CHAPTER Three

Basic Concepts under the

Income Tax Act, 1961
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Chapter Three
Basic Concepts under the
Income Tax Act, 1961

3.1 Introduction

The present Chapter presents the basic concepts

under the Income-tax Act, 1961 (hereinafter ‘the

Act’).

3.2 Assessment Year

Section 2(9) of the Act stipulates, "assessment

year” means the period oftwelve months commen­

cing on the 1st day ofApril every year In reality, it

means the period of twelve months starting from

April 1 of every year and ending on March 31 ofthe

next year. The period of assessment year is thus fixed

by the statute. Income in the previous year is taxed

in the following year at the rates prescribed for such

assessment year by the relevant Finance Act.

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3.3 Previous Year

Section 3 of the Act titled “‘Previous year’ defined” reads - for the purposes of

this Act, ‘previous year ’ means the financial year immediately preceding the

assessment year.

Income earned in a particular year is taxable in the next year. The year in

which income is earned is known as ‘previous year’ and the next year in which it

becomes taxable is known as ‘assessment year’. For example, the income earned

in the previous year 2000-01 is taxable in the immediately following assessment

year, i.e. 2001-02. From the assessment year 1989-90 onwards, all assessees are

required to follow the financial year (i.e. April 1 to March 31) as the previous

year, for all sources of income.

The Section also has a Proviso that reads, “Provided that in the case of a

business or profession newly set up, or a source of income newly coming into

existence, in the said financial year, the previous year shall be the period

beginning with date of setting up of the business ofprofession or, as the case

may be, the date on which the source of income newly comes into existence and

ending with the saidfinancial year n. As a result of this Proviso, in the case of

newly set up business or profession or a source of income newly coming into

existence, the first previous year will be the period commencing from the date of

setting up of the business/profession or the date on which the source of income

comes into existence and ending on March 31 of the immediately following

calendar year. Thus, for a newly set up business, profession or a source of income,

could be for a period less than 12 months and the second and the subsequent

‘previous years’ would be of 12 months each (April to March).

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The rule that the income of the previous year is assessable as the income of

the immediately following assessment year has certain exceptions, namely,

1. Shipping business of non-residents (Sec. 172). The section is applicable if

the following conditions are satisfied -

(a) the taxpayer is a non-resident,

(b) he owns a ship or ship is chartered by the non-resident taxpayer;

(c) the ship carries passengers, livestock, mail or goods shipped

at a port in India;

(d) the non-resident taxpayer may (or may not) have an agent/

representative in India.

Ifthe above conditions are satisfied, 7.5 per cent of amount paid (or payable)

on account of such carriage (including demurrage charge of handling charge

or similar amount) to the non-resident taxpayer shall be deemed to be the

income ofthe taxpayer. For this purpose, the master ofthe ship shall submit

a return of income before the departure of the ship from the Indian port.

Unless the tax has been paid, a port clearance shall not be granted by the

Collector of Customs. The 7.5 per cent of amount of freight, fare, etc., is

deemed as income of the non-resident taxpayer and taxis payable in the

rate Applicable to a foreign company. Income is thus taxable in the same

year in which freight, fare, etc., is collected and not in the immediately

following assessment year.

2. Persons leaving India (Sec. 174). The Section becomes applicable when

(a) It appears to the Assessing Officer that an individual may leave India

during the current assessment or shortly thereafter;

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(b) The person has no present intention of returning to India;

(c) The total income of such person upto the probable date of his departure

from India shall be chargeable to tax in that assessment year.

His income is thus taxable in the same year and not in the immediately

following assessment year.

3. Persons likely to transfer property to avoid tax (Sec. 175). The salient

features of this Section are:

(a) It appears to the Assessing Officer during any current assessment

year that a person is likely to charge, sell, transfer, dispose of, or

otherwise part with, any of his asset;

(b) Such asset may be movable or immovable;

(c) The taxpayer is likely to part with the asset with a view to avoid

payment of any liability under the Income-tax Act;

(d) The total income of such person from the first day of assessment year

to the date when proceeding is started under the Income-tax Act.

His income is, thus, taxable in the same year and not in the immediately
/« " ' l

# following assessment year.

4. Discontinued business/profession (Sec. 176). The salient features of this

'

Section are:

(a) A business or profession is discontinued in any assessment year;

(b) Income ofthe business/profession from April 1 ofthe assessment year

(in which the business/profession is discontinued) to the date of

discontinuation may be taxable in the assessment year in which the

business/profession is discontinued;
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(c) The above income is taxable at the discretion ofthe Assessing Officer

in the assessment year in which business/profession is discontinued

or it may be taxed in the normal assessment year (i.e. assessment year

immediately following the previous year);

(d) If it is taxable in the assessment year in which the business/profession

is discontinued, then it is chargeable to tax at the rate applicable to

that assessment year.

It may be noted that in the first three exceptions (shipping business of non­

residents, persons leaving India and transfer of property), tax shall be ’

charged in the previous year itself (it is mandatory on the part of the

Assessing Officer), but in the case of discontinued business/profession, it is

at the discretion of the Assessing Officer.

3.4 Person

According to Section 2(31) of the Act, ‘person’includes: (i) an individual, (ii)

a Hindu undivided family, (Hi) 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 artificialjuridicalperson, notfalling within any ofthe

preceding sub-clauses.
' ,, ' *’»« •

Thus, there are seven categories of persons chargeable to tax under the

Act. The dilution of‘Person’ also is inclusive and not exclusive. Therefore, any

person not falling in these categories, may still fall in the four comers ofthe term

‘Person’ and may be liable to tax.

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(1) Under this Section, ‘an individual’ means only a natural person, i.e. a

human being, and also includes a minor or a person of unsound mind1 or a group

of individuals2

(2) ‘A Hindu undivided family’ (HUF) consists of all persons lineally

descended from a common ancestor and includes their wives and unmarried

daughters. Profits made by a joint Hindu family are chargeable to tax as income

of the Hindu undivided family as a distinct entity or unit of assessment. Some

further discussion is necessary in this respect.

Meaning ofHUF: Under the Act, a HUF is treated as a separate entity for

the purpose of assessment. The Hindu law defines HUF as a family which consists

of all persons lineally descended from a common ancestor and includes their

wives and unmarried daughters. The relation of a HUF does not arise from a

contract but arise from status.

Assessment ofHUF: Income of a joint Hindu family may be assessed as an

income of the HUF, if the following two conditions are satisfied:

(a) There should be a coparcenership (that is, those persons who acquire by

..birth an interest in the joint family property and its male members have the

right to enforce partition). Once the income of a joint Hindu family is

assessed as that of an HUF, it continues to be assessed as such in subsequent

assessment years till partition is claimed by its coparceners.

(b) There should be a joint family property which consists of ancestral property,

property acquired with the aid of ancestral property and property transferred

by its members.
I Shridhar Uday Narayan v. CIT (1962) 45 ITR 577 (All.)
2. WTO v. C.K.Mammed Kayi (1981) 129 ITR 307 (SC).
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Ancestral property may be defined as the property which a man inherits

from any of his thee immediate male ancestors, i.e. his father, grandfather and

great-grandfather. Therefore, property inherited from any other relation is not

treated as ancestral property. On the whole, taxation of income of an HUF is a

rather complex matter.

(3) Under section 2(17) of the Act, the expression ‘company’ is defined to

mean the following:

(a) any Indian company; or

(b) any body corporate incorporated by or under the laws of a country outside

India;

(c) any institution, association or a body which is assessed or was assessable/

assessed as a company for any assessment year commencing on or before

April 1, 1970; or

(d) any institution, association or a body, whether incorporated or not and

whether Indian or non-India, which is declared by general or special order

■s

of the Central Board of Direct Taxes to be a company.

The expression ‘company’ is subject to further refinements, e.g.

1. ‘An Indian Company’ (Sec.2(26)) means a company formed and registered

, under the Companies Act, 1956;

2. ‘Domestic Company’ means an Indian company or any other company which

is liable to be taxed under the Act;

3. ‘Foreign Company’ means a company which is not a domestic company;

4. ‘Industrial Company’ (See.2(8)(c) of the Finance Act, 1985) means a

company which is mainly engaged in the business of generation or

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distribution of electricity or any other form of power or in the construction

of ships or in the manufacturing, processing of goods or mining.

5. ‘Investment Company7 means a company whose gross total income consists

mainly of income which is chargeable under the heads ‘Income from house

property’, ‘Capital gains’ and ‘Income from other sources’.

6. ‘Closely-held Company’ means a company in which the public are not

substantially interested.

6. ‘Widely-held Company’ means a company in which the public are

substantially interested. Such companies are further divided as:

(a) Government/RBI-owned Company : A company owned by the

Government or the Reserve Bank of India or in which not less than

40 per cent shares (in terms ofvalue) are held by the Government or

the RBI or a corporation owned by the RBI;

(b) Section 25 Company: A company registered under Section 25 of the

Companies Act, 1956, namely, companies for promotion of commerce,

art, science, religion, charity and prohibiting the payment of any

dividends to its members;

(c) A Company without Share Capital: A company having no share capital

and declared by the Central Board of Direct Taxes to be a company

in which the public are substantially interested;

(d) Nidhi or Mutual Benefit Society: A company which carries on, as its

principal business, the business of accepting deposits from its members

and which is declared by the Central Government under section 620A

of the Companies Act to be a Nidhi or Mutual Benefit Society;

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(e) Company owned by a Cooperative Society : A company in which

shares carrying not less than 50 per cent of the voting power having

been allotted unconditionally to or acquired unconditionally by and

are throughout the relevant previous year held by one or more

cooperative societies;

(f) Listed Company: A company which is not a private company and its

equity shares are, as on the last day of the previous year, were listed

in a recognized stock exchange in India;

(g) Public Limited Company owned by Government and/or a widely-held

Company: A company which is not a private company, and its shares

carrying 50 per cent of voting power have been allotted uncondi­

tionally to, or acquired unconditionally by, and were throughout the

relevant previous year beneficially held by: (i) the Government, or

(ii) a statutory corporation; or (iii) a company in which the public are

substantially interested or any wholly-owned subsidiary company.

On the whole, taxation of income of a Company is another complex matter.

(4) Under Section 2(31), ‘firm’ is a taxable entity separate and distinct from its

partners. Section 4 of the Indian Partnership Act, 1932, defines partnership as a

‘relationship between persons who have agreed to share the profits ofbusiness carried

on by all or any of them acting for all’. Persons who have entered into partnership

with one another are called individually ‘partners’ and collectively a ‘firm’ and the

name under which their business is carried on is called the ‘firm name’.

Under the new scheme of taxation of firms, applicable from the assessment

year 1993-94, partnership firms are of two types: (a) partnership firms assessed as
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such; and (b) partnership firms assessed as association of persons.

On the whole, taxation of income of a Firm is another complex matter.

(5) Under Section 2(17) ‘an association of persons or a body of individuals’

means an association in which two or more persons join in a common purpose or

common action. The term ‘person’ includes any company or association or body

of individual, whether incorporated or not. An association of persons may have

companies, firms, joint families as its members.

(6) Under Section 2(31), *a local authority’ is a separate unit of assessment.

As per Sec.3(31) of the General Clauses Act, 1897, a local authority means a

municipal committee, district board, body ofport commissioners or other authority

legally entitled to or entrusted by the Government with the control and

management of a municipal or local fund. The local authority must generally

fulfill the following conditions:

(i) it must have a separate legal existence as a corporate body and autonomous

status;

(ii) it must function in a defined area and must ordinarily, wholly or partly,

directly or indirectly, be elected by the inhabitants of the area;

(iii) it performs Governmental functions such as running market, providing civic

amenities, etc.;

(iv) it must have power to raise funds for the furtherance of its activities and

the fulfillment of its projects by levying taxes/fees - this may be in addition

to money provided by the Government and control and management of the

fund must vest with the authority.

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(7) Lastly, the residuary classification of ‘every artificial juridical person’

also is a separate unit of assessment under Section 2(3^)*of the Act. Deities and

statutory corporations are assessable as ‘juridical persons’.

3.5 Assessee

Under Sec.2(7) of the Act, an ‘assessee’ means a person by whom any tax or any

other sum of money such as penalty or interest, is payable under the Act. The

term includes the following persons:

1. First Category: A person, i.e. an individual, an HUF, a company, a firm, an

association of persons or body of individuals, whether incorporated or not,

a local authority and every artificial juridical person, by whom any tax or

other sum of money, including interest and penalty, is payable under the

Act, irrespective of the feet whether any proceeding under the Act has

been taken against him or not.

2. Second Category: A person in respect of whom any proceeding under the

Act has been taken, whether or not he is liable for any tax, interest or

penalty. Proceedings may be taken -

(a) either for the assessment of the amount of his income or of the loss

sustained by him; or

(b) of the income (or loss) of any other person in respect of whom he is

assessable; or

(c) of the amount of refund due to him or to such other person.

3. Third Category : Every person who is deemed to be an assessee. For

instance, a representative assessee is deemed to be an assessee by virtue of

Sec. 160(2).
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4. Fourth Category: Every person who is deemed to be an assessee in default

under any provision of the Act. For instance, under Sec. 29(1), any person

who does not deduct tax at source, or after deducting fails to pay such tax,

is deemed to be an assessee in default. Likewise, under Sec.218, ifa person

does not pay advance tax, then he shall be deemed to be an assessee in

default.

3.6 Charge of Income-tax

As per Sec.4 ofthe Act, the following basic principles are followed while charging

the tax:

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

2. Income of previous year is charged in the next following assessment year at

the tax rates applicable for the assessment year. This rule, however, is subject

to certain exceptions as already detailed under 3.2.2 above.

3. Tax rates are fixed by the annual Finance Act and not by the Income-tax

Act.

4. Tax is charged on every ‘person’.

5. The tax is levied on the ‘total income’ (discussed later) of every assessee

computed in accordance with the provisions ofthe Act as they stand on the

first day of April in any assessment year.

3.7 Income

The definition of the term ‘income’ in Sec.2(24) is inclusive. It not only includes

those things which are included in Sec.2(24) but also includes such things which

the term signifies according to its general and natural meaning. Following are

some of the broad principles clarifying the concept of ‘Income’ under the Act:
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1. Regular and definite source : The term ‘income’ connotes a periodical

monetary return coming in with some sort, of regularity. However, it must

be read with reference to facts of each case.

2. Different forms of income : Income may be received in cash or in kind.

When income is received in kind, its valuation is to be made according to

the rules prescribed in the Income-tax Rules. If, however, there is no

prescribed rule, valuation thereof is made on the basis of market value.

3. Receipt vs. Accrual: Income arises either on receipt basis or on accrual

basis. Income may accrue to a taxpayer without its actual receipt. Tax

incidence arises either on ‘accrual’ or on ‘receipt’ basis.

4. Illegal income: The income-tax law does not make any distinction between

income accrued or arisen from a legal source and income tainted with

illegality.

5. Disputed title : Income-tax assessment cannot be held up or postponed

merely because of existence of a dispute regarding the title of income. The

recipient is, therefore, chargeable to tax, though there may be rival claims

to the source of the income. A mere claim, on the other hand, by a person

against the recipient of income is not sufficient to make income accrue to

the claimant and render him liable for tax.

6. Relief or reimbursement of expenses not treated as income: Mere relief or

reimbursement of expenses is not treated as income..

7. Diversion of income by overriding title vs. application of income : There

is a thin dividing line between diversion of income and application ofincome.

While application of income may be of little consequence, diversion of

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income has to be examined carefully.

8. Surplusfrom mutual activity: A person cannot make a taxable profit out of

a transaction with himself. Income must, therefore, come from outside.

9. Appropriation ofpayment between capital and interest: Where interest is

due on a capital sum and the creditor gets an open payment from the debtor,

the creditor is at liberty to appropriate the payment towards principal. If,

however, neither the creditor nor the debtor makes any appropriation of

payment as between capital and interest, the Income-tax Department is

entitled to treat the payment as applicable to the outstanding interest and

assess it as income.

10. Temporary andpermanent income : For the purpose of income-tax, there

. is no distinction between temporary and permanent income. Even temporary

income is taxable.

11;' Lump sum receipt: Income, whether received in lump sum or in installments,

is liable to tax. For instance, arrears of bonus, received in lump sum, is

income and taxable as salary.

12. Personal gifts : Gifts of a personal nature, e.g. birthday gifts, marriage

gifts, etc., do not constitute income and, therefore, recipient of such gifts is

not liable to income-tax.

13. Tax-free income: If a person receives tax-free income on which tax is paid

by the person making payment on behalf ofthe recipient, it has to be grossed

up for inclusion in his total income.

14. Receipt on account of Dharmada : Receipt on account of Dharmada,

Gaushala and Pathshala is not income and, therefore, not liable to tax.
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15. Devaluation of currency : The extra money received on account of

devaluation of currency is taxable.

16. Income includes loss: While income and profits and gains represent ‘plus

income’, losses represent ‘minus income’. Hence, while calculating the ‘total

income’, both negative and positive incomes should be taken into account.

17. Prizes and winnings : Winnings from lotteries, crossword puzzles, races,

card games and other games of any sort or from gambling or better of any

form or nature are taxable under the Act.

18. Same income cannot be taxed twice : It is a fundamental rule of the law of

taxation that, unless otherwise expressly provided, the same income cannot

be taxed twice.

19. Income should be real and not fictional: Income means real income and

not fictional income. In determining the question whether the income is

real or fictional, various factors will have to be taken into account.

20. Mere production does not amount to income : Mere production or receipt

of a commodity which may be converted into money certainly cannot be

construed to be an income in its normal connotation of ‘income’.

21. Source of income need not exist in the assessmentyear: It is not necessary

that the source of income should exist in the assessment year. If there is an
* »

income during the previous year, it is chargeable to tax in the following

assessment year.

22. Pin money - Pin money received by wife for her dress/personal expenses

and small savings made by a woman out of money received from her husband

for meeting household expenses is not treated as her income.

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23. Award received by a sportsman : Award money received by a professional

sportsman is taxable, but the award money received by a non-professional/

amateur sportsman is not liable to tax.

24. Entries in books of accounts are not conclusive of income : The way in

which entries are made by the assessee in his books of account is not

determinative of the question whether the assessee has earned any profit or

suffered any loss.

25. Income of a State is not liable for Union Taxation : By virtue of Article

289(1) of the Constitution, the property or income of a State is not liable

for Union taxation.

26. Revenue receipt vs. Capital receipt: A revenue receipt is taxable as income,

unless it is expressly exempt under the Act. But a capital receipt is generally

exempt from tax, unless it is expressly taxable under Sec.45.

3.8. Gross Total Income

As per Sec. 14 of the Act, the income of a person is calculated under the following

five-heads: (i) Salaries, (ii) Income from house property, (iii) Profits and gains of

business or profession, (iv) Capital gains, (v) Income from other sources.

: The aggregate income under these heads is termed as ‘gross total income’.

The several heads into which income is divided do not make different kinds of

taxes. Taxis always one but it may arise under different heads to which different

rules of computation have to be applied. These heads are in a sense exclusive to

one another and income which falls within one head cannot be assigned to or

taxed under another head. Income has to be brought under one of the heads

under Sec. 14 and can be chaiged to tax only ifit is chargeable under the computing
section corresponding to that head. The method of book keeping followed by an

assessee cannot decide under which head a particular income should go.

3.9 Total Income and Tax Liability

According to Sec.2(45), total income of an assessee is gross total income as

reduced by the amount deductible under Secs.80CCC to 80U.

The Income-tax Act contains the provisions for computing taxable income,

but the rate of tax is given by the Finance Act passed by the Parliament along

with the Union Budget every year.

3.10 Agricultural Income

By virtue of Sec.2(l A), the expression ‘agricultural income’ 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 agricultural operations including

processing of the agricultural produce, raised or received as rent-in-kind

so as to render it fit for the market or sale of such produce;

(c) income attributable to farm house subject to the conditions that the building

is situated on or in the immediate vicinity ofthe land and is used as a dwelling

house, store house or other outbuilding and the land is assessed to land

revenue or a local rate or, alternatively, the building is situated on or in the

immediate vicinity of land which (though not assessed to land revenue or

local rate) is situated outside the urban areas, i.e. any area which comprised

within the jurisdiction of a municipality or cantonment board having a

population of10000 or more in any area within such notified distance (upto

8 kilometres) from the local limits of such municipality or cantonment board.

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Sec. 10(1) exempts agricultural income from tax. The reason of exemption

of agricultural income from central taxation is that the Constitution gives exclusive

power to make laws with respect to taxes on agricultural income to the State

Legislature. However, in some cases, agricultural income is taken into

consideration to determine tax on non-agricultural income.

3.11 Casual Income

Vide provisions of Sec. 10, casual incomes and receipts are exempt from tax.

Casual income means a receipt which is casual and nonrecurring in nature. Since

the expression is not defined by the Act, its meaning must be construed in its

plain and ordinary sense. Casual receipts which are of casual and nonrecurring

nature are exempt from tax. The exemption is available only if the following

conditions are satisfied:

(a) the receipt should be casual in nature;

(b) it should be ‘nonrecurring’,

(c) it should not be taxable as capital gains under Sec.45;

i *

(d) it should not arise from business or the exercise! of a profession or

occupation;

(e) the receipt is not by way of addition to the remuneration of an employee.

V.K.Singhania and Kapil Singhania list atleast 57 types of casual income

and receipts.

3.12 Assessment

Under See.2(8), the word ‘assessment’ is defined to include reassessment. In

general context, the word ‘assessment’ means computation of tax and procedure

for imposing tax liability. Under the Act, there are seven kinds of assessments -
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self-assessment, provisional assessment, regular assessment, best judgment

assessment, reassessment, jeopardy assessment under Secs. 172 and 174 to 176

and precautionary assessment.

An assessment is said to be complete when both the assessment order is

made and the tax payable by the assessee is determined. Assessments have to be

made for every year and cannot be held up until the final result of a legal

proceeding, which may pass through several courts, is announced. Assessment

includes imposition of penalty. On the whole, the Act is rather ambivalent on the

issue of ‘assessment’ and hence, even the minute details of the procedure have

been fought right upto the Supreme Court. As a result, now there is abundance

of case-law on the matter.

3.13 Business

In view of See.2(13), business includes any (a) trade, (b) commerce, (c)

manufacture, or (d) any adventure or concern in the nature of trade, commerce

of manufacture. Under Sec. 28, the following eight types ofincomes are chargeable

to tax under the head ‘profits and gains of business or profession’ :

(1) prdfits and gains, of any business or profession;

(2) any compensation or other payments due to or received by any person

specified in section;

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

services performed for its members;

(4) profit on sale of import entitlement licences, incentive by way of cash

compensatory support and drawback of duty;

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(5) the value of any benefit or perquisite, whether convertible into money or

not, arising from business or the exercise of a profession;

(6) any interest, salary, bonus, commission or remuneration received by a partner

of firm from such firm;

(7) any sum received under a keyman insurance policy;

(8) income from speculative transactions.

On the whole, taxation of business income is another complex matter.

3.14 Capital Asset

According to Sec.45.(l), any profit or gain arising from the transfer of a capital

asset is chargeable to tax under the head ‘Capital gains’ in the previous year in

which the transfer took place, if it is not eligible ft»r exemption under. Secs.54,

54B, 54D, 54EC and 54G. The expression ‘capital asset’ means property of any

kind held fry an assessee, whether or not connected with his business or profession.

However, the following assets are excluded from the definition of ‘capital asset’:

(1) My stock-in-trade, consumable stores or raw materials held for the purposes

of business or profession;

(2) personal effects ofthe assessee, that is, movable property including wearing

apparel and furniture held for his personal use or for the use of any member

of his family dependent upon him (jeweller is treated as a capital asset,

even though it is mean for personal use).

(3) Agricultural land in India, provided it is not situated - (i) in any area within

the jurisdiction of a municipality or a cantonment board having a population

of 10,000 or more; or (ii) in any areas specified by the Government;

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(4) 6.1/2 per cent Gold Bonds, 1977, or 7 per cent Gold Bonds, 1980, or

National Defence Gold Bonds, 1980, issued by the Central Government;

(5) Special Bearer Bonds, 1991; and

(6) Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999.

Transfer, in relation to a capital asset, includes sale, exchange or

relinquishment of the asset or the extinguishment of any rights therein or the

compulsory acquisition thereof under any law.

Computation of capital gain depends upon the nature of capital asset

transferred, viz. short-term capital asset or long-term capital asset. Capital gain

arising on transfer of a short-term capital asset is short-term capital gain, whereas

transfer of long-term capital asset generates long-term capital gain. The tax

incidence is generally higher in the case of short-term capital gain as compared

to the long-term capital gain.

Fair market value, in relation to a capital asset, means the price that the

capital asset would ordinarily fetch on sale in the open market on the relevant

date. Where, however, such price is not ascertainable, it may be determined in

accordance with the;Jprescribed rules.

if
3.15 Capital receipts vs. Revenue receipts
Receipts are oftwo types, viz. capital receipts and revenue receipts. The distinction

between the two is vital because capital receipts are exempt from tax unless they

are expressly taxable (for instance, capital gains are taxable under Sec.45, even if

they are capital receipts), whereas revenue receipts are taxable unless they are

expressly exempt from tax (for instance, incomes except under Secs. 10 to 13 A).

As the Act does not define the terms ‘capital receipts’ and ‘revenue receipts’,
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one has to depend upon the natural meaning ofthe concepts as well as the decided

cases. The essential difference between capital and revenue is that capital is a

fund; revenue is a flow.

3.2.14 Capital expenditure vs. Capital receipts

The distinction between these two is vital because capital expenditure, even if

incurred for the purpose of earning income, is not deductible while computing

taxable income, unless the law expressly so provides. Revenue expenditure, on

the other hand, is deductible while computing taxable income unless the provides

specific rules to disallow such expenditures wholly or partly. As the Act does not

define the terms ‘capital expenditure’ and ‘revenue expenditure, one has. to depend

upon their natural meaning as well as decided cases.

3.16 Method of Accounting.

In accordance with the provisions of Sec. 145, income chargeable under the head

‘profits and gains ofbusiness or profession’ or ‘income from other sources’ is to

be computed as per the method of accounting regularly employed by the assessee.

Mainly, there are two types of accounting methods - mercantile system and

cash system. Under the mercantile system, income and expenditure are recorded

at the time of theirOccurrence during the previous year. For instance, income
accrued during the "previous year is recorded whether it is received during the

previous year or during a year preceding or following the previous year. Similarly,
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expenditure is recorded if it becomes due during the previous year, irrespective

of the fact whether it is paid dining the previous year or not. The profit calculated

under the mercantile system is profit actually earned during the previous year,

though not necessarily realized in cash. In other words, whether accounts are
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kept on mercantile basis, the profits or gains are credited, though they are not

actually realized and entries, thus, made really show nothing more than an accrual

or arising of the said profits at the material time. .

Under the cash system of accounting, revenue and expenses are recorded

only when received or paid. For instance, income received during the previous

year is included in taxable income whether it is earned during the previous year

or it is earned during a year preceding or following the previous year. Similarly,

expenditure is deductible from the taxable income only if it;is paid during the

previous year, irrespective of the fact whether it relates to the previous year or

not. Income under cash system of accounting is, therefore, excess of receipts

over disbursements during the previous year.

The assessee may select cash or mercantile system of accounting in respect

ofincome chargeable under the heads ‘profits and gains ofbusiness or profession’

and ‘income from other sources’. The choice of the method of accounting lies

with the assessee but the assessee must show that he has regularly followed the

method of accounting chosen by him. In other words, once a particular method

of accounting is followed by the assessee, he must follow it on a consistent basis.

3.17 Rules of Interpretation

Interpretation implies interpreting the provisions ofthe fiscal statute. The task of

interpretation is not a mechanical task. It is more than a mere reading of

mathematica} formulate. It is possible that the same word used in indifferent parts

of state may sound differently. It is through the task of interpretation that the

whole enactment is given a harmonious reasoning.

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Need for Interpretation

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English literature would have been much poorer if English language could

have been such that statutes could be drafted with divine precision. However,

judiciary cannot simply fold hands and blame the draftsman. Judiciary must set to

work on the interpretational activity of bringing out the true legislative intent.

Interpretation vs. Construction

While interpretation is interpreting the provisions of the statue and bringing

out of the basic legislative intent behind the enactment, construction of statute

stands on a different footing. When provisions of the statute are drafted in such

a way that plain interpretation of statutory provision produces manifestly absurd

and unjust result or provisions are contradicting one-another so that they cannot

be harmonized, Court may modify the language used by the Legislature or even

do some violence to it, so as to achieve the obvious intension of the Legislature

and produce a rational construction.

Rules of Interpretation

Literal rule - Primarily, statute should be interpreted according to the

expressions used in it. If the language of the statute is clear and unambiguous

and iftwo interpretations are not reasonably possible, it would be wrong to discard

the plain meaning pf the words used in order to meet a possible injustice. One of

the pillars of statutory interpretation, viz. literal rule, demands that ifthe meaning

of the statutory interpretation is plain, the court must apply the same regardless

of the result. So long as the provision is free from ambiguity, the words used

therein should be given their plain meaning without importing into it any foreign

words and without subtracting any words therefrom.

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Golden rule - If strict literal interpretation leads to an absurd result and

object sought to be accomplished would be defeated by such interpretation, then

a construction that would avoid such absurdity shall be thought of. The words

are modified so as to avoid the absurdity and inconsistency. Under such

circumstances, a construction would results in equity rather than injustice shall

be preferred although it is often said that equity and taxation are strangers. Golden

rule is, thus, also known as ‘rule of reasonable construction’.

Mischiefrule - When a statute is amended or previous enactment is repealed

to meet some specific purposes, in such a case, regard shall be had to the mischief

which was earlier prevailing in the law and now stood rectified. In this respect,

the following long established principles need to be borne in mind: “that for the

sure and true interpretation of all statutes in general (be they penal or beneficial,

restrictive or enlarging of the common law), four things are to be discerned and

considered: (i) what was the common law before the making of the Act; (ii) what

was the mischief and defect for which the common law did not provide; (iii)'Vhat

remedy Parliament has resolved and appointed to cure the disease of the

commonwealth; and (iv) the true reason ofthe remedy. And then, the office of all

the judge is always to make such construction as shall suppress the mischief and

advance the remedy, and to suppress subtle inventions and evasions for the

continuance of the mischief and to add force and life to the cure and remedy

according to the true intent of the makers of the Act.”

There is now the further addition that regard must be had not only to the

existing law but also to prior legislation and to the judicial interpretation thereof.

Rule of ‘ejusdem generis ’ - The maxim “generalia specialibus non derogant”

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is regarded as a cardinal principle of interpretation. The literal meaning of the '

expression is that if there is an apparent conflict between two independent

provisions of law, the special provision must prevail. The general provision,

however, controls the cases where the special provision does not apply as the

special provision is applicable to the extent of its. scope.

Beneficial to the assessee - It is necessary to remember that when a provision

is made in the context of a law providing the concessional rates of tax for the

purpose of encouraging an industrial activity, a literal construction should be put

upon the language of the statute. When two views are possible, the view that

favours the assessee or is beneficial to him should be followed.

Retrospective legislation - There is a well settled principle against

interference with vested rights by subsequent legislation unless the legislation

has been made retrospective expressly or by necessary implication. Ifan assessment

has already been made and completed, the assessee cannot be subject to

reassessment unless the statute permits that to be done. Legislative amendment

or enactment is principally concerned with establishment of future rules of conduct.

This presumption must be given effect to in the absence ofany expression intention

to operate the law retrospectively.

Use ofexpressions ‘may ‘shall’, ‘and’, ‘or’-Use ofword‘may* denotes

discretion in complying with the provisions of the statute, while ‘must’ or ‘shall’

denote imperative to comply with statutory provision. Yet, these words may be

interpreted., interchangeably. ‘Shall’ or ‘must’ can be interpreted as ‘may’

depending upon the nature and intention of the Legislature. When obligation to

exercise a power is coupled with a duty cast upon or non-performance of

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provisions of statute would make the purpose null and void, then ‘may’ can be

construed as ‘shall’ or ‘must’.

Finance Minister 5s speech - The object clause and the Finance Minister’s

speech are relevant only when the provision itself is not clear and is ambiguous.

The speech made by the mover of a Bill explaining the reason for the introduction

ofthe Bill can certainly be referred to for the purpose of ascertaining the mischief

sought to be remedied by the legislation and the object and purpose for which the

legislation is enacted. This is in accord with the recent trend in juristicthat

interpretation of a statute being an exercise in the ascertainment of meaning,

everything which is logically relevant should be admissible.

Marginal notes - It is undoubtedly true that the marginal note to a section

cannot be referred to for the purpose ofconstruing the section, but it can certainly

be relied upon as indicating the drift of the section. It cannot control the

interpretation of the words of a section, particularly when the language is clear

and unambiguous but, being part of the statute, it prima facie furnishes some

clue as to the meaning and purpose of the section.

Executive Instructions - Instructions issued by the Ministry or Department

for. guidance of its officers are of no assistance in interpreting a taxing statute.

Instructions are not binding on Commissioner (Appeals), Income-tax Appellate

Tribunal, High Court and the Supreme Court. Even an assessee is not bound by
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the executiveinstructions issued by the Central Board ofDirect Taxes. However,

departmental officers/assessing officers are bound by such instructions and

circulars. The interpretation of the CBDT’s instructions can be considered only

as an aid to understanding the intention of the Parliament in enacting a Section.

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Schedules to Act - Schedules to Act cannot override simple and plain

provisions of the Act.

Constitutional validity - Any provision of law affecting the rights of

individuals, will have to be read in the context of the Indian Constitution. The

provisions of law should not contravene the Constitutional provisions like the

fundamental rights.

Charging section - Charging section has to be construed strictly. Ifa person

1ms not been brought within the ambit of the charging section by clear words, he

cannot be taxed at all.

Catch phrase - A catch phrase possibly used as a populist measure to

describe some provisions in the Finance Bill in the explanatory memorandum

while introducing the Bill in Parliament can neither be determinative of. nor can

it camouflage the true object of the legislation.

Re-enactment - It is wry well recognized rule of interpretation of states

that where a provision of an Act is omitted by an Act and the said Act

simultaneously re-enacts a new provision which substantially covers the field

occupied by the repealed provision with certain modification, in that event, such

re-enactment is regarded having force continuously and the modification or

changes are treated as amendment coming into force with effect from the date of

enforcement of re-enacted provision.

Thus concludes, although somewhat lengthy, explanation of the basic

concepts of the taxation of income under the Income-tax Act, 1961.

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