for initial public offerings (IPOs). IPO helps a company to become public. When a firm gets public, then they sell their shares to the public. People who own the shares of the company are called shareholders of the company. Shareholders of the company hold shares of the company in lieu of offering money to the company. That means when a person purchases a share, he gives away the price of the share to the company. Through IPOs, the company earns a lot of money. And this money received from the shareholders can be called capital receipts because –

  • The money received from the shareholders creates a liability for the company.
  • The money received from the shareholders is non-recurring in nature.
  • The money received from the shareholders is also non-routine, meaning it doesn’t happen every now and then.

Capital Receipts Example: 2 – The money received from the debenture holders

When the company needs a lot of money, they go to people with bonds. The company issue bonds and the debenture holders buy the bonds in lieu of money. The company promises the debenture holders that it will pay off the debt and a high interest within a certain period of time. These bonds are not backed by any collateral and especially dependent on the creditworthiness of the issuer. That’s why the interest rate is quite high. The money received from the debenture holders is capital receipt because –

  • The money received from the debenture holders creates a liability for the company.
  • The money received from the debenture holders is non-recurring in nature.
  • The money received from the debenture holders is also non-routine, meaning it doesn’t happen every now and then.

Capital Receipts Example: 3 – Loans taken from banks or financial institutions

Often business needs to invest money to support any new project or partnership or expansion. But business always doesn’t have the money to invest. That’s why they go out to a bank or any financial institution to raise loans. These loans can be either secured loans or unsecured loans. The money received from these loans is then used for investing in the new project or for expanding their business. These loans taken from banks or financial institutions are capital receipts because –

  • These loans create liability for the company.
  • These loans are non-recurring in nature.
  • These loans are not taken every now and then.

Capital Receipts Example: 4 – Sale of Investments

Let’s say that a company has invested some money into an investment fund. Now the company needs to influx some cash into the business. That’s why it decides to sell the investments to a buyer. Selling off the investments will help the company get some immediate money. And we will call it a capital receipt for the following reasons –

  • Sale of investments reduces the assets of the company.
  • Sale of investments is non-recurring in nature.
  • Sale of investments is also non-routine.

Capital Receipts Example: 5 – Sale of Equipment

If a company sells out one of its equipment to get cash, it would be a capital receipt too. Here are the reasons why this is also a capital receipt –

  • Sale of equipment decreases the value of assets of the company.
  • Sale of equipment is non-recurring in nature.
  • Sale of equipment is non-routine as well.

Capital Receipts Example: 6 – Insurance claim for damaged plant & machinery

Insurance can be claimed when the plant & machinery loses its value. And we can call it capital receipt as well because of the following reasons –

  • Insurance claim means a reduction of assets of the company.
  • Insurance claim doesn’t occur every day.
  • Insurance claim is also not routine.

 Revenue Receipts

Revenue Receipts are those receipts that neither reduces the assets of the company, nor they create any liability. They are always recurring in nature, and they are earned during the normal course of business.

From the definition, it is clear that any type of receipt needs to satisfy one of the two conditions to be called as revenue receipt –

  • First, it must not reduce the assets of the company.
  • Second, it must not create any liability for the company.

Features of Revenue Receipts

Since revenue receipts seem to be the opposite of capital receipts, it makes perfect sense to look at different features of revenue receipts so that we can understand the meaning of revenue receipts and can compare to the features of capital receipts.

  • Means for survival: A business starts its operations because it expects to receive money as a result of their service to their customers. Either they can sell a bunch of products, or they can offer services. No matter what they do, without revenue receipts, they can’t survive for long because revenue receipts are collected from the direct operations of the business.
  • Applicable for a short term: Revenue receipts are money received for a short period. The benefit of revenue receipts can only be enjoyed for one accounting year and not more.
  • Recurring: Since revenue receipts offer benefits for a short period, the revenue receipts must be recurring. If revenue receipts don’t recur, the business wouldn’t be able to perpetuate for long.
  • Affects the profit/loss: Receiving revenue directly affects the profit/loss of the business. When the revenue is received, either profit is increased, or loss is decreased.
  • A small amount (volume): Compared to capital receipts, the number of revenue receipts is usually smaller. That doesn’t mean all revenue receipts are smaller. For example, if a company sells 1 million products in a given year, the revenue receipts could be huge and could also be more than its capital receipts during the year.

Examples of Revenue Receipts

In this section, we will look at six examples of revenue receipts. At the end of each example, we will investigate why this particular receipt can be called revenue receipt.

Revenue Receipts Example: 1 – Revenue earned by selling off waste/scrap material

When a firm doesn’t use the waste material or scram items, they decide to sell it off. By selling scrap items, the business earns a good amount of money. We will call it a revenue receipt. We will call it revenue receipt because of the following reasons –

  • Selling off scraps doesn’t reduce the assets of the company.
  • Selling off scraps doesn’t create any liability for the company.

Revenue Receipts Example: 2 – Discount received from vendors

When a firm purchases raw materials, they select vendors from whom they buy the ingredients. Often when the firm pays on time or early, vendors offer a discount. This discount received from vendors would be revenue receipt because –

  • Discount received from vendors doesn’t reduce the assets of the company.
  • Discount received from vendors doesn’t create any liability for the company.

Revenue Receipts Example: 3 – Services provided

When a firm provides services to its clients or customers, they earn revenues. We will call them revenue receipts since –

  • Services provided to clients don’t reduce the assets of the company.
  • Services provided to clients don’t create any liability.
  • And it is recurring in nature.

Revenue Receipts Example: 4 – Interest received

If a firm has put its money in any bank or financial institution, it will receive interest as its reward. It is a revenue receipt because –

  • It doesn’t create any liability of the company.
  • It also doesn’t reduce the assets of the company.

Revenue Receipts Example: 5 – Rent received

If a firm offers their place to another company, they can collect rent, and it would be considered as revenue receipt for the following reasons –

  • Rent would be received every month; that means it is recurring in nature.
  • Rent received wouldn’t create any liability for the company.
  • It would also not reduce the assets of the company.

Revenue Receipts Example: 6 – Dividend received

If the company has purchased shares for any other company, at the end of the year, if profit is made, the firm would receive the dividend. This dividend received would be revenue receipts since

  • It doesn’t reduce the assets of the company.
  • And it also doesn’t create any liability for the company.

Capital Receipts vs. Revenue Receipts

There are many differences between capital receipts vs. revenue receipts. Let’s look at the most prominent ones –

  • Capital receipts are non-recurring in nature; on the other hand, revenue receipts are recurring in nature.
  • Without capital receipts, a business can survive, but without revenue receipts, there is no chance that a business will perpetuate.
  • Capital receipts can’t be used as a distribution of profits; revenue receipts can be distributed after deducting the expenses incurred to earn the revenue.
  • Capital receipts can be found in the balance sheet. Revenue receipts can be found in the income statement.
  • Capital receipts either reduce the assets of the company or create liability for the company. Revenue receipts are the opposite. They neither create the liability for the company, nor do they reduce the assets of the company.
  • Capital receipts are non-routine. Revenue receipts are routine.
  • Capital receipts are sources from non-operational sources. On the other hand, revenue receipts are sourced from operational sources.

Capital Receipts vs. Revenue Receipts (Comparison Table)

Basis for Comparison – Capital Receipts vs. Revenue ReceiptsCapital ReceiptsRevenue Receipts
1.    Inherent meaningCapital Receipts are receipts that don’t affect the profit or loss of business.Revenue Receipts are receipts that affect the profit or loss of business.
2.    SourceCapital Receipts stem from non-operational sources.Revenue Receipts stem from operational sources.
3.    NatureCapital Receipts are non-recurring.Revenue Receipts are recurring in nature.
4.    Reserve fundsCapital Receipts can’t be saved for creating reserve funds.Revenue Receipts can be saved for creating reserve funds.
5.    DistributionNot available for distribution of profits.Available for distribution of profits.
6.    Loans – Capital Receipts vs. Revenue ReceiptsCapital Receipts can be loans raised from banks/financial institutions.Revenue Receipts are not loans, but the amount received from operations.
7.    Found inBalance Sheet.Income Statement.
8.    Example – Capital Receipts vs. Revenue ReceiptsSales of fixed assets.Sale of products of the business;

What is Capital and Revenue Expenditure?

-> Capital Expenditures

These are expenditures for high-value items that holds longer duration requirements. Capital expenditures are long-term expenditures. In other words, when the expenses are made for a particular asset but they do not get completely consumed in the specific time. Due to this the earning capacity increases, and in the meanwhile, the price of the assets decreases.

Consequently, the future costs are reduced because the costs of the assets are continuously revised according to the depreciation taking place. There is a requirement to redo the capital expenditures in the accounting year. These do not get exhausted in the accounting year and benefits the user in the future years. Besides that, capital expenditures enhance the position of the business and trade.

There different types of capital expenditure, for example

  • Cash money spent on business purposes.
  • Purchasing of  Plants and machinery items
  • IT items
  • Electric power equipment
  • Permanent additions to existing fixed assets

Revenue Expenditures

In contrast to the capital expenditure, revenue expenditures are not the high-value items, instead, they are the routine expenditures that takes place in the normal business. In other words, this kind of expenditure maintains fixed assets.

Unlike capital expenditure, earnings do not increase but stay maintained in revenue expenditure. The assets get consumed in an accounting year and no future benefits are available. Also, the prices of assets remain fixed. The assets are consumed in less than a year so there is a need to purchase them again. This is a recurring type of expenditure. There are two sub-categories of revenue expenditures:

  1. Direct Expenses: These include the cost of manufacturing of raw material to turn it into a finished product. For instance, Productive wages and salaries to workers, shipping costs, legal expenses, electricity, and water bills, fuels costs, rent, commissions, packaging charges.
  2. Indirect Expenses: These connect with only selling and distributing goods other than manufacturing. For example, salaries, depreciation, machinery, items of furniture and fixing, etc.

Need for Classification

Revenue expenditures and capital expenditures are both completely different things as a one. Revenue expenditure is a periodic investment of money that does not benefit the business nor leads to any loss in any way. While on the other hand, capital expenditure is the long-term investment that only benefits the business.

It is very necessary to determine its capital nature or revenue nature. Because both have their own advantages and shortcoming that are not understandable separately.

Let us look into the key differences between capital expenditure and revenue expenditure to develop a clear understanding of their functions in a business.

Capital ExpenditureRevenue Expenditure
Definition
Expenditure incurred for acquiring assets, to enhance the capacity of an existing asset that results in increasing its lifespanExpense incurred for maintaining the day to day activities of a business
Tenure
Long TermShort term
Value Addition
Enhances the value of an existing assetDoes not enhance the value of an existing asset
Physical Presence
Have a physical presence except for intangible assetsDo not have a physical presence
Occurrence
Non-recurring in natureRecurring in nature
Availability of Capitalisation
YesNo
Impact on Revenue
Do not reduce business revenueReduces business revenue
Potential Benefits
Long-term benefits for businessShort-term benefits for business
Appearance
Appears as assets in the balance sheet and some portion in the income statementAlways appears in the income statement

How far method of accounting is relevant in computing income?

-> Relevance of Method of Accounting While Computing Taxable Income:-

  • Generally, there are two main methods of accounting, viz., Cash system of accounting and mercantile system of accounting.
  • Under mercantile system of accounting, also known as Accrual system, revenue and expenses are recorded on an accrual basis.
  • Under Cash system of accounting, revenue and expenses not realized/paid during the year are not recorded.
  • As far as income-tax is concerned, the method of accounting followed by the assessee is relevant only for computing income charged to tax under the heads “Profits and gains of business or profession” and “Income from other sources”.
  • The method of accounting followed by the assessee has no relevance while computing income charged to tax under the heads “Salaries”, “House property” and “Capital gains”.

What is Amalgamation?

-> Amalgamation is defined as the combination of one or more companies into a new entity. It includes:

  1. Two or more companies join to form a new company
  2. Absorption or blending of one by the other

Thereby, amalgamation includes absorption.

However, one should remember that Amalgamation as its name suggests, is nothing but two companies becoming one. On the other hand, Absorption is the process in which the one powerful company takes control over the weaker company.

Generally, Amalgamation is done between two or more companies engaged in the same line of activity or has some synergy in their operations. Again the companies may also combine for diversification of activities or for expansion of services

Transfer or Company means the company which is amalgamated into another company; while Transfer Company means the company into which the transfer or company is amalgamated.

Amalgamation is different from Merger because neither of the two companies under reference exists as a legal entity. Through the process of amalgamation a completely new entity is formed to have combined assets and liabilities of both the companies.

Types of Amalgamation

  1. Amalgamation in the nature of merger:

In this type of amalgamation, not only is the pooling of assets and liabilities is done but also of the shareholders’ interests and the businesses of these companies. In other words, all assets and liabilities of the transferor company become that of the transfer company. In this case, the business of the transfer or company is intended to be carried on after the amalgamation. There are no adjustments intended to be made to the book values. The other conditions that need to be fulfilled include that the shareholders of the vendor company holding atleast 90% face value of equity shares become the shareholders’ of the vendee company.

  1. Amalgamation in the nature of purchase:

This method is considered when the conditions for the amalgamation in the nature of merger are not satisfied. Through this method, one company is acquired by another, and thereby the shareholders’ of the company which is acquired normally do not continue to have proportionate share in the equity of the combined company or the business of the company which is acquired is generally not intended to be continued.

If the purchase consideration exceeds the net assets value then the excess amount is recorded as the goodwill, while if it is less than the net assets value it is recorded as the capital reserves.

Procedure for Amalgamation

  1. The terms of amalgamation are finalized by the board of directors of the amalgamating companies.
  2. A scheme of amalgamation is prepared and submitted for approval to the respective High Court.
  3. Approval of the shareholders’ of the constituent companies is obtained followed by approval of SEBI.
  4. A new company is formed and shares are issued to the shareholders’ of the transferor company.
  5. The transferor company is then liquidated and all the assets and liabilities are taken over by the transferee company.

Accounting of Amalgamation

  1. Pooling of Interests Method:

Through this accounting method, the assets, liabilities and reserves of the transfer or company are recorded by the transferee company at their existing carrying amounts.

  1. Purchase Method:

In this method, the transfer company accounts for the amalgamation either by incorporating the assets and liabilities at their existing carrying amounts or by allocating the consideration to individual assets and liabilities of the transfer or company on the basis of their fair values at the date of amalgamation.

Computation of purchase consideration: For computing purchase consideration, generally two methods are used:

  1. Purchase Consideration using net asset method: Total of assets taken over and this should be at fair values minus liabilities that are taken over at the agreed amounts.
ParticularsRs.
Agreed value of assets taken overXXX
Less: Agreed value of liabilities taken overXXX
Purchase ConsiderationXXX
  1. Agreed value means the amount at which the transfer or company has agreed to sell and the transferee company has agreed to take over a particular asset or liability.
  2. Purchase consideration using payments method: Total of consideration paid to both equity and preference shareholders in various forms.

Example: A. Ltd takes over B. Ltd and for that it agreed to pay Rs 5,00,000 in cash. 4,00,000 equity shares of Rs 10 each fully paid up at an agreed value of Rs 15 per share. The Purchase consideration will be calculated as follows:

ParticularsRs.
Cash5,00,000
4,00,000 equity shares of Rs10 fully paid up at Rs15 per share60,00,000
Purchase Consideration65,00,000

Advantages of Amalgamation

  • Competition between the companies gets eliminated
  • R&D facilities are increased
  • Operating cost can be reduced
  • Stability in the prices of the goods is maintained

Disadvantages of Amalgamation

  • Amalgamation may lead to elimination of healthy competition
  • Reduction of employees may take place
  • There could be additional debt to pay
  • Business combination could lead to monopoly in the market, which is not always positive
  • The goodwill and identity of the old company is lost

Recently announced Amalgamation

One of the recent amalgamations announced on the corporate front is of PVR Ltd. Multiplex operator PVR Ltd has approved an amalgamation scheme between Bijli Holdings Pvt Ltd and itself to simplify PVR’s shareholding structure. As per the management, the purpose of the amalgamation is to simplify the shareholding structure of PVR and reduction of shareholding tiers. It also envisages demonstrating Bijli Holdings’ direct engagement with PVR. After the amalgamation, individual promoters will directly hold shares in PVR and there will be no change in the total promoters’ shareholding of PVR.

Other examples of Amalgamations

  1. Maruti Motors operating in India and Suzuki based in Japan amalgamated to form a new company called Maruti Suzuki (India) Limited.
  2. Gujarat Gas Ltd (GGL) is an amalgamation of Gujarat Gas Company Ltd (GGCL) and GSPC Gas.
  3. Satyam Computers and Tech Mahindra Ltd
  4. Tata Sons and the AIA group of Hongkong amalgamated to form Tata AIG Life Insurance.

What is Demerger?

-> A demerger can be defined as the transfer of a company’s business undertakings to another company. The source company, i.e., the company whose undertakings are being transferred is called the demerged company. The other company is often known as the resulting company.

Demergers can be of more than one type. Some examples are given below:

  • In some cases, a division or a line of business of a conglomerate company ends up becoming a separate entity. This type of demerger is called a spinoff.

For instance, company A used to operate in two lines of business viz. logistics and hospitality. If company A decides to separate all its logistics business in a separate entity, it would be called a spinoff. It needs to be noticed that both companies would exist as separate legal entities. Hence, A would still exist, and a new company B would also come into existence. The parent company would not be dissolved as a result of this separation of concerns.

  • In other cases, a conglomerate may want to split its businesses into separate companies. This is called a split.

For instance, if company A decides to create two new companies B and C to hive off its hospitality and logistics business respectively, such an arrangement would be called a split. It needs to be noticed that company A would not continue to exist in this case.

  • In other cases, company A may want to sell off its logistics business to an external party. Hence, it may sell some portion of its equity stake in a subsidiary company to a third party or to a strategic investor. This type of transaction is called an equity carve out. There are two things to be noticed about this transaction. Firstly, spin-offs and splits do not constitute a sale to an external party. Hence, an equity carve-out results in the infusion of cash whereas spinoffs and splits do not. Secondly, in this case, A remains the same legal entity. The carved out unit B becomes part of another company i.e. it does not remain an independent unit under the aegis of the parent company.

Advantages of a Demerger

Some of the most obvious advantages of demerger have been listed below.

  • Focus on Core Competency: Conglomerate companies are known for not have focused business operations. These companies try to manage a lot of diverse operations which require different competencies. In several cases, these companies lose to competitors who have a single-minded focus on any one particular line of business. The modern business environment is more about specialization. Generalists do not survive for very long. It is for this reason that it is important that companies need to focus on their core competencies. This reasoning has led many conglomerates to streamline their operations and demerger has been a major tool used during the process.
  • Management Accountability: When companies are split off, the management of each company has its own balance sheet. As a result, it is not possible for certain entities in the group to live as parasites off the earnings of other entities. The management of each company becomes accountable for its own financial results. Also, management tends to have more control over their operations. They have the right to make their own investments and even raise funds from the market on their own account.
  • Increase in Market Capitalization: In many cases, demergers are used to create stock market value. Investors have more visibility over the operations and cash flow of a firm that has been spun off. This enables them to make better investing decisions. Investors are willing to pay a premium for this better information. As a result, spinning off units to form separate legal entities does result in increased market capitalization for the group as a whole.

How Demergers Actually Work

In order to conduct a demerger, the following steps need to be followed:

  • The value of all the assets related to the resulting company needs to be found out and listed
  • The value of all the liabilities related to the resulting company also needs to be found out and listed
  • These values are then transferred out of the balance sheet of the demerged company and into the newly created balance sheet of the resulting company. The transfer of these assets and liabilities takes place at their current written down value in the balance sheet of the parent company.
  • In very few cases, a premium may be paid to the demerged company. However, such practices are heavily scrutinized by the tax authorities. This is because there have been past instances where demergers have been strategically used to evade taxes.

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