CU-MCOM-SEM-IV-Tax Planning and Procedure-Second Draft

MASTER OF COMMERCE SEMESTER-IV TAX PLANNING AND PROCEDURE

First Published in 2021 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the event, Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. 2 CU IDOL SELF LEARNING MATERIAL (SLM)

CONTENT Unit- 1 Tax Planning ............................................................................................................. 4 Unit- 2 Tax Evasion, Avoidance, Planning .......................................................................... 16 Unit- 3 Residential Status: Income Tax ............................................................................... 28 Unit- 4 Set Off And Carry Forward Of Losses..................................................................... 39 Unit- 5 Computation Of Income Tax ................................................................................... 53 Unit- 6 Tax Planning For Salaried Employees ..................................................................... 67 Unit- 7 Corporate Taxation ................................................................................................. 84 Unit- 8 Computation Of Book Profit And Mat Credit ........................................................ 114 Unit- 9 Tax Planning And Management ............................................................................ 127 Unit- 10 Dividend Policy .................................................................................................. 143 Unit- 11 Bonus Shares....................................................................................................... 158 Unit- 12 Mergers And Amalgamations .............................................................................. 169 Unit- 13 Direct Tax Planning ............................................................................................ 187 Unit- 14 Double Taxation Avoidance Agreement .............................................................. 204 3 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT- 1 TAX PLANNING STRUCTURE 1.0 Learning Objectives 1.1Introduction 1.2 Principles of Taxation 1.2.1 Equity 1.2.2 Economy 1.2.3 Certainty 1.2.4 Convenience 1.3 Direct and Indirect Taxes 1.3.1 Direct Tax 1.3.2 Indirect Tax 1.3.3 Incidence of Tax 1.4 Goals of Taxation 1.4.1 Economic Goals 1.4.2 Social Goals 1.5Tax Planning 1.5.1 Tax Planning Strategies 1.5.2 Judicial Doctrines of Tax Planning 1.6 Summary 1.7 Keywords 1.8Learning Activity 1.9Unit End Questions 1.10 References 1.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the meaning definition of taxation; describe the principles and goals of taxation.  Explain the concept of tax planning and its objectives, and benefits. 4 CU IDOL SELF LEARNING MATERIAL (SLM)

1.1 INTRODUCTION Definition of Taxation It has been said that ‘what the government gives it must first take away’. The economic resources available to society are limited, so an increase in a government’s expenditure will mean a reduction in the spending capacity of the private sector. Taxation is the main means by which a government raises revenue to meet its expenditure. Taxation may also be used by a government as a means of influencing economic decisions or controlling the economy. In this way taxation will also reflect prevailing social values and priorities in a country. This characteristic helps explain why no two countries’ tax systems will be identical in every respect and it also explains why governments continually change their tax systems. Revenue raised from taxation is needed to finance government expenditure on items such as the health service, retirement pensions, unemployment benefit and other social benefits, education, financing government borrowing (interest on government debt), etc. A tax is defined as follows: A tax is a forced payment made to a governmental unit that is unrelated to the value of goods or services provided. Taxes are not voluntary. If we have income, we pay income taxes on that income to the Union government and possibly to state and local governments. If we purchase certain goods, the state may require the seller to collect a sales tax. If we fail to pay or remit these taxes to the government, we may be subject to civil, or even criminal, penalties. If we own real estate, the local government places an assessed value on that property and sends us a bill for property taxes. These taxes must be paid, or the government may seize the property. There are hidden taxes as well. Hidden taxes are those that are paid but that are not specifically itemized as part of the payment. When we buy petrol for our cars, there are significant taxes imbedded in the price paid. The same is true for many other items, such as cigarettes and alcoholic beverages. Taxes are not levied as punishment (as are fines for speeding), nor are they levied as payment for particular goods or services rendered by the government (such as a garbage collection fee). Although we may benefit from many governmental activities that are paid for by taxes, there is no direct connection between the benefit received by a taxpayer and the amount of tax the taxpayer must pay. Property taxes to support education are levied on the value of one’s property, with no relationship to the number of children, if any, a person may have who are benefiting from free public-school education. Thus, taxes are often termed forced extractions. You must pay them, but you may not necessarily derive any benefit from them. 5 CU IDOL SELF LEARNING MATERIAL (SLM)

1.2 PRINCIPLES OF TAXATION No tax system is perfect, but an ‘ideal’ system should conform to certain principles if it is to achieve its objectives without producing negative effects. In 1776 Adam Smith in his book The Wealth of Nations proposed that a ‘good’ tax should have the following characteristics(Smith, 1976): 1.2.1 Equity Taxes should be fair to different individuals and should reflect a person’s ability to pay.The basic idea of equity is that persons with similar incomes will face similar taxes. It is important that tax should be fairly levied as between one taxpayer and another. Horizontal equity, one of the key principles of tax fairness, asserts that persons in similar circumstances should face similar tax burdens. The difficult part is determining when different taxpayers are in similar circumstances. Equity has another side, however—vertical equity. Vertical equity would require higher-income persons to pay a greater proportion of their income than lower-income persons. Vertical equity is often referred to as the ability to pay concept. Vertical equity is the basis for a progressive tax system. As a person’s income increases, he or she is assumed to need a smaller percentage of that income for basic living and other expenses and, thus, is in a better position to pay a greater share of that income in taxes. 1.2.2 Economy A tax meets the criterion of economy or efficiency when the amount of revenue it raises is at an optimum level after the costs of administration and compliance are considered. The costs of a tax are not just limited to the costs incurred by the tax administration office in collecting the tax. Certain taxes impose an enormous burden on the taxpayer for compliance. Consider that more than half the individual taxpayers in India use some form of tax preparer to assist in preparing their tax returns. Many businesses have their own tax departments with no other responsibility than to ensure that all taxes are paid in a timely manner. Economy is also related to the concept of simplicity. The simpler a tax system is, the less it costs to administer and comply with the tax. One of the major thrusts of the government has been to simplify the tax system. There is a basic realisation among tax professionals that the current system is so complex that even a reasonably well-educated person and his or her tax advisor can readily fall into tax traps because of obscure and obtuse provisions. When tax professionals make errors because of the complexity of the law, they may still be held liable for these mistakes—and the cost to the professional may be significant. 1.2.3 Certainty Certainty is also a canon related to simplicity. Certainty would dictate that a taxpayer knows with reasonable accuracy the tax consequences of a transaction at the time the transaction 6 CU IDOL SELF LEARNING MATERIAL (SLM)

takes place. Unfortunately, our tax laws are continually changing. The quest for a balanced budget has led to a hodgepodge of revenue-raising measures that have added complexity to the laws and reduced the certainty of the outcomes of various transactions. It is not uncommon today for a change in the tax laws to be effective from the date it was proposed, rather than from the date it was passed. This practice imposes a totally uncertain environment on the taxpayer who was contemplating a transaction that could be affected by a tax law change. He or she does not know if the law will be passed—thus, he or she cannot know if the transaction will be affected. Certainty would dictate that tax laws change as little as necessary so that the outcome of a particular transaction could be predicted with reasonable accuracy. 1.2.4 Convenience The last canon to be addressed is convenience. A convenient tax would be one that would be readily determined and paid with little effort. Again, it may be helpful to think of the difference between a sales tax and an income tax. A sales tax is paid each time a taxed purchase is made. Most of us do not even think about the fact that we are paying a tax in addition to making a purchase of some good or service. Although the withholding of income taxes from salaries offers a measure of convenience, the myriad of forms and schedules that must be filed to reconcile the actual tax liability with withholding does not always meet the test of convenience. Consider the requirements for estimated tax payments for significant amounts of income other than salaries and wages subject to withholding. Persons must make estimated tax payments based on their anticipated tax liability, including the income that may be passed through from partnerships. It may be impossible during the year for a partner to obtain the information to accurately assess the anticipated tax liability. Having to make estimated payments based on unknown information places an enormous burden on the taxpayer. 1.3 DIRECT AND INDIRECT TAXATION 1.3.1 Direct Taxes A direct tax is one that falls directly on the person or entity who is expected to pay it. For example, Income tax is a direct tax. The formal incidence and effective incidence of a direct tax are usually the same, although in some situations if it is known in advance that tax will have to be paid, it may be possible to charge a higher rate for the work so that the tax due will be covered. A direct tax is levied on an individual or entity, so it can be designed to take account of certain individual or entity circumstances, for example, family size, financial commitments, level of investment in non-current assets, etc. 1.3.2 Indirect Taxes 7 CU IDOL SELF LEARNING MATERIAL (SLM)

An indirect tax is one that is levied on one part of the economy with the intention that itwill be passed on to another. For example, in India, the Goods and Service Tax (GST) is levied onall businesses involved with the production and distribution of a good for a final customer.In most cases the GST will be added to the final price paid by the customer.As an indirect tax is not levied on the eventual payer of the tax, it cannot be related tothe individual circumstances of that taxpayer. 1.3.3 Incidence The incidence of tax refers to the distribution of the tax burden. The incidence of a tax ison the person who actually pays it. For example, the incidence of an income tax is on thetaxpayer as it is the taxpayer who is assessed and pays the tax.Incidence can be split into two elements: formal and informal incidence Formal incidence occurs when the person or entity has direct contact with the tax authorities.For example, the formal incidence of GST will be on the entity makingthe sale of goods or provision of services. It is the entity making the sale that must account for the transaction and paythe tax collected to the revenue collection authorities. Effective (or actual) incidence occurs when the person or entity ends up bearing the cost of thetax as they cannot pass it on to someone else. If GST is added to the selling price,it is passed on to the customer and it is actually the customer who ends up paying thetax. The effective incidence is on the customer. 1.4 GOALS OF TAXATION Many people believe the sole purpose of the income tax is to raise revenue to operate the government. This belief is not accurate. The tax law has many goals other than raising revenue. These goals fall into two general categories—economic goals and social goals—and it is often unclear which goal a specific tax provision was written to meet. 1.4.1 Economic Goals Tax provisions have been used for such economic motives as reduction of unemployment, expansion of investment in productive (capital) assets, and control of inflation. Specific examples of economic tax provisions are the limited allowancefor expensing of capital expenditures and the accelerated depreciation. In addition to pure economic goals, the tax lawis used to encourage certain business activities and industries. For example, an incometax credit encourages businesses to engage in research and development activities, thenew energy credits encourage investment in solar and wind energy businesses, and aspecial deduction for entities in special category states such as Himachal Pradesh, Uttaranchal, Arunachal Pradesh, Assam, Manipur, Meghalaya, Mizoram, Nagaland, and Tripura. 8 CU IDOL SELF LEARNING MATERIAL (SLM)

1.4.2 Social Goals Social goals have also resulted in the adoption of many specific tax provisions. The deduction with respect to tuition fees of children, deduction with respect of premium paid on life and medical insurance, and the charitable contributiondeduction are examples of tax provisions designed to meet social goals. Social provisionsmay influence economic activities, but they are written primarily to encourage taxpayersto undertake activities to benefit themselves and society. An example of a provision that has both economic and social objectives is the provision allowing deduction of interest paid on a loan obtained to purchase a residential house. From a social standpoint, this helps a family afford anew home, but it also helps achieve the economic goal of ensuring that the government policy of affordable housing (Singhania & Singhania, 2021). The use of the income tax as a tool to promote economic and social policies hasincreased in recent years. Realizing this, the beginning tax student can better understandwhy and how the tax law has become so complex. 1.5 TAX PLANNING The process of arranging one’s financial affairs to minimize one’s overall tax liability is often referred to as tax planning. There is nothing wrong with tax planning to avoid tax, provided legal methods are used. Judge Learned Hand best stated the doctrine of tax planning in 1947 when he wrote “over and over again, courts have said there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich, or poor, and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced extractions, not voluntary contributions”. Tax planning is defined as follows: Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost. When illegal methods are used to reduce tax liability, the process can no longer be consideredtax planning, but instead becomes tax evasion. Tax evasion can subject the taxpayerand tax practitioner to fines, penalties, or incarceration. Illegal acts are outside the realm oftax-planning services offered by a professional tax practitioner. Tax planning covers two basic categories of transactions, the ‘‘open’’ transaction and the‘‘closed’’ transaction. In an open transaction, all the events have not yet been completed;therefore, the taxpayer has some degree of control over the tax consequences. In a closedtransaction, all material parts of the transaction have been completed. As a result, tax 9 CU IDOL SELF LEARNING MATERIAL (SLM)

planninginvolving a closed transaction is limited to presentation of the facts to the tax authorities in themost favourable, legally acceptable manner possible. 1.5.1 Tax Planning Strategies Tax planning strategies include timing, income shifting, and changing the character of income. Timing Income and Deductions. Timing involves the question of when income and deductions should be claimed. One traditional technique defers the recognition of income and accelerates the recognition of deductions. This technique relies on savings achieved due to the time value of money by delaying tax payments on deferred income or accelerating tax savings by taking deductions in an earlier period. Changing marginal tax rates also impacts the year that income or educations should be taken. Good tax plans recognize income in the years with the lowest anticipated marginal tax rates and deduct expenses in years with the highest marginal tax rates. Income Shifting. The purpose of income shifting is to lower the total tax paid by splitting income among two or more taxpayers in the same family or between different entities that are owned by the same individual. The total tax paid is lower because of the progressive tax rate system. To legally shift income to family members, the parents will need to transfer ownership of income-producing property to the children; a mere assignment of income will not result in the desired tax shifting. Another popular income-shifting technique used by owner-employees of a company is to split income between themselves and the company by paying themselves salaries, which are deductible by the company, to take advantage of the progressive tax rates for individuals and companies. Changing the Character of Income. The character of income is determined by tax law and is ultimately characterized aseither ordinary income or capital gain. Income from sale of merchandise to customers is characterized as ordinary income and is subject to tax using the regular tax rates. Capital assets enjoy favourable tax treatment with most gains on capital assets held (the time from acquisition to disposition) for more than 36 months taxed to individuals at a lower rate, compared to the top current individual tax rate of 30 percent. 1.5.2 Judicial Doctrines of Tax Planning Tax planners must consider three legal doctrines that the tax authorities can invoke when a taxpayer seems to be taking excessive advantage of the tax law. The courts and the tax authorities require taxpayers to adhere not only to the letter of the law but the spirit of the law as well. 10 CU IDOL SELF LEARNING MATERIAL (SLM)

Business Purpose Doctrine. The business purpose doctrine holds that a transaction will be recognized for tax purposes only if it is made for some business or economic purpose other than a tax avoidance motive. For example, Mega Corporation has Rs. 10,000,000 in taxable income and is looking for a way to avoid paying taxes. Loser Corporation has Rs. 9,000,000 of tax losses that it cannot use because it has no prospect of profits. Mega Corporation acquires Loser Corporation in a tax-free merger. If Mega Corporation has no business purpose for the merger other than to acquire Loser’s tax losses, the tax authorities can prevent Mega from using the tax losses. Substance-Over-Form Doctrine. Taxpayers attempting to avoid taxation sometimes carefully craft transactions that are completely unrealistic. Although the courts have consistently held that taxpayers are under no legal obligation to pay more tax than the law prescribes, the courts have also said that the form of the transaction cannot be used to disguise its actual substance. This judicially created concept is referred to as the substance-over-form doctrine and states that the taxability of a transaction is determined by the reality of the transaction, rather than its appearance. For example, a profitable closely held corporation that has never paid dividends pays a huge employment bonus to its CEO, who is also the company’s major shareholder. The tax authorities can recharacterize all or part of the bonus as a dividend.Under the circumstances, although the payment is in the form of a bonus, its substance is that of a dividend.Dividends are not deductible by companies so recharacterizing dividend as bonus decreasesthe company’s taxable income and increases its tax liability. Step Transaction Doctrine. Under the step transaction doctrine, the tax authorities can collapse a series of intermediate transactions into a single transaction to determine the tax consequences. This doctrine is usually applied to transactions that are so interdependent that the taxpayers would probably have not completed the first transaction without anticipating that the entire series would take place. The tax authorities most frequently invoke this doctrine for a series of transactions occurring within a short period of time. The taxpayer should have a bona fide business purpose for each individual step of the transaction to prevent the tax authorities from negating what seems to be a good tax plan. Tax planners need to be aware of these doctrines when crafting a creative tax plan, making sure it complies not just with the letter of the law but also with the spirit of the law. 1.6 SUMMARY  A responsible government is one that is elected to represent its community members. It is a basic premise of the relationship between community members that they will share the burden of funding their common government. Taxes are the way in which 11 CU IDOL SELF LEARNING MATERIAL (SLM)

those community members are, at least initially, obliged to share that burden. More particularly, taxes are a compulsory contribution levied by government to raise funds to be spent for public purposes (public services), including the support of the government.  An ideal tax system should conform to certain principles if it is to achieve its objectives without producing negative effects. In 1776 Adam Smith in his book The Wealth of Nations proposed that a ‘good’ tax should have the following four characteristics: equity, economy, certainty, and convenience.  Taxes are classified into direct and indirect. A direct tax is one that falls directly on the person or entity who is expected to pay it. An indirect tax is one that is levied on one part of the economy with the intention that it will be passed on to another. Apart from raising revenue, tax systems try to achieve other goals such as economic goals and social goals.  Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost. Tax planning strategies include timing, income shifting, and changing the character of income. Tax planners must consider three legal doctrines that the tax authorities can invoke when a taxpayer seems to be taking excessive advantage of the tax law: the business purpose doctrine, substance-over-form doctrine, and the step transaction doctrine. 1.7 KEYWORDS  Tax: A tax is a forced payment made to a governmental unit that is unrelated to the value of goods or services provided.  Direct Tax: A direct tax is one whose burden falls directly on the person or entity who is expected to pay it. For example, income tax.  Indirect Tax: An indirect tax is one that is levied on one part of the economy with the intention that it will be passed on to another. For example, Goods and Service Tax (GST).  Incidence of Tax. The incidence of tax refers to the distribution of the tax burden.  Tax Planning. Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost.  Business Purpose Doctrine. The business purpose doctrine holds that a transaction will be recognized for tax purposes only if it is made for some business or economic purpose other than a tax avoidance motive. 12 CU IDOL SELF LEARNING MATERIAL (SLM)

 Substance-Over-Form Doctrine. The substance-over-form doctrine and states that the taxability of a transaction is determined by the reality of the transaction, rather than its appearance.  Step Transaction Doctrine. Step transaction doctrine, the tax authorities can collapse a series of intermediate transactions into a single transaction to determine the tax consequences.  Horizontal Equity. Horizontal equity asserts that persons in similar circumstances should face similar tax burdens.  Vertical Equity. Vertical equity assets that higher-income persons should pay a greater proportion of their income than lower-income persons. Vertical equity is often referred to as the ability to pay concept. 1.8 LEARNING ACTIVITY 1. Research the goals that the government aims to achieve by offering the following tax incentives: a. Deduction for payment of health insurance premium for the family. b. Deduction of interest paid on purchase of a residential property. ___________________________________________________________________________ ___________________________________________________________________________ 2. Research the amount of tax collected by the government over the last three years from: a. Direct taxes b. Indirect taxes. ___________________________________________________________________________ ___________________________________________________________________________ 1.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the canon of equity in taxation in one or two sentences. 2. Explain the canon of economy in taxation in one or two sentences. 3. Explain the canon of certainty in taxation in one or two sentences. 4. Explain the canon of convenience in taxation in one or two sentences. 5. Explain the concept of horizontal equity in one or two sentences. 6. Explain the concept of vertical equity in one or two sentences. 7. Explain the business purpose doctrine in one or two sentences. 13 CU IDOL SELF LEARNING MATERIAL (SLM)

8. Explain the substance-over-form doctrine in one or two sentences. Long Questions 1. Define tax and explain its characteristic features. 2. Explain Adam Smith’s canon of taxation. 3. Discuss the economic and social goals of taxation. 4. Elucidate the various tax planning strategies. 5. Enumerate and elucidate various judicial doctrines applicable to tax planning. B. Multiple Choice Questions 1. Which of the following is a feature of a tax? a. Compulsion b. Imposition by Public Authority c. No direct benefit to the taxpayer d. All of these 2. The statement 'a tax system should raise enough revenue to pay for government spending, without creating negative distortions such as reducing incentives towards work for individuals and towards investment incentives for companies' reflects which of the following Adam Smith's canon of taxation? a. Efficiency b. Convenience c. Equity d. Certainty 3. Which of the following is NOT a feature of a tax? a. Compulsion b. Imposition by Public Authority c. Direct benefit to the taxpayer d. Taxes are not penalty 4. Which of the following is NOT a feature of a tax? 14 a. Compulsion CU IDOL SELF LEARNING MATERIAL (SLM)

b. Taxes are a form of penalty c. No direct benefit to the taxpayer d. Imposition by Public Authority 5. The statement 'taxes should be fair and based on people's ability to pay' reflects which of the following Adam Smith's canon of taxation? a. Efficiency b. Convenience c. Equity d. Certainty Answer 1-d, 2-a, 3-c, 4-b, 5-c 1.10 REFERENCES Reference Books  Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press.  Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann.  Smith, A. (1976). The Wealth of Nations. London: Hackett Publishing Company. Website: Fiore, N. (2002, February 1). Guiding Principles of Good Tax Policy. Journal of Accountancy. Retrieved from https://www.journalofaccountancy.com/issues/2002/feb/guidingprinciplesofgoodtaxpolic y.html#:~:text=To%20help%20evaluate%20changes%20in%20tax%20rules%2C%20the, Similarly%20situated%20taxpayers%20%20should%20be%20taxed%20similarly. 15 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-2 TAX EVASION, AVOIDANCE, PLANNING STRUCTURE 2.0 Learning Objectives 2.1 Introduction 2.1.1 Definition and Meaning 2.1.2 Methods 2.1.3 Deterrence 2.1.4 Measure to Control Tax Evasion 2.1.5 Penalties 2.2 Tax Avoidance 2.2.1 Evolution of Judicial Thinking on Tax Avoidance 2.2.2 Definition of Tax Avoidance 2.2.3 Types of Tax Avoidance 2.2.4 General Anti-Avoidance Rules 2.3 Tax Evasion Vs Tax Avoidance 2.4 Tax Evasion Vs Tax Planning 2.5 Tax Avoidance Vs Tax Planning 2.6 Summary 2.7 Keywords 2.8 Learning Activity 2.9 Unit End Questions 2.10 References 2.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the meaning definition of taxation evasion, tax avoidance, and tax planning.  State expected to compare and contrast the concepts taxation evasion, tax avoidance, and tax planning. 16 CU IDOL SELF LEARNING MATERIAL (SLM)

2.1 INTRODUCTION Tax Evasion Tax evasion is an important issue because it affects the distribution of the tax burden as well as the resource cost of raising taxes— bread- and- butter concerns of public economics. If the tax gap could somehow be eliminated and the true liability remitted, the additional money collected could be used to finance worthy government projects or used to finance an across- the- board cut in tax rates that would benefit most compliant taxpayers. But expanding government programmes could be financed in a number of other ways, such as by raising tax rates or by broadening the income tax base and a tax reduction could be financed by cuts in overall spending. The real question is whether curbing evasion would improve the equity and efficiency implications of the public finances. 2.1.1 Tax Evasion: Definition and Meaning Tax evasion is an illegal activity in which a person or entity deliberately avoids paying a true tax liability. Those caught evading taxes are generally subject to criminal charges and substantial penalties. According to the Oxford Dictionary of Law tax evasion is defined as follows: Tax evasion refers to any illegal action taken to avoid the lawful assessment of taxes; for example, by concealing or failing to declare income (Martin, 2003). Tax evasion is illegal. Minor cases of tax evasion have generally been settled out of court on the payment of penalties. However, serious cases of tax evasion, particularly those involving fraud, will continue to be the subject of criminal prosecutions which may lead to fines and/or imprisonment on conviction. 2.1.2 Tax Evasion: Methods Tax evasion consists of seeking to pay too little tax by deliberately misleading HMRC by either:  Suppressing information to which they are entitled (for example, failing to notify the tax authorities that you are liable to tax, understating income or gains or omitting to disclose a relevant fact, for example, that business expenditure had a dual motive), or  Providing them with deliberately false information (for example, deducting expenses which have not been incurred or claiming capital allowances on plant that has not been purchased). 2.1.3 Deterrence 17 CU IDOL SELF LEARNING MATERIAL (SLM)

Why would an individual or business evade taxes? To an economist, the natural starting point is to consider the private costs and benefits of evasion. And indeed, the standard framework for considering whether and how much to evade taxes is a deterrence model. In this model, a risk-averse taxpayer decides whether and how much to evade taxes in the same way she would approach any risky decision or gamble. People are influenced by possible legal penalties no differently than any other contingent cost: there is nothing per se about the illegality of tax evasion that matters. Nor is there any intrinsic willingness to meet one’s tax obligations, sometimes referred to as “tax morale.” The model predicts that an increase in either the probability of detection or the penalty if detected will reduce evasion but does not pin down how big these effects are. The effect of a change in the marginal tax rate is less clear and depends on the form of the penalty. Some social scientists have argued that the deterrence framework misses important elements of the tax evasion decision, and its central assumptions that nothing per se about the illegality of evasion matters, and everyone acts as a free rider, so that there is no issue of intrinsic willingness to pay, or “tax morale”. 2.1.4 Measure to Control Tax Evasion The tax authorities have framed the concept of statement of financial transaction or reportable account to keep a watch on high value transactions undertaken by the taxpayers. The tax authorities collect information on high value transactions undertaken by a person. The statement of financial transaction or reportable account is required to be filed by the government entities. They are required to furnish the details of financial transactions registered, recorded, or maintained by them during the year. On the basis of the information provided by the above authorities the tax authorities keeps a track of financial transactions carried on by a person with a view to unearth cases of tax evasion. The following are some of the reportable transactions:  A bank is required to report to the income tax authorities any payment made by their client in cash for purchase of bank drafts of an amount of rupees ten lakhs or more in a financial year.  A company or a financial institution is required to report to the income tax authorities any receipt from any person of an amount of rupees ten lakhs or more in a financial year for acquiring bonds or debentures issued by it.  A Registrar appointed under the Registration Act, 1908 is required to report to the income tax authorities any purchase or sale by any person of immovable property for an amount of rupees ten lakhs or more. 2.1.5 Penalties for Tax Evasion 18 CU IDOL SELF LEARNING MATERIAL (SLM)

The Income-tax Act contains provision to penalise various defaults committed by the taxpayer. Some of the penalties are mandatory and a few are at the discretion of the tax authorities. Where a taxpayer under reports his income, he is liable for a penalty of 50 per cent of the tax payable on under-reported income under section 270A of the Income Tax Act, 1961. However, in a case the under-reporting of income results from misreporting of income, the taxpayer is liable for penalty at the rate of 200 per cent of the tax payable on such misreported income. As per the Finance Act, 2021, a penalty of Rs. 5,000 if an assessed files a return after the due date. However, if the total income of an assessed is below Rs. 500,000 the penalty is Rs. 1,000. The tax authorities also conduct search at the premises of the taxpayer to unearth the undisclosed income. If a search has been initiated and any undisclosed income is unearthed in the search, then penalty can be levied under section 271AAB of the Income Tax Act, 1961. 2.2 TAX AVOIDANCE Tax avoidance, in a very broad sense, includes any legal method of reducing one’s tax burden, for example taking advantage of tax shelter opportunities explicitly offered by tax legislation. However, the term is more commonly used in a narrower sense, to denote ingenious arrangements designed to produce unintended tax advantages for the taxpayer. The effectiveness of tax avoidance schemes has often been examined in the courts. Traditionally the tax rules were applied to the legal form of transactions, although this principle was qualified in later cases. It was held that the courts could disregard transactions which were preordained and solely designed to avoid tax. Traditionally, the response of the tax authorities has been to seek to mend the loopholes in the law as they come to their attention. 2.2.1 Evolution of Judicial Thinking on Tax Avoidance Tax avoidance is a process whereby an entity plans his finances to apply all exemptions and deductions provided by tax laws to reduce his tax liability. Through tax avoidance, an assessed takes advantage of all legal opportunities to minimize his taxes. Many court decisions have affirmed the legitimacy of tax avoidance. According to Justice Shah: Avoidance of tax liability by so arranging commercial affairs that charge of tax is so distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the (law). 19 CU IDOL SELF LEARNING MATERIAL (SLM)

Tax avoidance may be the dodging of one's duties to society, or alternatively the right of every citizen to structure one's affairs in a manner allowed by law, to pay no more tax than what is required. Attitudes vary from approval through neutrality to outright hostility. According to Justice Jagadisan: Avoidance of tax is not tax evasion, and it carries no ignominy with it, for, it is sound law and, certainly, not bad morality, for anybody to so arrange his affairs as to reduce the brunt of taxation to a minimum. 2.2.2 Definition of Tax Avoidance Tax avoidance is a difficult term to define. Tax avoidance falls between tax evasion, which is illegal, and tax planning, which is a legitimate method of reducing one’s tax liability. A commonly accepted definition of tax avoidance is as follows: Tax avoidance is the minimization of the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law. Any practitioner who is contemplating participation in some form of tax evasion should first study the penalties that are assessed for civil and criminal tax fraud. 2.2.3 Types of Tax Avoidance In recent years the legitimacy of tax avoidance has been questioned by the Supreme Court. In McDowell v. CTO, the court divided tax avoidance in two categories: legitimate and illegitimate. Legitimate tax avoidance involves use of devices which are in conformity with the intentions of the Parliament, such as donations to charity or investments in certain assets which qualify for tax relief. In this sense, tax avoidance may be called as ‘tax mitigation’. When taxpayers adopt ‘colourable devices’ to avoid taxes it is illegitimate tax avoidance and is as reprehensible as tax evasion. 2.2.4 General Anti-Avoidance Rules The General Anti-Avoidance Rules (GAAR) was introduced in India to guard against schemes designed for tax avoidance, following the hugely controversial tax dispute over telecom major Vodafone buying Hutchison Essar's India operations in a tax haven, the Cayman Islands, in 2007. The GAAR provides that certain transactions would be impermissible avoidance arrangement if the main purpose is to obtain tax benefit and it has one or more of the following characteristics:  It creates rights and obligations, which are not normally created between parties dealing at arm's length.  It results in misuse or abuse of the provisions of the tax law. 20 CU IDOL SELF LEARNING MATERIAL (SLM)

 It lacks commercial substance.  It is carried out by means or in a manner which is normally not employed for an authentic (bona fide) purpose. 2.3 TAX EVASION VS TAX AVOIDANCE Tax avoidance differs from tax evasion in that it attempts to comply with the letter of the law while at the same time trying to gain a taxation benefit not intended by the legislature. If business structures are used to disguise transactions which were not intended to benefit from the tax relieving provisions or business arrangements, it is sometimes referred to as ‘unacceptable’ avoidance. Unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed. Taxation systems often contain provisions deliberately targeted at stimulating certain commercial activities within the economy. Legitimate business structures may receive favourable taxation treatment and are referred to as ‘acceptable’ avoidance, generally termed tax planning. Under tax laws, taxes may have to be paid, but the laws also provide credits, benefits, refunds, and other entitlements. While in layman's terms tax avoidance and tax evasion would seem to be synonymous, there is a definite distinction. The following are some of the specific areas of difference between tax evasion and tax avoidance.  Tax evasion refers to any illegal action taken to avoid the lawful assessment of taxes; for example, by concealing or failing to declare income (Martin, 2003), whereas tax avoidance is the minimization of the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law.  Tax evasion typically involves deliberately ignoring a specific part of the law. Tax avoidance results when actions are taken to minimize tax, while within the letter of the law, those actions contravene the object and spirit of the law.  Tax evasion, unlike tax avoidance, has criminal consequences. Tax evaders face prosecution in criminal court. Tax avoidance, unlike tax evasion, does not have criminal consequences.  Some of the practices that constitute tax evasion include under-reporting taxable receipts or claim expenses that are non-deductible or overstated. Examples, of tax avoidance include designing complex scheme to deceive tax authorities 21 CU IDOL SELF LEARNING MATERIAL (SLM)

 Tax evasion refers to wilfully refusing to comply with legislated reporting requirements. Tax avoidance involves complying with the letter of the law though not in a way it was intended by the legislature. 2.4 TAX EVASION VS TAX PLANNING The differences between tax evasion and tax planning are clearer compared to the differences between tax evasion and tax avoidance. The following are some of the specific areas of difference between tax evasion and tax planning.  Tax evasion refers to any illegal action taken to avoid the lawful assessment of taxes; for example, by concealing or failing to declare income (Martin, 2003), whereas tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost.  Tax evasion typically involves deliberately ignoring a specific part of the law. Tax planning involves efforts to minimise one’s tax liability by not only the letter of the law but also the spirit of the law.  Tax evasion has criminal consequences. Tax evaders face prosecution in criminal court.Tax planning is legal and as such there are no adverse consequences.  For example, those participating in tax evasion may under-report taxable receipts or claim expenses that are non-deductible or overstated. An example of tax planning would be locating a manufacturing plant is a backward area to claim tax holiday. This is legitimate as it is allowed by the law and is also in line with the intention of the law.  Tax evasion also refers to wilfully refusing to comply with legislated reporting requirements. Tax planning involves scrupulously following all the legal mandates. 2.5 TAX AVOIDANCE VS TAX PLANNING The differences between tax avoidance and tax planning are razor thin. At the core both tax avoidance and tax planning involve scrupulously obeying the letter of the law. Illegitimate tax avoidance involves violating the intention of the law whereas tax planning involves complying with both the letter, and the intention of, the law. The following are some of the specific areas of difference between tax avoidance and tax planning.  Tax avoidance is the minimization of the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law, whereas tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost. 22 CU IDOL SELF LEARNING MATERIAL (SLM)

 Tax avoidance results when actions are taken to minimize tax, while within the letter of the law, those actions contravene the object and spirit of the law. Tax planning involves efforts to minimise one’s tax liability by not only the letter of the law but also the spirit of the law.  Tax avoidance, if illegitimate, is subject to penalties. Tax planning is legal and as such there are no adverse consequences.  Examples of tax avoidance include devising complex scheme to avoid paying taxes. An example of tax planning would be locating a manufacturing plant is a backward area to claim tax holiday. This is legitimate as it is allowed by the law and is also in line with the intention of the law.  Tax avoidance involves complying with the letter of the law though not in a way it was intended by the legislature. Tax planning involves scrupulously following all the legal mandates. 2.6 SUMMARY  Tax evasion is an illegal activity in which a person or entity deliberately avoids paying a true tax liability. Those caught evading taxes are generally subject to criminal charges and substantial penalties. It refers to any illegal action taken to avoid the lawful assessment of taxes; for example, by concealing or failing to declare income.  Tax avoidance is the minimization of the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law. Tax planning is the process of evaluating the tax consequences associated with a transaction and making recommendations that will achieve the desired objective at a minimal tax cost.  Tax avoidance differs from tax evasion in that it attempts to comply with the letter of the law while at the same time trying to gain a taxation benefit not intended by the legislature. If business structures are used to disguise transactions which were not intended to benefit from the tax relieving provisions or business arrangements, it is sometimes referred to as ‘unacceptable’ avoidance.  The differences between tax evasion and tax planning are clearer compared to the differences between tax evasion and tax avoidance. Tax evasion typically involves deliberately ignoring a specific part of the law. Tax planning involves efforts to minimise one’s tax liability by not only the letter of the law but also the spirit of the law.  The differences between tax avoidance and tax planning are razor thin. At the core both tax avoidance and tax planning involve scrupulously obeying the letter of the 23 CU IDOL SELF LEARNING MATERIAL (SLM)

law. Illegitimate tax avoidance involves violating the intention of the law whereas tax planning involves complying with both the letter, and the intention of, the law. The following are some of the specific areas of difference between tax avoidance and tax planning. 2.7 KEYWORDS  Colourable device. A colourable device refers to an illegitimate method used by an assessed to reduce his tax liability.  GAAR.The General Anti-Avoidance Rules (GAAR) is a set of rules issue in India to identifyand punish schemes designed for tax avoidance.  Tax Audit. A tax audit is defined as an objective examination, by an independent professional, of the records of assesse to determine compliance with his tax obligations.  Tax Avoidance. Tax avoidance is the minimization of the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law.  Tax Evasion. Tax evasion refers to any illegal action taken to avoid the lawful assessment of taxes; for example, by concealing or failing to declare income. 2.8LEARNING ACTIVITY Companies like Amazon and Starbucks have been accused of engaging in aggressive tax planning, bordering on tax evasion, in many tax jurisdictions. Research the following in this regard: 1. Specific charges levied against the above companies. ___________________________________________________________________________ _____________________________________________________________________ 2. The response of the above companies in their defence. ___________________________________________________________________________ _____________________________________________________________________ 2.9 UNIT END QUESTIONS A. Descriptive Questions 24 Short Questions 1. Explain the concept of tax evasion in brief. 2. Explain the concept of tax avoidance in brief. 3. Explain the concept of tax audit in brief. CU IDOL SELF LEARNING MATERIAL (SLM)

4. Explain the concept of colourable device in brief. 5. Discuss the measure taken by the government to control tax evasion. Long Questions 1. Define tax evasion and describe some of the methods adopted to evade taxes. 2. Define tax avoidance and describe some of the methods adopted to avoid taxes. 3. Discuss the legitimate and illegitimate tax avoidance. 4. Differentiate between tax evasion and tax avoidance. 5. Differentiate between tax evasion and tax planning. 6. Differentiate between tax avoidance and tax planning. 7. What do you understand by tax audit? Explain the objectives of tax audit. B. Multiple Choice Questions 1. What is the penalty for filing the income tax return after the due date, where the total income of the assesse is above Rs. 500,000? a. Rs. 10000 b. Rs. 5000 c. Rs. 1000 d. Nil 2. Which of the following refers to an attempt to minimize the tax burden by using unacceptable, or colourable devices, which comply with the letter of the law though not the intention and spirit of the law? a. Tax planning b. Tax evasion c. Tax avoidance d. Tax abuse 3. Which of the following a point of difference between tax evasion and tax avoidance? a. Tax evasion typically involves deliberately not complying with a provision of the tax law whereas tax avoidance involves taking actions to minimize tax, while within the letter of the law; those actions contravene the object and spirit of the law. b. Tax avoidance typically involves deliberate non-compliance of a specific part of the law whereas tax evasion results when actions are taken to minimize tax, while within the letter of the law, those actions contravene the object and spirit of the law. c. Tax evasion typically involves complying with the letter of the tax law, whereas tax avoidance involves complying with the spirit of the tax law. 25 CU IDOL SELF LEARNING MATERIAL (SLM)

d. Tax avoidance has penal consequences, whereas tax evasion has no penal consequences. 4. Which of the following a point of difference between tax evasion and tax planning? a. Tax evasion typically involves deliberately ignoring a specific part of the law. Tax planning involves efforts to minimise one’s tax liability by not only the letter of the law but also the spirit of the law. b. Tax planning typically involves deliberate non-compliance of a specific part of the law whereas tax evasion results when actions are taken to minimize tax, while within the letter of the law, those actions contravene the object and spirit of the law. c. Tax planning typically involves complying with the letter of the tax law, whereas tax evasion involves complying with the spirit of the tax law. d. Tax planning has penal consequences, whereas tax evasion has no penal consequences. 5. The use of 'colourable devices’ to reduce one's tax liability is referred as which of the following? a. Tax evasion b. Tax avoidance c. Tax planning d. Tax saving Answer 1-b, 2-c, 3-a, 4-a, 5-b 2.10 REFERENCES Reference Books  Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press.  Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann.  Smith, A. (1976). The Wealth of Nations. London: Hackett Publishing Company. Website  Fiore, N. (2002, February 1). Guiding Principles of Good Tax Policy. Journal of Accountancy. Retrieved from https://www.journalofaccountancy.com/issues/2002/feb/guidingprinciplesofgoodtaxp 26 CU IDOL SELF LEARNING MATERIAL (SLM)

olicy.html#:~:text=To%20help%20evaluate%20changes%20in%20tax%20rules%2C %20the,Similarly%20situated%20taxpayers%20%20should%20be%20taxed%20simil arl 27 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT- 3 RESIDENTIAL STATUS: INCOME TAX STRUCTURE 3.0 Learning Objectives 3.1 Introduction 3.2 Residence Tests 3.2.1 Individuals 3.2.2 HUF, Firms and Association of Persons 3.2.3 Companies 3.2.4 Other Persons 3.3 Not Ordinarily Resident 3.4 Non-Resident 3.5 Scope of Income Based on Residence 3.5.1 Total Income of a Resident Assessee 3.5.2 Total Income of an Assessee who Not Ordinarily Resident 3.5.3 Total Income of a Non-Resident Assessee 3.5.4 The Accrual Concept 3.5.5 The Arising Concept 3.5.6 Income Deemed to Accrue or Arise in India 3.6 Summary 3.7 Keywords 3.8 Learning Activity 3.9 Unit End Questions 3.10 References 3.0 LEARNING OBJECTIVES After studying this unit, you will be able to:  Explain the meaning residential status of an assess and various tests of residence.  State expected to apply the tests to determine the residential status of various types of assessees. 28 CU IDOL SELF LEARNING MATERIAL (SLM)

3.1 INTRODUCTION Residential Status of Assesses The incidence of income tax on an assessee depends on his residential status. All taxable entities are classified in three categories: resident, not ordinarily resident and non-resident. Alternative tests for residence are provided for:  Individuals  Hindu Undivided Family (HUF),  Firms and other association of persons  Companies The correct determination of residential status of an assessee is important because that determines which of the income is taxable in India and which is not. 3.2TESTS OF RESIDENCE The tests of residence are with respect to the previous year, the residential status of a person during the assessment year is irrelevant. The question of residence must be determined with reference to each year. Merely because a person was resident in one year does not mean we can assume that he would be resident in the next year too. If a person is resident in India in a previous year relevant to an assessment year in respect of any source of income, he shall be deemed to be resident in India in the previous year relevant to the assessment year in respect of each of his other sources of income. 3.2.1 Residence Test for an Individual General Case  An individual is said to be resident in India in any previous year if he is in India in the previous year for a period (or periods) amounting in all to 182 days or more.  Alternatively, a person can be said to be a resident if: o He stayed in India for at least 365 days during the four years preceding the previous year; and o Stayed in India for at least 60 days during the previous year. Exceptional Case #1 In the case of an Indian citizen of India, who leaves India in any previous year as a member of the crew of an Indian ship or for the purposes of employment outside India, the condition of stay in India during the previous year is increased from 60 days to 182 days. 29 CU IDOL SELF LEARNING MATERIAL (SLM)

Further, in the case of an Indian citizen, or a person of Indian origin, who, being outside India comes on a visit to India in any previous year, the condition of stay in India during the previous year is increased from 60 days to 182 days. Exceptional Case #2 Assessment Year 2021-22 onwards, in the case of an Indian citizen of India, who leaves India in any previous year as a member of the crew of an Indian ship or for the purposes of employment outside India, the condition of stay in India during the previous year is 120 days if his total income from Indian sources is more than Rs. 15 lakhs during the previous year Section 6 (1A) of the Income Tax Act, 1961. Further, in the case of an Indian citizen, or a person of Indian origin, who, being outside India comes on a visit to India in any previous year, the condition of stay in India during the previous year is increased from 60 days to 182 days(PriceWaterhouseCoopers (PwC), 2021). 3.2.2 Residence Test for a HUF, Firm or Other Association of Persons A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year if the control and management of its affairs is situated wholly, or in part, in India. The test emphasizes the importance of control and management. The residence of individual members of the HUF, or partners, members of the association of persons is immaterial for the purpose of determining the residence of a HUF, firm, or other association of persons. Control of business does not necessarily mean the carrying on of the business. It is possible that the business is substantially carried on in one place, but the control is somewhere else. Control and management signify the controlling and directive power, the head, and the brain of the entity. The term control and management mean de facto, or actual, control and management and not merely the right or power to control and manage. 3.2.3 Residence Test for a Company The law defines a company to include: (a) an Indian company, or (b) anybody corporate incorporated by or under the laws of a country outside India, or (c) any institution, association or body which is or was assessable or was assessed as a company for any assessment year under the Indian Income-tax Act, 1922, or which is or was assessable or was assessed under Income Tax Act, 1961 as a company for any assessment year commencing on or before April 1, 1970, or Any institution, association, or body, whether incorporated or not and whether Indian or non- Indian, which is declared by general or special order of the Central Board of Direct Taxes (CBDT) to be a company.The test of residence for a company is different for an Indian company and a non-Indian company. 30 CU IDOL SELF LEARNING MATERIAL (SLM)

Under the law, an Indian company means a company formed and registered under the Companies Act, 1956, and includes: (a) a corporation established by or under a Central, State or Provincial Act; and (b) any institution, association or body which is declared by the CBDT to be a company. Further,for an entity to be considered as an Indian company its registered office (or principal office) must be located in India. An Indian company is automatically considered resident in India. No other factor needs to be taken into consideration. A non-Indian company is considered resident if, during the previous year, if the place of effective management (POEM) issituated wholly in India. The place of effective management (POEM) is the basis on which a non-Indian company’s residential status is determined.The term place above means geographical location. It needs to be determined whether this place is within the territory of India or outside India.The term effective management above means de facto management and not mere formal or de jure effective management.The term effective management above means key management and not mere low-level management. The Central Board of Direct Taxes (CBDT) has provided guidelines for determining the place of effective management (POEM)(Government of India, 2017):  The location where a company’s Board of Directors (BOD) regularly meets and makes decisions where it has not delegated its authority to a committee of key members of senior management.  Where the BOD has delegated its authority to a committee of key members of senior management, the place where the committee formulates key strategies and policies.  The location of a company’s head office is an important factor.  Due to use of technology has rendered place less important, as such the place where the persons taking the decisions usually reside may also be a relevant factor.  The decisions made by shareholder on matters which are reserved for shareholder decision under the company laws are not relevant.  The place where routine operational decisions undertaken by junior and middle management is not relevant for the purpose of determination of POEM. 3.2.4 Residence Test for Persons Not Covered Above Every other person, not being an individual, HUF, firm, association of persons or a company, is said to be resident in India in any previous year if the control and management of his affairs is situated wholly, or in part, in India. 31 CU IDOL SELF LEARNING MATERIAL (SLM)

3.3 NOT ORDINARILY RESIDENT The second category in which taxable entities are categorized is whether the entity is ordinarily resident or not ordinarily resident. This concept of ordinarily resident or not ordinarily resident is only applicable to an assessee who is an individual or a HUF. Further, the question of an individual or a HUF being ordinarily resident arises only if such individual or HUF are resident in the first instance. An individual is said to be not ordinarily resident in India in any previous year if such person has been a non-resident in India in nine out of the ten previous years preceding that year, or has during the seven previous years, preceding the previous year, been in India for a period of, or periods amounting, in all to 729 days or less. A Hindu undivided family is said to be not ordinarily resident in India in any previous year if the manager of the HUF has been a non-resident in India in nine out of the ten previous years preceding that year or has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to, 729 days or less. 3.4 NON-RESIDENT An individual who fails the test of residence is considered non-resident. A HUF, firm, or an association of persons is considered non-resident if its control and management is wholly situated outside India. Similarly, a non-Indian company is considered non-resident if its control and management is wholly situated outside India. 3.5 SCOPE OF TOTAL INCOME The components of total income of an assessee depend upon his, or its, residential status. 3.5.1 Total Income of a Resident Assessee The total income of any previous year of a person who is a resident includes all income from whatever source derived which: (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year. 3.5.2 Total Income of an Assessee who Not Ordinarily Resident The total income of any previous year of a person who is a not-ordinarily resident includes all income from whatever source derived which: (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (b) accrues or arises or is deemed to accrue or arise to him in India during such year; or (c) accrues or arises to him outside India during such year provided it is derived from a business controlled, or a profession set up, in India. 32 CU IDOL SELF LEARNING MATERIAL (SLM)

3.5.3 Total Income of a Non-Resident Assessee The total income of any previous year of a person who is a non- resident includes all income from whatever source derived which: (a) is received or is deemed to be received in India in such year by or on behalf of such person; or (ii) accrues or arises or is deemed to accrue or arise to him in India during such year. It is explained that income accruing or arising outside India shall not be deemed to be received in India by reason only of the fact that it is considered in a balance sheet prepared in India. It is further declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India. 3.5.4 The Accrual Concept The Oxford English Dictionary defines ‘accrue’ as “to fall as a natural growth or increment; to come … as an accession or advantage”. The accrual concept is a fundamental accounting concept that means that income must be considered in the accounts for the period for which it is earned, rather than the period in which the money is received. Income is said to be accrued only when the assessee acquires a right to receive that income. 3.5.5 The Arising Concept The Oxford English Dictionary defines ‘arise’ as “to spring up, come into existence”. Income may arise at one place but may be received in another. The arising concept means that all income arising in the previous year in considered to calculate the total income, irrespective of the fact whether the income has been, or will be received in India, or not. 3.5.6 Income Deemed to Accrue or Arise in India The law contains a list of income that is deemed to accrue or arise in India. Some of these items are as follows:  All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.  Income which falls under the head salaries if it is earned in India.  Income chargeable under the head salaries payable by the Government to a citizen of India for service outside India.  Dividend paid by an Indian company outside India.  Income by way of interest payable by: (a) the government; or (b) a person who is a resident, except where the interest is payable in respect of any debt incurred, or moneys borrowed and used, for the purposes of a business or profession carried on 33 CU IDOL SELF LEARNING MATERIAL (SLM)

by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the interest is payable in respect of any debt incurred, or moneys borrowed and used, for the purposes of a business or profession carried on by such person in India.  Income by way of royalty payable by: (a) the government; or (b) a person who is a resident, except where the royalty is payable in respect of any right, property or information used or services utilized for the purposes of a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India ; or (c) a person who is a non-resident, where the royalty is payable in respect of any right, property or information used or services utilized for the purposes of a business or profession carried on by such person in India or for the purposes of making or earning any income from any source in India. 3.6 SUMMARY  The incidence of income tax on an assessee depends on his residential status. All taxable entities are classified in three categories: resident, not ordinarily resident and non- resident. Alternative tests for residence are provided for various types of assessees.  Generally, an individual is said to be resident in India in any previous year if he is in India in the previous year for a period (or periods) amounting in all to 182 days or more. Several exceptions are provided for individuals depending on their citizenship, person of Indian origin, and the purpose for which they went outside India or being outside India came into India.  A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year if the control and management of its affairs is situated wholly outside India.  An Indian company is automatically considered resident in India. No other factor needs to be taken into consideration. A non-Indian company is considered resident if, during the previous year, the In the case of a non-Indian company the place of effective management (POEM) is situated wholly in India.  Every other person, not being an individual, HUF, firm, association of persons or a company, is said to be resident in India in any previous year if the control and management of his affairs is situated wholly, or in part, in India.  An individual who fails the test of residence is considered non-resident. A HUF, firm, or an association of persons is considered non-resident if its control and management is wholly situated outside India. Similarly, a non-Indian company is considered non- resident if its control and management is wholly situated outside India. 34 CU IDOL SELF LEARNING MATERIAL (SLM)

3.7 KEYWORDS  Accrued Income. Income is said to be accrued when the assessee acquires a right to receive that income.  Deemed Income. Deemed income is something which the law considers as income of an entity, when it not considered income, generally.  Not Ordinarily Resident (NOR). An individual or a HUF is considered as not ordinarily resident (NOR) when they satisfy the test of resident but do not pass the additional test for ordinary residence.  POEM. The place of effective management (POEM) is the basis on which a non- Indian company’s residential status is determined.  Tax Residency. A tax residence is the place where an assesseeis legally required to pay income tax. Based on test of residency, an entity may be either considered resident or non-resident. 3.8 LEARNING ACTIVITY 1. Under what circumstances a Hindu Undivided Family (HUF) would be considered as non- resident for the purpose of calculating its income tax liability. ___________________________________________________________________________ _____________________________________________________________________ 2. What indicators would you consider for determining the geographical location of the place of effective management (POEM) of a non-Indian company? ___________________________________________________________________________ _____________________________________________________________________ 3.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the concept of place of effective management (POEM) in brief. 2. Explain in brief the conditions under which a Hindu Undivided Family (HUF) is considered a resident person in India. 3. Explain in brief the conditions under which a company is considered a resident person in India. 4. Explain in brief the concept of accrued income. 5. Explain in brief the concept of arisen income. Long Questions 35 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Discuss the test for determining the residence of an individual for the purpose of calculating his income tax liability. 2. Discuss the test for determining the residence of a Hindu Undivided Family(HUF) for the purpose of calculating its income tax liability. 3. Discuss the test for determining the residence of a partnership firm for the purpose of calculating its income tax liability. 4. Discuss the test for determining the residence of an association of persons for the purpose of calculating its income tax liability. 5. Under what circumstances a resident individual would be considered as ordinarily resident for the purpose of calculating its income tax liability. 6. Under what circumstances a resident individual would be considered as not ordinarily resident for the purpose of calculating its income tax liability. 7. Under what circumstances an individual would be considered as non- resident for the purpose of calculating his income tax liability. B. Multiple Choice Questions 1. Aries Limited is a company incorporated in India, but its entire business is conducted outside India and a majority of its shareholders are non-residents. Under Income Tax Act, 1961 this company is considered as: a. Resident b. Not Ordinarily Resident c. Non-Resident d. Insufficient information 2. A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year if...: a. The control and management of its affairs is situated wholly in India. b. The control and management of its affairs is situated partially in India. c. The control and management of its affairs is situated wholly, or partly, in India. d. The business of the entity is situated in India. 3. Asha Ahire is an Indian citizen and has stayed in India from April 1, 2019, to March 31, 2020. In between she had gone for a vacation for one month to Maldives in the month of December 2019. What is the residential status of Asha Ahire for the assessment year 2021- 22? a. Not Ordinarily Resident b. Non-Resident 36 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Resident d. Insufficient information 4. Bushra Banu is a citizen of Pakistan and has stayed in India from April 1, 2019, to March 31, 2020. In between she had gone to Pakistan for one month in the month of December 2019. What is the residential status of Bushra Banu for the assessment year 2021-22? a. Not Ordinarily Resident b. Resident c. Non-Resident d. Insufficient information 5. Chitra Chitre a citizen of Bhutan and has stayed in India from April 1, 2019, to August 31, 2019. She had stayed for the entire period from April 1, 2015, to March 31, 2019, in India. What is the residential status of Chitra Chitre for the assessment year 2021-22? a. Not Ordinarily Resident b. Non-Resident c. Resident d. Insufficient information Answer 1-a, 2-c, 3-c, 4-b, 5-c 3.10REFERENCES Reference Books  Martin, E. A. (2003). The Dictionary of Law. Oxford: Oxford University Press.  Singhania, V., & Singhania, K. (2021). Direct Taxes Law & Practice. New Delhi: Taxmann.  Smith, A. (1976). The Wealth of Nations. London: Hackett Publishing Company. Website:  Fiore, N. (2002, February 1). Guiding Principles of Good Tax Policy. Journal of Accountancy. Retrieved fromhttps://www.journalofaccountancy.com/issues/2002/feb/guidingprinciplesofgood taxpolicy.html#:~:text=To%20help%20evaluate%20changes%20in%20tax%20rules %2C%20the,Similarly%20situated%20taxpayers%20%20should%20be%20taxed%20 similarl 37 CU IDOL SELF LEARNING MATERIAL (SLM)

 Government of India. (2017, January 24). Guiding Principles for determination of Place of Effective Management. Retrieved from Central Board of Direct Taxes: https://www.incometaxindia.gov.in/News/Circular06_2017.pdf  Price Waterhouse Coopers (PwC). (2021, July 5). World Tax Summaries. Retrieved from Individual - Residence: https://taxsummaries.pwc.com/india/individual/residence 38 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT- 4 SET OFF AND CARRY FORWARD OF 39 LOSSES STRUCTURE 4.0 Learning Objectives 4.1 Computation of Income under Different Heads of Income 4.2 Set off of Losses 4.2.1 Intra-Head Set Off of Losses 4.2.2 Restrictions on Intra-Head Set Off of Losses 4.2.3 Inter-Head Set Off of Losses 4.2.4 Restrictions on Inter-Head Set Off of Losses 4.2.5 Special Restrictions on Inter Head Adjustments 4.3 Carry forward of losses 4.3.1 Carry Forward of General Business Loss 4.3.2 Carry Forward of Specified Business Loss 4.3.3 Carry Forward of Loss of Racehorses Business 4.3.4 Carry Forward of Loss of Speculative Business 4.3.5 Carry Forward of House Property Loss 4.3.6 Carry Forward of Loss under Capital Gains 4.3.7 Carry Forward of Unabsorbed Depreciation 4.3.8 Change in the Constitution of Business 4.4 Summary 4.5 Keywords 4.6 Learning Activity 4.7 Unit End Questions 4.8 References 4.0LEARNING OBJECTIVES After studying this unit, you will be able to: CU IDOL SELF LEARNING MATERIAL (SLM)

 Explain the circumstances under which an assessee is allowed to take benefit of intra- and inter-head setting off of losses.  Explain the circumstances under which an assessee is allowed to carry forward losses to subsequent assessment year. 4.1 INTRODUCTION Computation of Income under Different Heads The Income Tax, 1961 envisions that an assessee should classify his income under the following five heads:  Income from Salaries  Income from House Property  Profits and Gains from Business and Profession  Capital Gains  Income from Other Sources 4.2 SET OFF OF LOSSES An assessee may have earned income from multiple sources during the previous year. It is possible that within each head of income listed above, the assessee may have earned income from multiple sub sources. For example:  An assessee may have earned, or received, income from more than one employer.  An assessee may have earned income from multiple house properties.  An assessee may have earned profits or gains from multiple businesses.  An assessee may have capital gains from multiple transactions.  An assessee may have earned income from multiple sources within the head. 4.2.1 Intra-Head Set Off of Losses When an assessee earns income from multiple sub-sources within a single head of income, it is possible that there may be a positive income from some sub-sources and losses in some other sub-sources. The Income tax law allows an assessee to set off a loss in one or more sub- sources against the positive income in other sub-sources within a single head of income in the same previous year. This is called as intra-head set off of losses (Cruz, Deschamps, Niswander, Prendergast, & Schisler, 2018). Such intra-head adjustment of losses is allowed under each head of income except salaries, subject to some conditions. The exemption of salaries from inter-source set off is obvious because one cannot conceive of a situation where an assessee has a loss from salaries. This is because, the maximum deduction allowed from salaries in limited to the extent of salaries earned or received in the previous year (Income Tax Department, 2021). 40 CU IDOL SELF LEARNING MATERIAL (SLM)

4.2.2 Restrictions on Intra-Head Set Off of Losses Generally, an assessee may adjust losses within the same head of income. However, in the following cases there are restrictions on such inter-source adjustment (Institute of Chartered Accountants of India, 2019).  Long-term capital loss A capital loss is the loss arising from the sale of an asset. Where the asset was held by the assessee for a ‘long-term’ period before its sales, the loss is considered a long-term capital loss.Long-term period is generally 36 months, but in case of shares and some units of mutual funds the period is 12 months.Long-term capital loss cannot be set off against any income other than income from long-term capital gain. However, short-term capital loss can be set off against long-term or short-term capital gain.  Loss from speculation business A speculative transaction is one in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business is deemed to be distinct and separate from any other business.Loss from speculative business cannot be set off against any income other than income from speculative business. For example, Mr. D runs two businesses: one is speculative and the other is not. His taxable income from the non-speculative business is Rs. 10 lakhs during the previous year and he suffered a loss of Rs. 5 lakhs on the speculative business. Although, both the sources fall within the general head of ‘profits and gains from business and profession, the loss from speculative business is not allowed to be set off against the gain from non-speculative business. However, non-speculative business loss can be set off against income from speculative business.For example, Mr. E runs two businesses: one is speculative and the other is not. His taxable income from the speculative business is Rs. 10 lakhs during the previous year and he suffered a loss of Rs. 5 lakhs on the non-speculative business. The loss from non-speculative business is allowed to be set off against the gain from speculative business.  Loss from the activity of owning and maintaining racehorses Some assessees are involved in the business of owning and maintaining racehorses. The most obvious way a racehorse owner makes money is by winning races. But owners can also make money other ways as well such as: breeding, selling racehorses, and providing support services.Any loss from the business of owning and maintaining racehorses cannot be set off against any income other than income from the business of owning and maintaining racehorses. 41 CU IDOL SELF LEARNING MATERIAL (SLM)

 Losses of specified business Some of the businesses are specified for special treatment. They include a cold chain facility, warehousing facility for storage of agricultural produce, and developing and building a housing project.Loss from business specified cannot be set off against any other income except income from specified business.  Income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature. At times we have a windfall gain. These gains are taxed independently.No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature. A taxpayer who shares winnings with others may have to pay tax on the entire amount, depending on the sharing arrangement. If the taxpayer wins and then gives away part of the winnings, the taxpayer will be taxed on the full amount.  Loss from an exempted source If income from a particular source is exempt from tax, then loss from such source cannot be set off against any other income which is chargeable to tax. For example, agricultural income is exempt from tax. Where an assessee incurs loss from agricultural activity, then such loss cannot be adjusted as all the income within this sub-source is exempted. 4.2.3 Inter-Head Set Off of Losses We saw in the previous section that an assessee is allowed to set off losses within the same head of income. However, it may be possible that the losses within a head of income could not be satisfied with that source. There could be several reasons for this. For example, the assessee may have suffered a in each of the sub-heads within the same head of income. It is also possible that the loss in one or more sub-head is so large that it cannot be fully absorbed by the other sub-heads within the same head of income. Finally, it is also possible that the assessee has a single source of income within a head of income. When intra-head set off of losses is not possible, the law allows setting off of losses from one head against the income of another head. This is called as inter-head set off of losses. Thus, inter-head adjustments mean the setting off of losses from one head of income against income from other heads of income.For example, an assessee may have a loss under the head of house property. This loss may be set off against the profits under another head, such as income from salaries.Such inter-head adjustments are allowed subject to certain restrictions. 4.2.4 Restrictions on Inter-Head Set Off of Losses 42 CU IDOL SELF LEARNING MATERIAL (SLM)

We saw that the law allows inter-head adjustments, that is, setting off of losses from one head of income against income from other heads of income. Such inter-head adjustments are allowed subject to the following restrictions:  Inter-head adjustment is allowed to be made only after making intra-head adjustment. For example, Mr. C is a salaried person who also owns multiple house properties. His taxable salary income during the previous year is Rs. 10 lakhs. From the house properties he owns he earned a profit of Rs. 2 lakhs on one property and a loss of Rs. 100,000 from the second property. In this case, Mr. C is required to first make intra-head set off that is the loss of Rs. 100,000 from the second property should first be set off against the profit of Rs. 2 lakhs on the first property. Inter-head adjustment is allowed only after making intra-head adjustment.  Loss from speculative business cannot be set off against any other income. We discussed in the previous section that loss from speculative business cannot be set off against any income other than income from speculative business. This means that in case of speculative businesses neither intra-head set off is allowed, nor inter-head set off is allowed. However, non-speculative business loss can be set off against income from speculative business. Continuing from the previous section, for example, Mr. D runs two businesses: one is speculative and the other is not. His taxable income from the non-speculative business is Rs. 10 lakhs during the previous year and he suffered a loss of Rs. 5 lakhs on the speculative business. Assume further that Mr. D has earned a taxable income of Rs. 5 lakhs from other sources. We saw earlier, that although, both the sources fall within the general head of ‘profits and gains from business and profession, the loss from speculative business is not allowed to be set off against the gain from non-speculative business. That is, intra-head set off of loss of speculative in not allowed. Now, it is further provided that the loss from speculative business is also not allowed to be set off against the income from any other head. That is, even inter- head set off of loss of speculative in not allowed.  Loss under head capital gains cannot be set off against income under other heads of income. We saw in the previous section that long-term capital loss cannot be set off against any income other than income from long-term capital gain. However, short-term capital loss can be set off against long-term or short-term capital gain. That is, intra-head set off of long capital losses is not allowed. Now, it is further provided that long capital losses are also not allowed to be set off against the income from any other head. That is, even inter-head set off of long capital loss is not allowed. 43 CU IDOL SELF LEARNING MATERIAL (SLM)

 No loss can be set off against income from winnings from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature. We saw in the previous section that any loss under from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or naturecannot be set off against any income other than income. That is, intra- head set off of such losses is not allowed. Now, it is further provided that any loss under from lotteries, crossword puzzles, race including horse race, card game, and any other game of any sort or from gambling or betting of any form or nature are also not allowed to be set off against the income from any other head. That is, even inter-head set off of such loss is not allowed.  Loss from the business of owning and maintaining racehorses cannot be set off against any other income. We saw in the previous section that loss from the business of owning and maintaining racehorses cannot be set off against any other income. That is, intra-head set off of such losses is not allowed. Now, it is further provided that loss from the business of owning and maintaining racehorses is also not allowed to be set off against the income from any other head. That is, even inter-head set off of such loss is not allowed.  Loss from specified business cannot be set off against any other income. We saw in the previous section that loss from specified businesscannot be set off against any other income. That is, intra-head set off of such losses is not allowed. Now, it is further provided that loss from specified businessis also not allowed to be set off against the income from any other head. That is, even inter-head set off of such loss is not allowed. Specified business is defined to include the business of running a cold chain facility, warehousing facility for storage of agricultural produce, and developing and building a housing project. 4.2.5 Special Restrictions on Inter Head Adjustments Apart from the general restrictions discussed above, there are some restrictions on inter-head adjustments. The following are the special restrictions:  Loss from business and profession cannot be set off against income chargeable to tax under the head salaries. For example, Mr. A is an individual assessee who has earned a taxable salary of Rs. 10 lakhs during the previous year. Mr. A also runs a business which suffered a loss of Rs. 10 lakhs during the previous year. Mr. A would wish to set off his loss under the head profit and gains from business and profession against his income from salary and report nil taxable income. This is not allowed. The loss from business and profession cannot be set off against income chargeable to tax under the head salaries. It should be 44 CU IDOL SELF LEARNING MATERIAL (SLM)

noted that this special restriction is only against a loss from business and profession. This does not apply to loss under other heads of income.  Loss under the head house property can be set-off against any other head of income only to the extent of Rs. 2, 00,000 for any assessment year. For example, Mr. B is an individual assessee who has earned a taxable salary of Rs. 10 lakhs during the previous year. During the previous year, Mr. B suffered a loss of Rs. 300,000 under the head ‘income from house property’. Mr. B would wish to set off the entire loss of Rs. 300,000 under the head ‘income from house property’ against his salary income. This is not allowed. The maximum loss from house property that is allowed to be set off is Rs. 200,000. 4.3 CARRY FORWARD OF LOSSES We discussed in the previous section that a loss from a source is first allowed to be set off against the gain within the same head of income (intra-head set off). If such intra-head set off was not possible the assessee is allowed to set off the loss in one head against the gain in another head of income (inter-head set off). Both, intra- and inter-head set off of losses are subject to several general and special restrictions. It may be possible that the loss incurred by an assessee are so big that it cannot be fully absorbed both, within the head of income, and across the heads of income. In such a scenario, the assessee may be allowed to carry forward the loss to subsequent assessment years. 4.3.1 Carry Forward of General Business Loss Where an assessee suffers any loss from carrying on any business or profession (other than speculative business) cannot be fully adjusted in the year in which it is incurred, then the unadjusted loss can be carried forward for making adjustment in the next assessment year. In the subsequent year(s) such loss can only be adjusted against income charged to tax under the head profits and gains of business and profession.Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.Loss under this head can be carried forward only if the return of income of the year in which loss is incurred is furnished on or before the due date. 4.3.2 Carry Forward of Specified Business Loss Loss from specified business cannot be set off against any other income except income from the specified business. Such loss can be carried forward for adjustment against income only from specified business for any number of years.Loss from specified business can be carried forward only if the return of income of the year in which loss is incurred is furnished on or before the due date. 4.3.3 Carry Forward of Loss of Racehorses Business 45 CU IDOL SELF LEARNING MATERIAL (SLM)

Loss from the business of owning and maintaining racehorses cannot be set off against any income other than income from the business of owning and maintaining racehorses.Such loss can be carried forward for four years immediately succeeding the year in which the loss is incurred. 4.3.4 Carry Forward of Loss of Speculative Business Where any loss of any speculative business cannot be fully adjusted in the year in which it is incurred, then the unadjusted loss can be carried forward for making adjustment in the next year. In the subsequent year(s) such loss can be adjusted only against income from speculative business.Such loss can be carried forward for four years immediately succeeding the year in which the loss is incurred.Loss from speculative business can be carried forward only if the return of income of the year in which loss is incurred is furnished on or before the due date. 4.3.5 Carry Forward of House Property Loss Where any loss under the head “income from house property” cannot be fully adjusted in the year in which such loss is incurred, and then unadjusted loss can be carried forward to next year.In the subsequent years(s) such loss can be adjusted only against income chargeable to tax under the head “income from house property”.Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.Loss under the head “Income from house property” can be carried forward even if the return of income is not furnished on or before the due date. 4.3.6 Carry Forward of Loss under Capital Gains If loss under the head capital gains incurred during a year cannot be adjusted in the same year, then unadjusted capital loss can be carried forward to next year.In the subsequent year(s), such loss can be adjusted only against income chargeable to tax under the head capital gains; however, long-term capital loss can be adjusted only against long-term capital gains. Short-term capital loss can be adjusted against long-term capital gains as well as short- term capital gains. Such loss can be carried forward for eight years immediately succeeding the year in which the loss is incurred.Loss under the head capital gains can be carried forward only if the return of income of the year in which loss is incurred is furnished on or before the due date. 4.3.7 Carry Forward of Unabsorbed Depreciation While computing income chargeable to tax under the head “profits and gains of business or profession” we are allowed to claim various deductions, including: (a) Depreciation; (b) Capital expenditure on scientific research; (c) Capital expenditure for promoting family planning amongst its employees. 46 CU IDOL SELF LEARNING MATERIAL (SLM)

Where the income of the year in which these expenses are incurred falls short of these expenses, then the unabsorbed expenses can be carried forward to next year in the form of: (a) Unabsorbed depreciation, or (b) Unabsorbed capital expenditure on scientific research, or (c) Unabsorbed capital expenditure on promoting family planning amongst the employees. Depreciation is first deducted from the income chargeable to tax under the head “Profits and gains of business or profession”. If such depreciation could not be fully adjusted against such income chargeable to tax in that previous year, the unabsorbed portion is added to the amount of depreciation for the following year and is deemed to be the part of depreciation for that year. However, in the case of set off, following order of priority is to be followed:  First adjustments are to be made for current scientific research expenditure, family planning expenditure and current depreciation.  Second adjustment is to be made for brought forward business loss.  Third adjustments are to be made for unabsorbed depreciation, unabsorbed capital expenditure on scientific research or on family planning. 4.3.8 Change in the Constitution of Business Businesses change to keep up with the change in the business environment. A business can be reconstituted in several ways, such as: (a) amalgamation; (b) demerger; (c) conversion of proprietary firm into company (d) conversion of partnership firm into company. Generally, the person incurring the loss is only entitled to carry forward the loss to be adjusted in subsequent year(s). However, in certain cases of reconstitution of the business like, the reconstituted entity is entitled to carry forward the unadjusted loss of predecessor entity subject to some conditions. In case of a company, the loss incurred in any year prior to the previous year is allowed to be carried forward and set off against the income of the previous year only when the majority of beneficial shareholding remains unchanged. This is applicable only to companies in which the public are not substantially interested. The condition of constancy of shareholding for carry forward of losses is not applicable under the following cases:  The change in shareholding takes place consequent upon the death of a shareholder or on account of transfer of shares by way of gift to any relative of the shareholder making such gift; or  The change in shareholding take place in the previous year pursuant to approved resolution plan under the Insolvency and Bankruptcy Code, 2016.  Where the National Company Law Tribunal (NCLT) has suspended the board of directors of a company and has appointed new directors. 47 CU IDOL SELF LEARNING MATERIAL (SLM)

 Change in shareholding is approved by the NCLT. 4.4 SUMMARY  The Income Tax, 1961 envisions that an assessee should classify his income under the following five heads: (a) salaries; (b) house property; (c) profits and gains from business and profession; (d) capital gains; and (e) other sources. An assessee may have earned income from multiple sources during the previous year. It is possible that within each head of income listed above, the assessee may have earned income from multiple sub sources.  Intra-head set off of losses means setting off a loss in one or more sub-sources against the positive income in other sub-sources within a single head of income in the same previous year. Such intra-head adjustment of losses is allowed under each head of income except salaries, subject to some conditions.  When intra-head set off of losses is not possible, the law allows setting off of losses from one head against the income of another head. This is called as inter-head set off of losses. Thus, inter-head adjustments mean the setting off of losses from one head of income against income from other heads of income. For example, an assessee may have a loss under the head of house property. This loss may be set off against the profits under another head, such as income from salaries. Such inter-head adjustments are allowed subject to certain restrictions.  It may be possible that the loss incurred by an assessee are so big that it cannot be fully absorbed both, within the head of income, and across the heads of income. In such a scenario, the assessee may be allowed to carry forward the loss to subsequent assessment years. 4.5 KEYWORDS  Carry Forward of Loss. Carry forward of loss is a rule which allows an assessee to set off the loss in one assessment year to another assessment year, subject to certain conditions.  Depreciation. Depreciation is a measure of the diminution in value of a fixed asset due to wear and tear or obsolescence over an accounting period.  Inter-HeadSet Off Loss. The inter-head set off loss is a rule that allows an assessee to set off loss in one head of income against income from other heads of income. For example, an assessee may have a loss under the head of house property which he is allowed to set off against the income from salaries. 48 CU IDOL SELF LEARNING MATERIAL (SLM)

 Intra-Head Set off Loss. The intra-head set off loss is a rule that allows an assessee to set off a loss in one or more sub- sources against the positive income in other sub- sources within a single head of income in the same previous year.  Speculative Transaction. A speculative transaction is one in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. 4.6 LEARNING ACTIVITY 1. What are the conditions for carry forward of house property loss? ________________________________________________________________________ ________________________________________________________________________ 2. What are the conditions for carry forward of loss of speculative business? ________________________________________________________________________ ________________________________________________________________________ 4.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain the concept of intra-head set off of losses in brief. 2. Explain the concept of inter-head set off of losses in brief. 3. Explain the concept of speculative business in brief. 4. Explain the concept of shareholding pattern in brief. 5. Explain the concept of unabsorbed loss in brief. Long Questions 1. Describe the concepts of intra- and inter-head set off of losses. 2. What are the conditions for intra-head set off of losses? 3. What are the general conditions for inter-head set off of losses? 4. What are the special conditions for inter-head set off of losses? 5. What are the general conditions for carry forward of losses to subsequent assessment years? 6. What are the conditions for carry forward of loss under capital gains? 7. What are the conditions for carry forward of unabsorbed depreciation? 8. What are the conditions for change in the constitution of business? 49 CU IDOL SELF LEARNING MATERIAL (SLM)

B. Multiple Choice Questions 1. The loss in one sub-head of income is allowed to set-off against another sub-head under the same head of income. However, such intra-head adjustment of losses is not allowed under which of the following head of income? a. Income from Salaries b. Income from House Property c. Income from Other Sources d. Profits and Gains of Business and Profession 2. Ms. Deepa Dey runs two businesses: one is speculative and the other is not. Her taxable income from the non-speculative business is Rs. 10 lakhs during the previous year and she suffered a loss of Rs. 5 lakhs on the speculative business. Which of the following statements is TRUE with reference to Ms. Deepa Dey? a. The loss of Rs. 5 lakhs of the speculative business is NOT allowed to be set off against the income from a non-speculative business. b. The loss of Rs. 5 lakhs of the speculative business is fully allowed to be set off against the income from a non-speculative business. c. The loss of Rs. 5 lakhs of the speculative business is partially allowed to be set off against the income from a non-speculative business to the extent of 50 per cent of the loss of speculative business. d. The loss of Rs. 5 lakhs of the speculative business is fully allowed to be set off against the income from a non-speculative business provided the assessee is resident and ordinarily resident in India. 3. Ms. Chitra Chaya runs two businesses: one is speculative and the other is not. Her taxable income from the speculative business is Rs. 10 lakhs during the previous year and she suffered a loss of Rs. 5 lakhs on the non-speculative business. Which of the following statements is true with reference to Ms. Dey? a. The loss of Rs. 5 lakhs of the non-speculative business is NOT allowed to be set off against the income from a speculative business. b. The loss of Rs. 5 lakhs of the non-speculative business is fully allowed to be set off against the income from a speculative business. c. The loss of Rs. 5 lakhs of the non-speculative business is partially allowed to be set off against the income from a speculative business, to the extent of 50 per cent of the loss of speculative business. 50 CU IDOL SELF LEARNING MATERIAL (SLM)