APPLIATION OF INCOME AND DIVERSION OF INCOME

A cursory perusal of the S.60 of the Act will make it clear that unless there is transfer of the
assets from which the income arises, the income arising from that asset will be included in
the income of the transferor for computation of tax

The respondent in Commissioner of Income Tax, Bombay v. Sitaldas Tirathdas sought to

deduct a sum of Rs. 1,350 in the first assessment year and a sum of Rs. 18,000 in the second
assessment year on the ground that under a decree he was required to pay these sums as
maintenance to his wife and his children. This was disallowed by the Income Tax Officer.
The matter reached till the Supreme Court.

The Supreme Court made a distinction between the amount which a person is obliged to
apply out of his income and an amount which by the nature of an obligation cannot be said to
be the part of the income of the assessee. When the income does not reach the hands of the
assessee due to diversion under an obligation, it is deductible. But on the other hand when the
income is required to be applied to discharge an obligation after such income reaches the
assessee, the same consequence in law does not follow. The first kind of payment is
exempted under the Income Tax Act but not the second one. The second one is a case of
application of income which has been received. The first is a case in which the income never
reaches the assessee, who even if he were to collect it, does so, not as part of his income, but
for and on behalf of the person to whom it is payable. On the facts and circumstances of the
case it was held that it was a mere case of application of income to discharge an obligation.
The wife and children of the assessee who continued to be members of the family received a
portion of the income of the assessee only after the assessee had received the income as his
own. Therefore there was no diversion of income by an overriding charge.
Diversion of Income

 The concept of application of income cannot be fully appraised without understanding

the concept of diversion of income by overriding title. The following case laws would
throw light on the matter. In Raja Bejoy Singh Dudhuria v. Commissioner of
Income Tax, Bengal, the step mother and the Raja had entered into a compromise
decree whereby a sum of Rs. 1, 100 per month was to be paid to her for her
maintenance. This amount was declared as a charge upon the properties in the hands
of the Raja by the Court. The Raja sought to deduct this amount from his assessable
income. This was disallowed by the High Court of Calcutta. He went on appeal to the
Judicial Committee.

The Judicial Committee held that the amount which the Raja paid to his step-mother
did not constitute his income. This was a case of diversion of income by overriding
title, as the Court had created a charge on the whole resources of the Raja with a
specific payment to his step-mother. To that extent it was not his income. Further it
was observed that it is not a case where the appellant is applying his income in a
particular way rather it is the allocation of a sum out of his revenue before it becomes
income in his hands. It is submitted that given the facts and circumstances of the case
it was correctly held that the case was of diversion of income by overriding title. The
assessee never received the sum of Rs. 1, 100 in his hands. Even if he received it was
 not for himself. He was acting as a mere collector of that income which was to be paid
to his step-mother. Thus, he was like a conduit pipe between his step-mother and the
resources which generated the income.
 The Supreme Court in Moti Lal Chhadami Lal Jain v. Commissioner of Income
Tax, observed that what is of cardinal importance is the nature of obligation by reason
of which the income becomes payable to a person other than the one entitled to it.
Where the obligation flows out of an antecedent and independent title, it effectively
diminishes the total income of an individual and so it would be a case of diversion.
Whereas when the obligation is self imposed or gratuitous, it is only a case of
application of income.

From the above observation of the Apex Court, it is submitted that there is a
difference between an amount which a person is obliged to apply out of the income
and an amount which by the nature of the obligation cannot be said to be the part of
the income.

 Sunil j kinari vala – in notes.

 CIT V bankipur- Notes

 RSMN CO. V ADD CJT – in notes

Conclusion

 Income emanates from a source. Income is got through receipt or accrual or it is

deemed to accrue. Under the Income Tax Act, once the income has come into
existence it is liable for tax. Taxable event is the source generating the income. When
I earn income, I set apart it for certain things. It may arise under a contractual
obligation or statutory obligation or involuntary/voluntary disposition. It is not every
obligation under which an income is applied is taken into account while computing
tax. The emphasis is on the nature of the obligation. If the nature of obligation is
such that the income gets diverted before it reaches the hands of the assessee due to
operation of law or due to creation of charge, then such amounts are deductible
while computing the tax liability of the individual. Rational behind this is that
presence of an independent title effectively slices away a part of the corpus of the
right of the assessee to receive the entire income. On the other hand if the obligation
is self imposed, it is a mere application of income.

Due to the ingenuity of the people, S.60 has been provided in the Act. The section
tries to curb the mischief whereby individuals try to escape tax liability by
transferring the income. Unless and until the source has been assigned to someone
else, it w8ill not fall within the domain of diversion of income. The test is to see
precisely at what time the transfer had taken place. If transfer had taken place after the
accrual of income then it is an application of income. But if transfer has taken place
 after the assignment of source then it is not application of income. There exists a
difference between an amount which a person is obliged to apply out of his
income and an amount which by the nature of the obligation cannot be said to be
a part of the income of the assessee. All this has to be seen in the broader context of
the Act that the Act is nonchalant about the destination or disposal or what happened
to the income once it has accrued in the hands of the assessee

House property(s. 22-27)

 Every money receipt by a person is not chargeable to tax. Section 14 of the Act
specifies five heads of income on which tax can be imposed under the Income tax
Act. In order to be chargeable, an income has to be brought under one of these five
heads. The 8heads are (i) salaries (ii) Income from House property (iii) profits and
gains of business or profession (iv) capital gains and (v) income from other sources.
In the discussion to follow, the relevant provisions of the Act relating to Income from
House Property would be considered and how the computation of income from this
source is to be made, namely, how the income is to be worked out and what are the
deductions to be given for computing the taxable income shall be explained. Sections
22 to 27 of the Act deal with the subject of taxation of income from house property.
Section 22 provides for taxation of ‘annual value’ of a property consisting of any
buildings or lands appurtenant thereto, of which the assessee is owner, under the head
“income from House Property”. Tax imposed under section 22 is a tax on `annual
value’ of house property and is not a tax on “House Property”. However, if a house
property is occupied by a taxpayer for the purpose of business or profession carried on
by him (the profits of which are chargeable to income tax), annual value of such
property is not chargeable to tax under the head 'Income from House Property'.

In the earlier discussion, the phrase ‘lands appurtenant thereto’ has also been used. It
needs to be clarified in this context that income from letting of vacant plots of land
when there is no adjoining building will not be taxed under this head (but will be
taxed as income from other sources). The existence of a building is, therefore, an
essential prerequisite. Building will, of course, include residential house (whether let
out or self occupied), office building, factory building, godowns, flats, etc. as long as
they are not used for business or profession by owner. And the purpose for which the
building is used by the tenant is also immaterial. Thus, income from letting out
godowns will be taken as income from house property. It does not make any
difference at all if the property is owned by a limited company or a firm..
 CONDITIONS NECESSARY FOR TAXING INCOME FROM HOUSE
PROPERTY
These are:

# The property should consist of any building or land appurtenant thereto

# The assessee should be the owner of the property

# The property should not be used by the owner for the purpose of any business or
profession carried on by him, the profits of which are chargeable to tax.

Unless all the aforesaid conditions are satisfied, the property income cannot be
charged to tax under the head ‘Income from House property’.
or the purpose of section 22, the concept hitherto understood even in court decisions
has been that the owner has to be a legal owner. Annual value of property is assessed
to tax under section 22 in the hands of owner even if he is not in receipt of income or
even if income is received by some other person. For instance, if a person makes gift
of rental income to a friend or a relative, without transferring ownership of the
property, annual value of property is taxable in the hands of the donor, even if rental
income is received by the done
Deemed ownership
In the following situations the ownership shall be deemed for taxing income from
house property in view of section 27 of the Act:

# When house property is transferred to spouse (otherwise than in connection with an

agreement to live apart) or minor child (not being a married daughter) without
adequate consideration (Section 27(i))

# In the case of holder of an impartible estate (Section 27(ii))

# A member of a cooperative society, company etc. to whom a building or part

thereof has been allotted or leased under a house building scheme (Section 27(iii)).
Thus, when a flat is allotted by a cooperative society or a company to its
members/shareholders who enjoy the flat, technically the co-operative
society/company may be the owner. However, in such situations the allottees are
deemed to be owners and it is the allottees who will be taxed under this head.

# A person who is allowed to take or retain possession of any building (or part therof)
in part performance of a contract of the nature referred to in section 53A of the
Transfer of Property Act, 1882, is deemed as the owner of that building (or part
thereof) [Sec. 27 (iiia)].

Persons who purchase properties on the basis of Power of Attorney and under long
term leases (12 months & more) are also deemed to be owners. The concept of
deemed owner is introduced to prevent misuse like transferring properties in the name
of spouse or minor child etc. and for assessment of income in the hands of beneficial
owner.
Section 26 concerns properties which are owned by co-owners. This section provides
that where property consisting of building or buildings and land appurtenant thereto is
owned by two or more persons and their respective shares are definite and
ascertainable such persons shall not, in respect of such property, be assessed as an
association of persons, but the share of each such person in the income from the
property as computed in accordance with sections 22 to 25 shall be included in his
total income.

DETERMINATION OF INCOME FROM HOUSE PROPERTY

The determination of ‘Annual Value’ is important in the context of taxation of income
from House Property because though the tax under the head ‘Income from house
property’ is tax on income, yet it is not in that sense a tax on income but upon
inherent capacity of such property to yield income and for this ‘annual value’ is the
yardstick. The inherent capacity has been defined as the sum for which the property
might reasonably be expected to be let from year to-year. It is not necessary, that the
property should be actually let. It is also not necessary that the reasonable return from
property should be equal to the actual rent realized when the property is, in fact, let
out. Where the actual rent received is more than the reasonable return, it has been
specifically provided that the actual rent will be the annual value. Where, however,
the actual rent is less than the reasonable rent (e.g. in case where the tenancy is
affected by manipulation, emergency, close relationship or such other consideration),
the latter will be annual value. The municipal value of the property, the cost of
construction, the standard rent if any under the Rent Control Act, the rent of similar
properties in the same locality are relevant factors for the determination of the annual
value. However, if a property is let and was vacant during any part or whole of the
year and due to such vacancy, the rent received is less than the notional rent, such
lesser amount shall be the Annual Value. For example, in case of a house, whose
municipal valuation is Rs. 24,000/- and actual rent received is Rs. 36,000/- the annual
lettable value will be taken at Rs.36,000/-. If the actual rent received is Rs. 18,000/-
and municipal valuation is Rs.24,000/-, the annual value would be Rs. 24,000/- for the
purpose of the Income-tax Act. Here, if the property was vacant for six months and
the rent received is Rs. 18,000/- for six months the Annual Value shall be Rs.
18,000/-.

Where the property is subject to Rent Control Act, its annual value under section
23(1) cannot exceed the standard rent (fixed or determined) under the Rent Control
Act unless it is actually let out for a higher amount. Such a view has been expressed
by the Supreme Court in the cases of Dewan Daulat Rai Kapoor v. NDMC (1980) 122
ITR 700 (SC); Amolak Ram Khosla v. CIT (1981) 131 ITR 589 (SC) & Mrs. Shiela
Kaushik v. CIT (1981) 131 ITR 435 (SC).

CASE LAWS
 CIT West Bengal v. Biman Behari Shaw, Shebait (1968) 68 ITR 815
(Cal)
88Facts & Issue: Premises in questions were properties dedicated to deities. The
will in respect of the property laid down that “no body save and except the Brahmin
performing the worship of the deity and servants shall ever be competent to reside in
the property”. ITO thus conducted the bona fide annual value of the properties at the
amounts which they were likely to fetch if let out into the market. The assessee
objected to the assessment of annual value of the properties that they were not let out
and no income accrued there from. It was contended that in view of injunction
contained in the will the premises had no letting value.

Cal HC observed: -
(1) The tax shall be payable by an assessee under the head income from property in
respect of the bona fide annual value of property consisting of any buildings or lands
appurtenant thereto of which he is the owner, other than such portions of such
property as he may occupy for the purpose of any business, profession or vocation
carried on by him the profits of which are assessable to tax, subject to the following
allowance, namely,......

(2) For the purposes of the section, the annual value of the property shall be deemed
to be the sum for which the property might reasonably be expected to let from year to
year."

It is apparent from the section quoted above that even where a property is not let and
even where it does not produce any income, the Income-tax Officer is to proceed on
the basis of a notional income, which the property might reasonably be expected to
yield from year to year. Now, where a property, is not actually let, even then there
ought to be included in the annual income of the owner a notional income from the
property. The letting value of property, whether let or not, can be objectively
ascertained on reasonably basis. If there be restrictions on the letting of the premises,
that may merely reduce letting value but it cannot be said, without more, that because
of the existence of a restrictive clause there can be no notional annual income deemed
to arise from the premises.
2. (17) East India Housing & Land Development Trust Ltd v. CIT (1961) 42 ITR
49(SC)
Held that income from letting out house property is assessable under the head
‘Income from house property’, even if it has been earned by a company set up with an
object of developing and setting up markets.
 RB Jodhamal Kuthiala v. CIT. AIR 1972 SC 126
The assessee was a, registered firm deriving income    from securities, property,
business and other- sources. In 1946 it purchased a hotel in 'Lahore for a sum of Rs.
46 lacs. For that purpose it raised a loan of Rs. 30 lacs from a bank and a loan of Rs.
 18 lacs from one R. The 'loan taken from the, bank was largely repaid but with R the
assessee came to an agreement whereby R accepted a half share in the said property in
lieu of the loan advanced and-. also 1/3rd of the outstanding liability of the bank.
This arrangement came into effect on November 1, 1951. After the creation
of Pakistan, Lahore became a part of Pakistan and the hotel in question was declared
evacuee property. As such it came to vest in the Custodian in Pakistan. In its returns
for the assessment years 1952-53, 1955-56 and 1956-57 the assessee claimed  certain
amounts as losses on account of interest payable to the bank but showed the gross
annual letting value from the said property at Nil. The Income-tax Officer held that
since the property had vested in the Custodian no income or loss from that
property could be considered in the assessee's case. The Appellate Assistant
Commissioner confirmed the order of the Income-tax Officer. The Appellate Tribunal
however came to the conclusion that the assessee still continued to be the owner of
the property for the purpose of the computation of loss, and the interest paid was a
deductible allowance under s. 9(1) (iv) of the Income-tax Act, 1922. In. reference the
High Court on an analysis of the various provisions of the Pakistan (Administration of
Evacuee Property) Ordinance.15 of. 1949 came to the conclusion that for the purpose
of s. 9 of the Act-the assessee could not be considered as the owner of that property:
'In the assesee's appeal to this Court it was contended that the property vested in the
Custodian only for. the purpose of administration and the assessee still continued to
be its- owner.
 HELD :  Under the Pakistan (Administration of Evacuee Property) Ordinance 1949
the evacuee could not take possession of his property. He could not lease that
property. He could not sell the property without the consent of the custodian. He
could not mortgage that property. He could not realise the income of the property. All
the rights that the evacuee had in the property were exercisable by the Custodian
excepting that he could not appropriate the proceeds to his own use.
The              evacuee had only a beneficial interest in the property. In the eye of the
law the Custodian who had all the powers of the owner was the owner of the
property. His position was no less than that a Trustee.
 Section 9 of the Income-tax Act,- 1922, brings to tax the income from
property and. not the interest of a. person in the property. A property cannot be
owned by two persons, each one having independent and exclusive right over it.
 Hence for the purpose of s. 9 the owner must be that person who can exercise the
rights of the owner, not on behalf of the owner but in his own right.
Accordingly the assessee was not the owner of the property in question during the
relevant assessment years for the purpose of s. 9 of the Act.

Determination of Annual Value of Self-occupied property

In case of one self-occupied house property which has not been actually let out at any time,
the annual value is taken as ‘nil’. If, one is having more than one house property using all of
them for self-occupation, he is entitled to exercise an option in terms of which, the value of
one house property as specified by him will be taken at nil. The annual value of the other self
occupied house properties will be determined on notional basis as if these had been let out.

CAPITAL GAIN
Capital Gains: Any profits or gains arising from the transfer of a capital asset effected in the
previous year shall be chargeable to income-tax under the head capital gains.(section 45)
Examples of assets are a flat or apartments, land, shares, mutual funds, gold among many
others. There are two types of capital gains:
Short term- This is an asset that is held for not more than 36 months immediately preceding
the date of its transfer. This period of 36 months is substituted to 12 months in case of certain
assets like equity or preference shares held in a company, any other security listed on a
recognised stock exchange of India, Units of specific equity mutual funds and Zero coupon
bonds.

Long term capital asset: This is an asset that is held for more than 36 months or 12 months
as the case may be. Transfer is defined as the sale of the asset, giving up of rights on the
asset, forceful takeover by law or maturity of the asset. Many transactions are not considered
as transfer, for example, transfer of a capital asset under a will. Stocks and units of equity
diversified mutual funds qualify for long term capital gains if held for more than a year. In
case of real estate, it qualifies for long term capital gains if it is held for more than two years.
Earlier to the Finance Act 2017, real estate was considered as a long term capital asset only if
it was held for more than three years.

Capital gains shall be chargeable to tax if following conditions are satisfied:

a) There should be a capital asset. In other words, the asset transferred should be a capital
asset on the date of transfer;

b) It should be transferred by the taxpayer during the previous year;

c) There should be profits or gain as a result of transfer.

Meaning of Capital Asset [Sec 2(14)]

Capital Asset is defined to include:

a) Any kind of property held by an assessee, whether or not connected with business or
profession of the assessee.

b) Any securities held by a FII which has invested in such securities in accordance with the
regulations made under the SEBI Act, 1992.

 However, the term ‘capital asset’ shall exclude the following:

a) Stock-in-trade, consumable stores, raw materials held for the purpose of business or
profession;

b) Movable property held for personal use of taxpayer or for any member of his family
dependent upon him. However, jewellery, costly stones, and ornaments made of silver, gold,
platinum or any other precious metal, archaeological collections, drawings, paintings,
sculptures or any work of art shall be considered as capital asset even if used for personal
purposes;

c) Specified Gold Bonds and Special Bearer Bonds;

d) Agricultural Land in India, not being a land situated:

a. Within jurisdiction of municipality, notified area committee, town area committee,

cantonment board and which has a population not less than 10,000;

“Transfer” [Section 2(47)], in relation to a capital asset, includes:

(i) Sale, exchange or relinquishment of the asset;

(ii) Extinguishment of any rights in relation to a capital asset;

(iii) Compulsory acquisition of an asset;

(iv) Conversion of capital asset into stock-in-trade;

(v) Maturity or redemption of a zero coupon bond;

(vi) Allowing possession of immovable properties to the buyer in part performance of the
contract;

(vii) Any transaction which has the effect of transferring an (or enabling the enjoyment of)
immovable property; or

(viii) Disposing of or parting with an asset or any interest therein or creating any interest in
any asset in any manner whatsoever.

Section 46- where the assets of a company are distributed to its shareholders on its
liquidation99, such distribution shall not be regarded as a transfer by the company for the
purposes of section 45. (2) Where a shareholder on the liquidation of a company receives any
money or other assets99 from the company, he shall be chargeable to income-tax under the
head “Capital gains”, in respect of the money so received or the market value of the other
assets on the date of distribution, as reduced by the amount assessed s dividend within the
meaning of sub-clause (c) of clause (22) of section 2 and the sum so arrived at shall be
deemed to be the full value of the consideration for the purposes of section 48.

Case laws
B.D. Bharucha v. CIT., AIR 1967 SC 1505

The appellant, who was carrying on the business of financing film producers and distributors,
had advanced a sum of Rs. 1,00,000 to a firm of film distributors. Clause 3 of the agreement
between the parties provided that the appellant was not entitled to any interest but that he was
to share with the distributors their profit and loss;           and cl. 7 provided that in case the
picture was not released within the stipulated time, the distributors would return to the
appellant all              the moneys advanced by him together with interest at 9% per annum.
There was delay in releasing the picture and a dispute arose between the appellant and the
distributors, which was settled. The appellant found that a sum of Rs. 80,759 was
irrecoverable. He accordingly wrote it off as a bad debt and claimed it as a revenue
loss which should be deducted under s. 10(2)(xi) of the Income-tax Act, 1922.
The department, the Appellate Tribunal, and the    High Court on reference, held against the
appellant, on the basis of cl. 3 of the agreement, that the loss suffered by the appellant was a
capital loss.

In appeal to this Court,

HELD :  Since all payments reduce capital one is apt to consider a loss as a capital loss.  But
losses in the running of a business cannot be said to be of capital. To find out whether an
expenditure is on the capital account or on revenue account, one must consider the
expenditure in relation to the business. In the present case, the debt was in respect of  and
incidental to the business of the appellant in the relevant accounting year, and the accounts of
his business were kept on mercantile basis. If cls. 3 and 7 of the agreement are read together,
the transaction would be a money-lending transaction or a transaction in the nature of a
financial deal in the course of the appellant's business, resulting in a loan repayable with
interest. Therefore, the loss suffered was a revenue loss and the appellant was entitled to
claim the deduction of the amount as a bad debt under s. 10(2) (xi) of the Act.

2. maharaja raja hemant singh ji v cit

Section 2(4A) (ii), Income Tax 'Act, 1922, provides that 'personal effects, that is to say,
movable property (including wearing apparel, jewellery, and Furniture) held for personal
use by the assessee or any member of his family dependent on him,' shall not be included in
the 'capital assets' of the assessee. The context in which the expression 'personal effects'
occurs and the enumeration of articles like wearing apparel, jewellery and furniture, show
that only those articles are to be included as personal effects which are intimately and
commonly used by the assessee. The dictionary meaning of the expression is also the
same. Therefore, 'personal effects' mean those items which are normally, commonly or
ordinarily intended for personal use and not items which are capable of being intended for
personal use. [425E-426F-427C-D] Where the assessee was in possession of a large number
of gold sovereigns, silver rupee coins and silver bars, which were used at the time of the
puja of deities on special religious festivals or rituals, they could not be deemed to
be 'effects' meant for Personal use. They are capital assets and not personal effects and so,
when sold, could not be excluded while computing the capital gains liable to capital gains
tax under s. 12B, Income Tax Act,1922. [427F].

CHARGEABILITY OF INCOME SALARY(S- 15,16,17)

he following income  shall  be  chargeable  to income-tax under the head “Salaries” :

(a) any salary due from an employer or a former employer to an assessee in the previous
year, whether paid or not;

(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a
former employer though not due or before  it became due to him.
(c) any arrears of salary paid or allowed to him in the previous year by or on   behalf of   an
employer or a former employer, if not charged to income-tax for any earlier previous year.

(2) For the removal of doubts, it is clarified that where any salary paid in advance is included
in the  total income  of any person for any previous year it shall not be included again in the
total income of the person when  the salary  becomes  due.

Any salary, bonus, commission  or remuneration, by whatever name called, due to, or
received by, a partner of a firm from the firm shall not be regarded as “Salary”.

Salary” (Section 17) includes:-

i.       wages,  fees,  commissions, perquisites, profits in lieu of, or, in addition to salary,
advance  of salary, annuity or pension, gratuity,  payments in respect  of  encashment of leave
etc.

ii.       the portion of the annual  accretion  to the balance at the credit of the employee
participating in a recognized provident fund:

a) contributions   made by the employer to the account of the employee in a recognized

provident fund   and

iii.       the contribution made by the Central Government or any other employer to the
account of the employee under the New
Pension Scheme .

It may be noted that, since   salary  includes   pension,   tax   at  source would have to  be
deducted from pension also, unless otherwise so required. However, no tax is required to be
deducted from the commuted portion of pension to the extent exempt under section 10 (10A).

Family Pension is chargeable to tax under head “Income from other sources” and not under
the head “Salaries”. Therefore, provisions of section 192 of the Act are not applicable.
Hence, DDOs are not required to deduct TDS on family pension paid to person.

Perquisite includes:

I.           The value of rent free accommodation

II.           The value of any concession in the matter of rent;

III.         The value of any benefit or amenity granted or provided free of cost or at
concessional rate in any of the following cases:

i)          By a company to an employee who is a director of such company;

ii)        By a company to an employee who has a substantial interest in the company;

iii)       By an employer (including a company)to an employee, who is not covered by (i) or
(ii) above and whose  income  under  the head  “Salaries”  (whether  due from  or  paid  or
allowed  by  one or  more employers), exclusive of the value of all benefits and amenities not
provided by way of monetary payment, exceeds Rs.50,000/-.

V.          Any sum payable by the employer, whether directly or through a fund, other than a
recognized provident fund or an
approved superannuation fund or other specified funds u/s 17, to effect an assurance on the
life of an assessee or to effect a contract for an annuity.

VI.         The value of any specified security or sweat equity shares allotted or
transferred, directly or indirectly, by the employer, or former employer, free of cost or at
concessional rate to the employee and for this purpose, .

(a)         “specified  security”  means  the  securities  as  defined  in  section  2(h)    of  the
Securities  Contracts (Regulation) Act, 1956 and, where employees’ stock option has been
granted under any plan or scheme therefor, includes the securities offered under such plan or
scheme;

(b)“sweat equity shares” means equity shares issued by a company to its employees or
directors at a discount or for consideration other than cash for providing know-how or
making available rights in the nature of intellectual property rights or value additions, by
whatever name called;

(c) the value of any specified security or sweat equity shares shall be the fair market value of
the specified security or sweat equity shares, as the case may be, on the date on which the
option is exercised by the assessee as reduced by the amount actually paid by, or recovered
from the assessee in respect of such security or shares;

(d)“fair market value” means the value determined in accordance with the method as may be
prescribed (refer Rule 3(9) of the IT Rules);

(e) “option” means a right but not an obligation granted to an employee to apply for the
specified security or sweat equity shares at a predetermined price;

CASE LAWS
1. Ram Pershad v. CIT (1972) 2 SCC 696: AIR 1973 SC 637
 The assessee via a contract became the managing director of a company for a period of 20
years. He was required to do work of agent to and manager of and to do any other work as
agreed upon. The contract provided that the assessee was at liberty to resign and the
company would terminate his services before the end of 20 years if he acts irresponsibly. 
Assessee was to receive 2000 pm gross profit and 10% of Gross profits of company, and
he and his wife were entitled to free boarding, etc, in hotel.

In a particular assessment year he was assessed in respect of Rs 53000 payable to him as

10% of the profits of company which he gave up soon after the accounts were finalized
but before they were passed by general meeting of the shareholders, etc. The assessee
claimed that such amount is not liable to be included in his total income, because the
amount had not accrued to him at all and even if it had accrued, it is not taxable as
‘salary’  in his hands u/ S15(1).

Observation & Decisions

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

CIT v. L.W. Russel AIR 1965 SC 49

Facts and Issue- The respondent is an employee of the English and Scottish Joint Co-
operative Wholesale Society Ltd. incorporated in England. The Society established a
superannuation scheme for the benefit of the male European members of its staff employed
in India by means of deferred annuities. Under the terms of the scheme, the trustee has to
effect a policy of insurance for the purpose of ensuring an annuity to every member of the
,Society on his attaining the age of superannuation or on the happening of a specific
contingency. The Society contributed, one-third of the premium payable by each employee.
During the year 1956-57, the Society contributed Rs. 3333/- towards  the premium payable
by the respondent, an employee of the Society. The Income-tax Officer included the said
amount in the taxable income of the respondent for the year 1956-57 under s. 7(1),
Explanation 1, sub-cl. (v) of the Act. The appeals of      the respondent were dismissed both
by the Appellate Assistant Commissioner of Income-tax and the Income-tax Appellate
'Tribunal.

The Tribunal referred to the High Court the following three questions of law:-

(1) Whether the contribution paid by the employer to the assessee under the terms of a trust
deed in respect of a contract for a deferred annuity on the life of the assessee is a perquisite as
contemplated by s. 7(1) of the Income-tax Act?

(2) Whether the said contributions were allowed to, or due to the applicant by or from the
employer in the accounting year?

(3) Whether the deferred annuity aforesaid is annuity hit by s. 7(1) and para (v) of
Explanation 1 thereto.

The High Court held that the employer's contribution under the terms of the trust deed was
not a perquisite as contemplated by s. 7(1). The employer's contributions were not allowed to
or due to the employee in the accounting year. The legislature not having used the word
"deferred" with annuity      in s. 7(1) and the statute being a taxing one, the deferred annuity
would not hit para (v) of Explanation 1 to s. 7-(1) of the Act. Against the decision of High
Court, the appellant came to this Court by special leave. Dismissing the appeal,

Held: The answers to the questions of law as given by the High Court were correct. Unless a
vested interest in the sum accrues to an employee, it is not taxable. In the present case. No
interest in the sum contributed by the employer under the scheme vested in the employee, as
it was only a contingent interest depending upon his reaching the age of superannuation. It is
not a perquisite allowed to him by the employer or an amount, due to him from the employer
within the meaning of s. 7(1) of the Act. A perquisite is only that amount of money which is
allowed to the employee by or is due to him from the employer or is paid to him to effect an
insurance on his life.

CLUBBING OF INCOME (S.60-65)

Generally an assessee is taxed in respect of his own income. But sometimes in some respect
of income which legally belongs to somebody else. Earlier the taxpayers made an attempt to
reduce their tax liability by transferring their assets in favour of their family members or by
arranging their sources of income in such a way that tax incidence falls on others, whereas
benefits of income is derived by them . So to counteract such practices of tax avoidance,
necessary provisions have been incorporated in sections 60 to 64 of the Income Tax Act
Hence, a person is liable to pay tax on his own income as well as income belonging to others
on fulfillment of certain conditions. Inclusion of other’s Incomes in the income of the
assessee is called Clubbing of Income and the income which is so included is called Deemed
Income. It is as per the provisions contained in Sections 60 to 64 of the Income Tax Act.

Section 60 is applicable if the following conditions are satisfied:

1. The taxpayer owns an asset 

2. The ownership of asset is not transferred by him.

3. The income from the asset is transferred to any person under a settlement, or
agreement.

If the above conditions are satisfied, the income from the asset would be taxable in the hands
of the transferor 

Illustration : Amitabh Bachan owns Debentures worth Rs 1,000,000 of ABC Ltd., (annual)

interest being Rs. 100,000. On April 1, 2005, he transfers interest income to Sharukh Khan,
his friend without transferring the ownership of these debentures. Although during 2005-06,
interest of Rs. 100,000 is received by Sharukh Khan, it is taxable in the hands of Amitabh
Bachan as per Section 60

2. REVOCABLE TRANSFER OF ASSETS (SECTION 61)

‘Revocable transfer’ means the transferor of asset assumes a right to re-acquire asset or

income from such an asset, either whole or in parts at any time in future, during the lifetime
of transferee. It also includes a transfer which gives a right to re-assume power of the income
from asset or asset during the lifetime of transferee. 

If the following conditions are satisfied section 61 will become applicable.

 An asset is transferred under a “revocable transfer”, 

 The transfer for this purpose includes any settlement, or agreement 

  Then any income from such an asset is taxable in the hands of the transferor and not
the transferee (owner)

3. INCOME OF SPOUSE
The following incomes of the spouse of an individual shall be included in the total income of
the individual:

A REMUNERATION FROM A CONCERN IN WHICH SPOUSE HAS SUBSTANTIAL

INTEREST [SECTION 64 (1) (ii)]

Concern – Concern could be any form of business or professional concern. It could be a sole
proprietor, partnership, company, etc. 

Substantial interest - An individual is deemed to have substantial interest, if he /she

(individually or along with his relatives) beneficially holds equity shares carrying not less
than 20 per cent voting power in the case of a company or is entitled to not less than 20
percent of the profits in the case of a concern other than a company at any time during the
previous year.
Illustration - X has a substantial interest in A Ltd. and Mrs. X is employed by A Ltd. without
any technical or professional qualification to justify the remuneration. In this case, salary
income of Mrs. X shall be taxable in the hands of X.

(B)INCOME FROM ASSETS TRANSFERRED TO SPOUSE [SECTION 64(1) (IV)]

Income from assets transferred to spouse becomes taxable under provisions of section 64 (1)
(iv) as per following conditions:-

 The taxpayer is an individual 

 He/she has transferred an asset (other than a house property)

 The asset is transferred to his/her spouse

 The asset is transferred without adequate consideration. Moreover there is no

agreement to live apart.

If the above conditions are satisfied, any income from such asset shall be deemed to be the
income of the taxpayer who has transferred the asset. 

Illustration - X transfers 500 debentures of IFCI to his wife without adequate consideration.

Interest income on these debentures will be included in the income of X.
4. INCOME FROM ASSETS TRANSFERRED TO SON’S WIFE [SEC. 64 (1) (VI)]

Income from assets transferred to son’s wife attract the provisions of section 64 (1) (vi) as per
conditions below:-

1. The taxpayer is an individual.

2. He/she has transferred an asset after May 31, 1973.

3. The asset is transferred to son’s wife.

4. The asset is transferred without adequate consideration.

In the case of such individuals, the income from the asset is included in the income of the
taxpayer who has transferred the asset.

5. INCOME FROM ASSETS TRANSFERRED TO A PERSON FOR THE BENEFIT OF

SPOUSE [SEC. 64 (1) VII)]

Income from assets transferred to a person for the benefit of spouse attract the provisions of
section 64 (1) (vii) on clubbing of income. If: 

 The taxpayer is an individual.

 He/she has transferred an asset to a person or an association of persons.

 Asset is transferred for the benefit of spouse.

 The transfer of asset is without adequate consideration.

In case of such individuals income from such an asset is taxable in the hands of the taxpayer
who has transferred the asset.

6. INCOME FROM ASSETS TRANSFERRED TO A PERSON FOR THE BENEFIT OF

SON’S WIFE [SEC. 64 (1) (VIII)]

Income from assets transferred to a person for the benefit of son’s wife attract the provisions
of section 64 (1) (vii) on clubbing of income. If, 

1. The taxpayer is an individual. 

2. He/she has transferred an asset after May 31, 1973.

 3. The asset is transferred to any person or an association of persons.

4. The asset is transferred for the benefit of son’s wife.

5. The asset is transferred without adequate consideration.

In case of such individual, the income from the asset is included in the income of the person
who has transferred the asset.

7. INCOME OF MINOR CHILD (SEC. 64 (1A)

All income which arises or accrues to the minor child shall be clubbed in the income of his
parent (Sec. 64(1A), whose total income (excluding Minor’s income) is greater. However, in
case parents are separated, the income of minor will be included in the income of that parent
who maintains the minor child in the relevant previous year.

Exemption to parent [Sec10 (32)]

An individual shall be entitled to exemption of Rs. 1,500 per annum(p.a.) in respect of each
minor child if the income of such minor as included under section 64 (1A) exceeds that
amount. However if the income of any minor child is less than Rs. 1,500 p.a. the aforesaid
exemption shall be restricted to the income so included in the total income of the individual.

When Section 64(1A) is not applicable

In case of income of minor child from following sources, the income of minor child is not
clubbed with the income of his parent.

 Income of minor child on account of any manual work.

 Income of minor child on account of any activity involving application of his skill,
talent or specialized knowledge and experience.

 Income of minor child (from all sources) suffering from any disability of the nature
specified under section 80U .

8. OTHER RELATED POINTS 

Can negative income be clubbed?

If clubbing provisions are applicable and income from such a source is negative it will still be
clubbed in the income of assessee. 

Head of income under which an income belonging to somebody else would be clubbed

The other person’s income is taxable under the head under which it would have been taxable
if it is the income of the assessee himself. 

For example Mr. X gifts Mrs. X Rs 2 lakhs from which she starts a business. Now as per
clubbing provisions whatever is the profit from this business it will be taxable in the hands of
Mr. X. Since it is an income taxable under the head ‘Profits & gains of Business &
profession’ that is why it will be taxable under the same head and income will be calculated
as if it is the business of Mr. X.

CASE LAWS-

Mohini Thapar (dead) by Lrs v. CIT (Central) Calcutta (1972) 4 SCC 493

The assessee made certain gifts to his wife out of those gifts she purchased shares and
made investments. On the question whether the dividends earned and the interests
realised were income "from assets transfer-red directly or indirectly" by the assessee to his
wife within the meaning of s. 16(3) (a) (iii) of the Income-tax Act, 1922,

HELD : Section 16(3) (a) (iii) includes not merely the income that :arises directly from the
assets transferred but also the income that arises indirectly 'from. those assets. In the present
case the income has a nexus with the assets transferred and they are income indirectly
received in respect of the transfer of cash directly made. Therefore the department is
entitled to include the dividends and interest in question in computing the taxable
income of the assessee.

J.M. Mokashi v. CIT (1994) 207 ITR 252 (Bom)

Assessee Physician & Cardiologist, wife had passed 1 st year of BA and was employed as
receptionist cum accountant @8100 INR pm as salary. Held that wife’s salary to be clubbed
with assessee’s income u/S S64(1)(ii) of IT Act.

 Batta Kalyani v. CIT (1985) 154 ITR 59

Assessee runs a h/w & paint shop – appoints husband as manager – is husband’s income
includible in assessee’s income u/ S64(1)(ii) of the IT Act? – Held that income of husband to
be clubbed with income of assessee.

But held technical or professional degree from a recognized institute not the only criteria for
satisfying the proviso to S64(1)(ii) knowledge and experience if established is also enough.
But nothing in this case to prove that the assessee’s husband had the knowledge and skills for
the job he was in.

OTHER CASELAWS

 Kamakshya Narayan Singh v CIT – Income is a word difficult & impossible to define

in any precise general formula. Widest meaning to be given.
 CIT V GR KARTIKEN- moto gp driver-winner- 20k+2k, tax by govt- not reoccurring
but widest amplitude to be given. E-82 L-1.
 GANON DUNKERLY- sales tax- works contract.
 H S DHILLON – central can make law on taxes not mentioned in state list – including
agriculture income in wealth tax- act valid.
 Naveen Chandra Mafasal- capital gains- tax can be imposed- list 1 widest amplitude.

RESIDENTIAL STATUS

Section 6 of the Act divides the assessable persons into three categories

1. Ordinary Resident;

2. Resident but Not Ordinarily Resident; and

3. Non-Resident.

Residential status is a term coined under Income Tax Act and has nothing to do with
nationality or domicile of a person. An Indian, who is a citizen of India can be non-resident
for Income-tax purposes, whereas an American who is a citizen of America can be resident of
India for Income-tax purposes. Residential status of a person depends upon the territorial
connections of the person with this country, i.e., for how many days he has physically stayed
in India.
The residential status of different types of persons is determined differently. Similarly, the
residential status of the assessee is to be determined each year with reference to the “previous
year”. The residential status of the assessee may change from year to year. What is essential
is the status during the previous year and not in the assessment year

 
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