Tax

Answer-14 Note Amount Computation of deduction eligible u/s 80C for the A.Y. 2020-21 eligible Particulars ₹ (a) Life Insurance Premium 1 (b) Contribution to Public Provident fund 2 60,000 (c) Tuition fee 3 Nil (d) Housing Loan Principal repayment 4&5 (e) Investment in National Savings Certificate 30,000 (f) Subscription to Bonds issued by NABARD Nil Gross amount 60,000 Deduction u/s 80C restricted to 50,000 2,00,000 1,50,000 Notes: 1. Any amount of Life Insurance Premium paid in excess of 20% of capital sum assured shall be ignored for deduction u/s 80C. In the given case, 20% of capital sum assured is ₹60,000. Whereas, the premium paid during the year is ₹70,000. Therefore, the excess premium of ₹10,000 does not qualify for deduction. 2. In the case of an individual, contribution to PPF should be made in his name, spouse or children to qualify for deduction u/s 80C. As the contribution was made in the name of mother, deduction is not allowable. 3. Tuition fee paid is eligible for deduction u/s 80C for maximum of two children. Therefore, ₹30,000 shall be allowed. Tuition fee paid for educational institution situated outside India is not eligible for deduction. 4. In order to claim the principal repayment on loan borrowed for house property as deduction, the construction of such property should have been completed and should be chargeable to tax under the head \"Income from house property\". In the given case, since the property is under construction, principal repayment does not qualify for deduction. 5. Repayment of principal on housing loan is not allowed as deduction in case the loan is borrowed from friends, relatives etc. In order to qualify for deduction, the loan should have been obtained from specified employer / institution. 351

Sub-Section 2.6 Tax Characteristics of Business Forms 2.6.1. Sole Proprietorship The most common form of ownership found in the business world is sole proprietorship. In this form of organization, the proprietor is the only owner of the business assets and he is solely responsible for the affairs of the business. The merits and demerits of a sole proprietary form of organization may be summarized as under: Merits: (a) A sole proprietorship is easy to establish because of little interference of government regulations. (b) The cost of adopting this form of organization is small because of there being no legal requirement. (c) All the profits of the business go in the hands of proprietor himself. (d) In case of persons carrying on business on small scale and having small income from other sources, this form of organization would be suitable because the proprietor can avail of the basic exemption limit of ₹2,50,000 / ₹3,00,000 / ₹5,00,000. (e) Besides the deductions which are allowed to all assessees under Chapter VIA, a sole proprietor, being assessed as individual, is entitled to get certain deductions under the following sections: (i) section 80C (w.e.f. assessment year 2006-07) relating to contributions to provident fund, life insurance premium, subscription to certain equity shares or debentures, etc. (ii) section 80CCC relating to contribution to certain pension funds. (iii) section 8OCCD relating to contribution to notified pension scheme of the Central Government. (iv) section 80D relating to medical insurance premia. (v) section 80DD relating to maintenance of a dependent who is a person with disability. (vi) section 80DDB relating to expenditure on medical treatment, etc. (vii) section80E relating to repayment of loan taken for higher education. (viii) section 8OGG relating to rent paid. (ix) section 80QQB relating to royalty income, etc. of authors of certain books other than textbooks. (x) section 80RRB relating to royalty on payments. (xi) section 80U relating to persons with disability. 352

Demerits: (a) The liability of the proprietor is unlimited and it can extend even to his personal assets. When the proprietor incurs losses and business assets are not sufficient enough to meet the liabilities of business, his personal assets can be used for discharging the business liabilities. (b) The proprietor does not get deduction on account of remuneration payable to him attributable to the rendering of services. It is felt that it is the capital contributed and risk taken by the proprietor for which he is rewarded in profits and that he must be given remuneration for the service rendered by him which should be allowed as deductible expenditure. But this is not so in income-tax law. (c) Another main drawback of this form of organization is that it does not provide opportunities to finance the expanding business activities. In the case of a partnership firm, on the other hand, finance can be raised by the existing partners or by entering another partner. (d) In case of a business growing at a higher speed, and yielding higher profits, a sole proprietary organization may not be beneficial. As the salary paid to the proprietor, and interest paid on capital are not allowable, the profits become higher and tax incidence goes high. In case of other entities, on the other hand, remuneration payable to partners/managing director, interest paid to partners are allowed as admissible expenditure to the extent specified in the Act. 2.6.2. Partnership Firm A firm is to be assessed as a unit and the share income from the firm in the hands of the partners is exempt. There is no need for registration. General: Under section 2(23) of the Income-tax Act, the terms ‘firm’, ‘partner ‘and ‘partnership’ have the same meanings respectively as have been assigned to them under the Indian Partnership Act, 1932, but the expression ‘partner’ also includes another person who being a minor, has been admitted to the benefits of an existing partnership. A firm though not a legal person or juridical entity, is chargeable to tax as separate entity distant from the partners and the partners are assessable as individuals and not as an association persons or body of individuals. The term ‘firm’ as used in the Act covers both registered and unregistered firms. The residential status of a firm to be determined depending upon the fact whether or not the control and management of its affairs is exercised from within India. Even if the negligible part of the control and management is exercised from within India the firm would be resident in India for all the purposes. For determining the residential status of a firm, it is immaterial to ascertain the residential status of partners thereof because a firm may be resident even in cases where all the partners are not resident in India and they control or manage the affairs from outside India. Every firm is liable to pay tax flat rate of30% on its total income of the previous year computed in accordance with the provisions of the Act, plus education cess@2% plus secondary and higher education cess@ 1%. 353

The following are the salient features of assessment of partnership firms:  The firm will be taxed as a separate entity. There will be no distinction between registered and unregistered firm.  The share of the partner in the income of the firm will not be included in the hands of the partner. It will be exempt under section 10(2A).  Any salary, bonus commission or remuneration, by whatever name called, which is due to or received by a partner will be allowed as a deduction subject to certain restrictions.  Where a firm pays interest to any partner the firm can claim deduction of such interest from its total income. However, the maximum rate at which interest can be allowed to a partner will be 12% per annum.  The income of the firm will be taxed at a flat rate of 30%. Education cess @ 2% and secondary and higher education cess@1% will be levied on income tax. What are the conditions a firm should fulfill under section 184  There are five basic conditions which a firm has to satisfy-  A firm must be evidenced by an instrument[sec.184(1)(i)]  Individual share of partners must be specified in instrument.  Certified copy of the instrument should be submitted.  Revised instrument should be submitted whenever there is change in the constitution of firm/profit sharing ratio.  There should not be any failure as is mentioned in section 144. Where are the conditions for claiming deduction of remuneration of partners under section 40(b) See topic 2.3 Taxation of Limited Liability Partnership. The concept of Limited Liability Partnership (LLP) has been bought in India in 2008 with the introduction of the Limited Liability Partnership Act, 2008. However, there was no clarity on the taxation of the same since the LLPs have the limited liability of the partners like the shareholders of the company. There was no clarification in the Income Tax Act. 1961 about the status of the LLPs whether they will be considered as firms or a Company. It has been clarified by the Finance Act, 2009 that the LLP shall have 'the same status as that of partnership firms formed under the Indian Partnership Act, 1932. The definition of firms, partner and partnership has been amended to include the LLPs within its purview. Consequent to the Limited Liability Partnership Act, 2008 coming into effect in 2009 and notification of the Limited Liability Partnership Rules w.e.f. 1st April, 2009, the Finance (No.2) Act, 2009 has incorporated the taxation scheme of LLPs in the Income-tax Act on the same lines 354

as applicable for general partnerships, i.e. tax liability would be attracted in the hands of the LLP and tax exemption would be available to the partners. Therefore, the same tax treatment would be applicable for both general partnerships and LLPs. Consequently, the following definitions in section 2(23) have been amended -  The definition of ‘partner’ to include within its meaning, a partner of a limited liability partnership;  The definition of ‘firm’ to include within its meaning, a limited liability partnership; and  The definition of ‘partnership’ to include within its meaning, a limited liability partnership. The definition of these terms under the Income-tax Act would, in effect, also include the terms as they have been defined in the Limited Liability Partnership Act, 2008. Section 2(q) of the LLP Act, 2008 defines a ‘partner’ as any person who becomes a partner in the LLP in accordance with the LLP agreement. An LLP agreement has been defined under section 2(o) to mean any written agreement between the partners of the LLP or between the LLP and its partners which determines the mutual rights and duties of the partners and their rights and duties in relation to the LLP. Section 167c: Liability of Partners of Limited Liability Notwithstanding anything contained In the Limited liability Partnership Act ,2008, where any tax due from a limited liability partnership in respect of an Income of any previous year or from any other person in respect of any income of any previous year during which such other person was a limited liability partnership- can-not be recovered, In such case, every person who was a partner of the limited liability partnership at any time during the relevant previous year, shall be jointly and severally liable for the payment of such tax unless he proves that the non- recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation of the affairs of the limited liability partnership. Silent Features:  The income of the Limited Liability Partnership (LLP) shall be taxable at the flat rate of 30.90% LTCG and STCG shall be taxable as per section 112 and 111A.  The remuneration and interest paid b LLP to its partners shall be allowed as per section 40(b).  The share of profit received by the partner of LLP5hall be exempt under section 10(2Al.  The remuneration and interest received by partner of LLP shall be taxable as per section 28.  Capital gains shall arise when a company is converted into a LLP  There will be no implication under the Income Tax Act, where a partnership firm is converted into a LLP as clarified in the Memorandum Explaining Finance Bill, 2009. 355

 The liability of the partners of LLP shall be joint and several for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the limited liability partnership.  The Return of Income shall be signed by designated partner or where designated partner is not able to sign due to the unavoidable reasons, any partner shall sign Return of Income. Levy of Alternate Minimum Tax From the assessment year 2013-14 onwards, a limited liability partnership will be subject to alternate minimum tax which will be determined as follows- Step 1: Find out the regular income-tax liability of LLP ignoring the provisions of sections 115JC to 115JF. Step 2: Find out adjusted total income of LLP. Adjusted total income is net income or total income of LLP as increased by- Amount claimed as deduction by LLP under sections 80H to 80RRB, and Amount claimed as deductions by LLP under section 10AA. Step 3: Find out 19.055 per cent (i.e., 18.5 per cent + EC+SHEC) of adjusted total income computed under Step 1. Step 4: If amount computed under Step 1 is equal to or more than amount determined under Step 3, then the provisions of alternate minimum tax will not be applicable If, however, amount computed under Step 3 is more than the regular tax liability under Step 1, then- Adjusted total income determined under Step 2 will be deemed as total income of LLP for such previous year, and Step 5: The excess of the amount computed under Step 3 over the amount computed under Step 1 will be available as credit for alternate minimum tax. It can be carried forward and can be set off against regular tax liability of LLP of the next year or subsequent year (but not beyond the 10th assessment year). No interest is payable on such credit. Tax credit shall be allowed to be set off for an assessment year in which the regular income-tax exceeds the alternate minimum tax to the extent of the excess of the regular income-tax over the alternate minimum tax. 2.6.3. Hindu Undivided Family (HUF) In many financial transactions, people while buying or selling immovable property -residential, agricultural, commercial or industrial property, or any movable property - declare their status as that of Hindu Undivided Family, or HUF. But a mere declaration by a Hindu buyer or seller of real estate, or any other asset, that his status is that of an HUF cannot be accepted in law because there are certain legal requirements of a valid HUF status. Let us consider the main aspects which need to be borne in mind in saving tax through HUF status. 356

Concept of HUF Under the Income-tax Act, a Hindu undivided family (HUF) is treated as a separate entity for the purpose of assessment. It is included in the definition of the term “person” under section 2(31). The levy of income-tax is on “every person”. Therefore, income-tax is payable by a HUF. \"Hindu undivided family\" has not been defined under the Income-tax Act. The expression is however defined under the Hindu Law as a family, which consists of all males lineally descended from a common ancestor and includes their wives and unmarried daughters. The relation of a HUF does not arise from a contract but arises from status. A Hindu is born into a HUF. A male member continues to remain a member of the family until there is a partition of the family. After the partition, he ceases to be a member of one family. However, he becomes a member of another smaller family. A female member ceases to be a member of the HUF in which she was born, when she gets married. Thereafter, she becomes a member of the HUF of her husband. Some members of the HUF are called co-parceners. They are related to each other and to the head of the family. A HUF may contain many members, but members within four degrees including the head of the family (karta) are called co-parceners. A hindu coparcenary includes those persons who acquire by birth an interest in the joint coparcenary property. Only the coparceners have a right to partition. Two Schools of Hindu Law In India, Hindus are mainly governed by two schools of law, namely Mitakshara and Dayabhagh. In some parts of India, particularly in south India, certain other systems are also prevalent. The Dayabhagh system is especially prevalent in West Bengal and Assam, whereas for the rest of country for most of the Hindus the law relating to the ownership, devolution, etc. of properties is the Mitakshara School of Hindu Law. Generally speaking, under the Mitakshara School of Hindu Law the main principle is the survivorship principle in the matter of devolution of the ancestral or HUF property, in contrast to the principle of succession which applies to the individual property of a Hindu. Another principle is that no member of the HUF, so long as the Hindu family remains joint, can be said to have a specific share in the HUF property. It is only upon partition of an HUF that the share belonging to a particular member can be ascertained. Another way of attaining HUF status to a property is by way of partition and accretions to the partitioned property. Thus, if the property of an HUF is partitioned amongst its members as per the HUF law, then the member receiving the property will be said to hold it not in his individual capacity but as HUF, provided there is more than one member in the family. 357

Further, if any addition is made to such partitioned HUF property, then the addition so made to such property also gets the status of HUF property. It may be mentioned here that if an individual property is inherited as per the Hindu Succession Law, then the property so inherited is not to be termed as partitioned property. Very often a mistake is committed by the Hindus in declaring the property received by them on inheritance under the Hindu Succession Act, as HUF property, whereas it is in truth only the individual property of the person inheriting it. Another mode of acquiring the status of HUF in respect of property both movable and immovable is by a special gift made by the father or mother of the male member of a family. In some cases, there may not be any ancestral property. There might not have been any cases of partition of the HUF property and thus the status of a Hindu regarding his property is that of individual only. If he is interested in owning property in the status of HUF, he may get the gift of the property of any amount from his father or mother, or any relative or friend, specifically for his own HUF consisting of himself, his wife and children. In that case the amount so gifted by the father, etc. will form part of the HUF property. If some loans are taken by that HUF and an immovable property or a movable property is purchased by the HUF, the property so purchased will be known as HUF property. In some cases, the father, etc. may also pass on his individual property to the children as HUF property through a specific declaration in a will. What is most relevant is the intention of the donor to treat the gift for the specific recipient namely, whether the individual or the HUF. Tax Benefits of HUF The question of HUF status for a Hindu buyer or seller of any property assumes importance because of certain tax advantages attached with HUF under the income tax and wealth tax laws. Thus, if an individual has personal income and has also HUF income, he would be entitled to have an exemption of Rs 2,50,000 for his individual income and another Rs 2,50,000 for his HUF income. Besides, he would also be eligible to a further income tax deduction or exemption of Rs 150,000 under Section 80C in respect of LIC premia, PPF contribution, NSC, etc., both on individual and HUF income separately. Besides, under the Wealth Tax Act, 1957 too, separate exemptions are available for individual property and HUF property. 358

Thus, where the taxable individual wealth is eligible to a general exemption of Rs 180.000, the HUF's taxable wealth is also eligible to a further general exemption of Rs 180,000. Hence, persons having immovable property and jewellery and motorcars under HUF status stand to gain from the extra exemption under Wealth Tax Act as well. Other Points to Keep in Mind The bank account should be in the name of either the HUF or in the name of the Karta by specifically declaring that the account is that of the HUF only. Only the funds belonging to the HUF should be deposited in such an account. Normally, the Karta of the HUF is entitled to sign the bank transactions. He may, however, also permit the other adult members of the family to sign on behalf of the HUF. Another important thing that can be remembered in connection with HUF property is that where a person wants to transfer some property by Will to the members of his family, he can transfer the same for the specific purpose of the HUF of his son or sons so as to constitute the amounts so transferred through will or so gifted by will as the HUF property of the son(s) concerned. This would result into a good deal of income tax and wealth tax saving for the persons inheriting such property by will as mentioned above. Assessment of Hindu Undivided Family The income of a HUF is to be assessed in the hands of the HUF and not in the hands of any of its members. This is because HUF is a separate and a distinct tax entity. Partition of HUF – There are two types of partition. They are – (1) Total partition – is a partition by which the entire family property is divided amongst the coparceners. After the total partition, the HUF ceases to exist as such . (2) Partial partition – is a partition which is partial as regards either the persons constituting the joint family or as regards the properties belonging to the joint family or both. In case of a partial partition as regards persons constituting the joint family, some coparceners may separate from the joint family while the others might continue to remain as part of the joint family. In case of a partial partition as regards the property, there may be a division or severance of interest in respect of some part of the estate of the joint family, while the rest of the estate may continue to remain as property of the joint family. Effect of Partial Partitions made after 31st December, 1978 However, partial partitions after 31st December, 1978 are not recognized for tax purposes. If any partial partition has been effected after 31.12.78, then no claim of such partial partition shall be recorded by the Assessing Officer. Such family will continue to be assessed as if no such partial partition has been effected. Every member of the HUF, immediately before such partial partition, and the HUF shall be jointly and severally liable for any sum payable under the act. 359

The several liability of a member would be proportionate to the share of joint family property allotted to him on such partial partition. Assessment after Total Partition When a claim of total partition of HUF has been made by any member of the HUF on behalf of the HUF, the Assessing Officer shall inquire into such claim. For this purpose, he shall give notice to all the members of the HUF. Thereafter, the Assessing Officer shall, on completion of inquiry, record a finding as to whether total partition has taken place and if so, the date when such partition was effected. If partition has been effectedin the previous year, the total income of the HUF for the previous year up to the date of partition shall be assessed as income of the HUF. Every member of the HUF is jointly and severally liable for payment of tax on such assessed income of the HUF. The several liability of a member would be proportionate to the share of joint family property allotted to him on such partition. Computation of Total Income of HUF The following points should be taken into consideration while determining the total income of HUF - (1) Income from the transfer of a self-acquired property by an individual to his HUF for inadequate consideration or conversion of the self-acquired property into property of the HUF is not considered as the income of the HUF. It would be included in the income of the individual member who transferred the property to the HUF [section 64(2)] (2) Income from an impartibly estate is included in the hands of the holder of the estate and not in the hands of the HUF. Even if the impartible estate is owned by the HUF, income from such estate is includible in the hands of the holder of the estate who is the eldest member of the HUF. (3) Section 10(2) exempts any receipt by an individual as a member of a HUF out of the family income or out of the income of the impartible estate belonging to the family. (4) If a member of the HUF receives any fee or remuneration as a director or a partner in company or firm as a consequence of the investment made in such concern out of the funds of the HUF, such fee/remuneration shall constitute income of the HUF. However, any such fee or remuneration earned by a member of a HUF as a director or partner for services rendered purely in his personal capacity, will be included in the income of the individual member and not the HUF. Income received in the capacity as a member: Section 10(2) gives total exemption in respect of any sum received by an individual as member of a Hindu Undivided Family either out of income of the family or out of any impartible estate belonging to the family. Conversion of separate property into property of HUF: However, to the above exemption there is an exception provided by section 64(2) .Generally incomes from self-acquired property of an individual, who is a member of a HUF will be assessed as his personal income and not as the 360

income of the family. However, the individual can convert his separate properties into the property of the HUF. There are no legal formalities to be complied with. These principles have been upheld by various judicial rulings. It naturally follows that once the assets belonging to the individual are impressed with the character of joint family property, the income arising there from, should be assessed as the income of the HUF. However, the deeming provisions of section 64(2) specifically provide that the entire income from the converted property is taxable as the income of the transferor. This provision applies not only to property converted in the above manner but also covers transfer of property by an individual, directly or indirectly, to the family otherwise than for adequate consideration, in other words, gifts. Accordingly, where an individual makes direct or indirect gift of his separate property to the Hindu Undivided family of which he is a member or what he transfers his separate property to his family for less than its fair market value, the provision of section 64(2) will be attracted and the entire income from such separate property converted into HUF property will be included in the total income of the individual. Can a female member throw personal property into joint family hotchpot? A connected question here is that whether a female member can impress upon her personal property the character of joint family property. The right to blend is limited to coparceners and a female member of the joint family cannot blend her separate property (even if she is an absolute owner thereof) with the joint family property. To blend is to share along with others and not to surrender one’s interest in favour of others to the exclusion of oneself. A Hindu female cannot therefore “blend” because she, not being a coparcener, has no right to demand a share in the joint family property by asking for a partition. But she can always gift her absolute property to the family and then the property belongs to the family and the income arising out of the assets is to be taxed in the hands of the family. These principles emerge in the Supreme Court’s decision in Puspha Devi Vs. CIT (1977) 109 ITR 730. Business in the personal capacity of the Karta or member: Where the Karta or any member of a joint family carries on a business on his personal account, the income from any such business would constitute his personal income. It does not matter even if the business of the member and of the joint family is identical in nature and size. Now one important question arises. Suppose the capital for the individual’s business is borrowed from the funds of the family what will be the position? Consider the following example. Hence, students should carefully understand the following: (a) Where the funds of a HUF are invested in a company or a partnership firm, the dividends or share of profits are generally taxable as the income of the family. In such a case the fee, salary, commission or other remuneration received by the Karta, or any member of the family, in his capacity as director or partner would also be taxable as income of the family. The reasons for this treatment are as follows:  The income is earned by the detriment to the joint family funds.  It is earned with the aid of joint family funds. 361

 There is real and sufficient connection between the investment or the joint family funds and the income of remuneration earned. (b) However, where the income is earned by the karta or any other member of the family by the exercise of the personal skill the income should be assessed in their individual hands even if some detriment is caused to the family funds, say, by way of loan, guarantee etc. whose role is only secondary. Members of HUF and Partnership firms: A Hindu undivided family can become a partner in a firm. However, since it has no separate legal entity of its own, its Karta alone can be partner in the firm representing the family. The coparcenery has no place in the partnership. When the Karta of joint Hindu family enters into a partnership with strangers, the member of the family do not ipso facto become partners in that firm. They have no right to take part in its management or to sue for its dissolution. The creditors of the firm are entitled to proceed against the joint family assets including the shares of the non-partner coparceners for their debts. This is because under Hindu Law, the Karta has the right when carrying on business to pledge the credit of the joint family to the extent of its assets. The liability on the part of other members of the HUF arises by reason of their status as coparceners and not by reason of any contract of partnership by them. Partnership between Karta representing family and Coparcener: A Karta of a HUF representing the family on the one hand, and a member of that family in his individual capacity on the other, can enter into a valid partnership. An individual coparcener, while remaining joint, can possess, enjoy and utilize in any way he likes, property which is his individual property. Therefore, when he enters into partnership with the family he retains his share and interest in the property of the family while he simultaneously enjoys the benefit of his separate property and fruits of its investment. Salary paid to Karta for managing the family’s business: If remuneration is paid to the Karta of Hindu undivided family under a valid agreement which is bona fide and in the interest of and expedient for the business of the family and the payment is genuine and not excessive, such remuneration would be an expenditure laid out wholly and exclusively for the purpose of the business of the family and would be allowable as an expenditure. Salary paid to member: A Hindu undivided family can be allowed to deduct salaries paid to member of the family if the payment is made as a matter of commercial or business expediency, but the service rendered must be to the family. Gifts by HUF: A HUF as such is incapable of making a gift to any of its member. However the Karta of a HUF has power to gift out of joint family property for certain approved purposes. The gift should be reasonable. For example, a father may make a gift of the ancestral moveable properties of the joint family, of which he is the Karta, for the purpose of discharging duties prescribed by Hindu Law. The income of the joint family will stand reduced to the extent to the income arising out of the assets thus gifted out. 362

Gifts to HUF: Can an outsider make a gift to HUF? Under what circumstances will a gift made by an outsider be considered as a gift to the HUF? The answers to these questions are as follows:  If the HUF to which such a gift is made consists of only one coparcener, then the gifted property can be held by the members of the family only as tenants-in-common, i.e., the income arising out of such gifted property can be assessed as income in the hands of the Association of Persons (AOP).  If the HUF to which such a gift is made consists of minimum two coparceners, then the gifted property can be held by the members of the family as joint tenants and the income arising out of such gifted property can be assessed as income in the hands of the joint Hindu family. Section 56(2)(vi) provides that any sum of money received by a HUF from non-relatives on or after 1.4.2006 but before 1.10.2009 would be chargeable to income-tax under the head “Income from other sources”, if the aggregate value of such gifts exceed ₹50,000 during a year. Further, new clause (vii) has been inserted in section 56(2) w.e.f. 1.10.2009 to bring within its scope, in addition to any sum of money, the value of any property received without consideration or for inadequate consideration. 2.6.4 Association of Persons (AOP) The word ‘associate’ means, according to the Oxford Dictionary, ‘to join in common purpose or to join in an action’. Therefore, an AOP must be one in which two or more persons join in a common purpose or common action, and as the word occurs in section 2(31) of the Income Tax Act 1961, which imposes a tax on income, profits or gains, the association must be one the object of which is to produce income, profits or gains. For forming an ‘AOP’ the members of the association must join together for the purpose of producing an income. An ‘AOP’ can be formed only when two or more individuals voluntarily combine together for a certain purpose. Hence, volition on the part of the members of the association is an essential ingredient. Even a minor can join an ‘AOP’ if his lawful guardian gives his consent. In the case of receiving dividends from shares, where there is no question of any management, it is difficult to draw an inference that two or more shareholders function as an ‘AOP’ from the mere fact that they jointly own one or more shares, and jointly receive the dividends declared. Those circumstances do not by themselves go to show that they acted as an ‘AOP’. Taxation of AOP Sources of Income The term “Income” in the Income Tax Act connotes a periodical monetary return ‘coming in’ with some sort of regularity, or expected regularity, from definite sources. The definition of income Section 2(24) of the Income Tax Act 1961. under the Income Tax Act is inclusive in nature i.e. apart from the items listed in the definition, any receipt which satisfies the basic 363

condition of being income is also to be treated as income and charged to income tax accordingly. The Income Tax Act provides that for the purpose of charge of income tax and for computation of total income all income shall be classified under following sources of income. It includes profits or gains from business or profession including any benefit, amenity, perquisite obtained in the course of such business or profession. Salary income including any benefit, allowance, amenity or perquisite obtained in addition to or in lieu of salary. Dividend income, Winnings from lotteries, crossword puzzles, races, games, gambling or betting. Capital Gains on sale of capital assets. Amounts received under a Key Man Insurance Policy. Income of a person from each of these sources is calculated to find out the gross total income of the person. The total income from all the above heads of income is calculated in accordance with the provisions of the Income Tax Act as they stand on the first day of April of any assessment year. Permissible deductions are reduced and then income-tax payable is calculated at the prescribed rates. If income of a person is derived from various heads, the person is entitled to claim deduction permissible under respective head whether or not computation under each head results in taxable income. Since the term person also includes AOPs, they would also be subjected to taxation similarly with certain variations. Residential Status of AOPs Having established the source of income of the AOPs, the next step is to define the residential status. Income tax liability depends on the residential status of a person. AOPs can be either resident or non-resident. AOPs will be resident in India if control and management of their affairs are wholly or partly situated within India during the relevant previous year. If control and management of their affairs are situated wholly outside India, it will be non-resident in India Section 6(2) of the Income Tax Act gives the test of residence for an association of persons.. Indian income is always taxable in India in case of all tax payers, whether resident or non- resident. Foreign income is taxable in India in the case of AOPs. Assessment of AOPs An AOP is a separate assesse. First, the total income under the different heads i.e. income from house property, profits or gains of business or profession, capital gains, and income from other sources, ignoring the prescribed incomes exemptions. Thus, “gross total income” is obtained. From the gross total income, prescribed deductions In case of an AOP no deductions under section 80G, section 80GGA, section 80GGC, section 80HH, section 80HHA, section 80HHD, section 80-I, section 80-IA,80 I-B, 80I-C, 80I-D or section 80 I-E are allowed. Under Section 80A of the Income Tax Act of Chapter VI-A are made. The balance amount is the taxable income. Interest paid by the AOP to a member is not allowed as deduction from the income of the AOP. However, if an individual in a representative capacity has paid interest to the AOP then such interest shall not be disallowed as deduction. Any salary, bonus, commission or remuneration (by whatever name called), paid by the AOP to a member is not allowed as deduction from the income of the AOP. 364

The total income of the AOP is taxable, either at the rates applicable to an individual, or at the maximum marginal rate Maximum marginal rate includes the surcharge applicable in relation to the highest slab of income in case of an individual and as such surcharge is chargeable at the rate of 10% even if the total income of AOP does not exceed ₹10, 00,000or at a rate higher than maximum marginal rate. However when any member is charged at a higher rate than maximum marginal rate, the income shall be taxed at a higher rate. An AOP is assessed in two manners, firstly where shares of the members are indeterminate or unknown Section 167B(1) of the Income Tax Act and secondly, where shares of the members are determinate or known Section 167B(2) of the Income Tax Act Where shares of members are indeterminate or unknown The tax is charged on the total income of the AOP/BOI at the maximum marginal rate i.e. 30% plus surcharge @ 15% plus education cess @2% SHEC @1%, which is the rate of tax applicable in relation to the highest slab of income in the case where the individual share of the members of AOP in the whole or part of its income are indeterminate or unknown. However when any member is charged at a higher rate than maximum marginal rate, the income shall be taxed at a higher rate. In case where a foreign company is a member of AOP, the tax rate of the AOP would be 43.26% (40% plus surcharge 5% plus education cess 2% plus SHEC @ 1%). Long-term capital gain of AOP must be taxed at a special rate of 20% or 10% depending upon the case. Similarly, short-term capital gain is taxable at 15%. Where shares of the members are determinate or known The total income of an AOP wherein the shares of the members are determinate and known shall be computed as follows:  Any interest, salary, bonus or remuneration paid to any member of AOP shall be deducted from their total income. The balance income (either profit or loss) shall be apportioned to the members, to which salary, interest, etc. shall be added. This income shall be treated as member’s share in income of AOP.  The member’s share so ascertained shall be apportioned under various heads of income in the same manner as it is done for AOP.  Any interest paid by member on capital borrowings for investment purposes in AOP shall be deducted from member’s share while computing his income under the head profits and gains of business/profession.  The tax is chargeable on the total income of an AOP at the same rate as is applicable in the case of an individual. 365

The share of a member in the income of an AOP is treated in three different ways: Where the association or body is chargeable to tax at the maximum marginal rate or at a rate higher than the maximum marginal rate, the share of a member therein shall not be included in his total income at all[24]. Where the association or body is chargeable to tax at the normal rates applicable to individuals, etc. the share of a member therein shall be included in his total income, but a rebate shall be given on the same. Where no income tax is chargeable on the total income of the association or body, the share of a member therein shall be fully chargeable to tax as part of his total income and no rebate shall be given thereon. Thus, where an AOP/BOI is taxable at the normal rates applicable to individuals, etc, but has income below taxable limit so that no income tax is chargeable on the total income of the AOP/BOI, the share of a member in such association or body shall be fully taxable in his own assessment. In certain cases, income of a charitable/religious trust, which is not subject to exemption under section 11 or section 12, may be chargeable to tax as if it is the income of an AOP Section 164(2) of the Income Tax Act,1961. The income of the trust includes the following:  Income from property held under trust wholly for charitable or religious purposes.  Voluntary contributions without any direction that they shall form part of corpus of trust or  Income of trust or institution being profits and gains of business which is incidental to the attainment of the objectives of trust and separate books of account are maintained. Such income of the trust which is not exempt under section 11 should be assessed as the income of the AOPs. The AOPs are taxable at the same rate as applicable to an individual. However, if the whole or any part of the relevant income is not exempt under section 11 or 12 of the Income Tax Act, it should be charged at the maximum marginal rate. However, the maximum marginal rate of tax is not applicable in the following cases, and the income will be chargeable to tax as if it were income of an AOP Section 164(1) of the Income Tax Act,1961:- Where none of the beneficiaries has any other income chargeable to tax under the Income Tax Act and none of the beneficiaries is a beneficiary under any other trust or Where the relevant income or part of relevant income is receivable under a trust declared by any person by will and such trust is the only trust so declared by him or Where the trust is a non-testamentary trust created before March 1, 1970 for the exclusive benefit of relatives of the settler mainly dependent on him for their supporter maintenance or, where settler is a Hindu undivided family, for the exclusive benefit of its members so dependent upon it or 366

Where the trust is created on behalf of a provident fund, superannuation fund, gratuity fund, pension fund or any other fund created bona fide by a person carrying on a business or profession exclusively for the benefit of persons employed in such business or profession. In cases of (a), (b) and (c) supra, the relevant income is taxable in the hands of trustees as if it were the total income of an association of persons, while income falling under (d) supra is exempt from tax. A partnership firm may be assessed either as a partnership firm or as an association of persons (AOP). If the firm satisfies the conditions, it will be assessed as a partnership firm; otherwise it will be assessed as an AOP However, it is more beneficial to be assessed as a partnership firm than as an AOP, since a partnership firm can claim the following additional deductions which the AOP cannot claim:- Interest paid to partners, provided such interest is authorized by the partnership deed. Any salary, bonus, commission, or remuneration (by whatever name called) to a partner will be allowed as a deduction if it is paid to a working partner who is an individual. The remuneration paid to such a partner must be authorized by the partnership deed and the amount of remuneration must not exceed the given limits. Assessment of Wealth Tax when assets are held by certain AOPs Section 21AA of the Wealth Tax Act 1957 AOPs other than a company or a co-operative society or a society registered under the Society Registration Act, 1986 or any law corresponding to that act may be of two types: AOPs whose individual member’s share in income or assets or both in the said association are determinate or known: In this case wealth tax is levied upon and is included in the individual assessment of each member. AOPs whose individual member’s share in income or assets or both in the said association are indeterminate or unknown: In this case, wealth tax is levied upon and recoverable from such AOP in a similar way as it is levied upon an individual who is a citizen of India and resident in India. However, if such an AOP has been dissolved or the business of such AOP has been discontinued then assessment is made on the net wealth[29] of the AOP as if no such discontinuation or dissolution had taken place and all the provisions relating to levy ofpenalty or any other sum chargeable of the Wealth Tax Act would apply. 2.6.5. Cooperative Societies General Provisions: The expression “co-operative society” means a society registered under the Cooperative Societies Act, 1912 or under any other law for the time being in force in any State for the registration of co-operative societies [section 2(19)]. For purposes of taxation, it is treated as a separate assessable entity. The profits of any business of insurance carried on by a co- operative society are to be computed in accordance with the rules set out in the First Schedule to 367

the Act. Apart from this, the computation of income in the case of a co-operative society should also be made in the same way under each head of income as in the case of any other assessee. Entrance fees received by a co-operative society from its members is taxable as its income from business irrespective of the nature of the business carried on by the society as was held in Co- operative Central Bank vs. C.l.T. (1965). 57 I.T.R. 579. A member of a co-operative society to whom a building or a part thereof is allotted or leased under a house building scheme of the society must be deemed to be the owner of that building or part thereof under section 27(iii). Accordingly, the co-operative society is not liable to pay tax in respect of the income from the house property even though it may be the real owner according to official records and the tenant may have taken the building on lease. But where the tenant is not a member of the society or where the house is allotted to him otherwise than under a house building scheme of the society, the society will be liable to tax in respect of the income of the house property. Exemptions:  The income of a marketing society derived from the letting out of go down or warehouses for storage, processing or facilitating the marketing of commodities is totally exempt from tax under section 10(29).  Section 80P provides certain exemptions to co-operative societies. However, the exemption is not available to co-operative banks, other than primary agricultural credit societies and primary co-operative agricultural and rural development banks. It may also be noted that the provisions of section 194A which require deduction of income-tax at source from interest other than interest on securities, credited or paid, where the aggregate payment in any financial year exceeds ₹5,000 do not apply to such income credited or paid –  by a co-operative society to a member thereof or to any other co-operative society;  in respect of deposits with a primary agricultural credit society or a primary credit society or a co-operative land mortgage bank or a co-operative land development bank;  in respect of deposits with a co-operative society, other than a co-operative society or bank engaged in carrying on the business of banking. 2.6.6. Trusts Computation of Total Income – Section 11 Computation of Total Income of Charitable Trust for AY 2020-21{Section 11(1)} Particulars Amount Amount Income (Revenue) 1. Voluntary Contributions (Donations) – other than anonymous donations (a) Donations with a specific direction that they shall form part Exempt of the corpus of the trust 368

(b) Donations – without such direction (i.e. general purpose xxx xxxx(A) donations) xxxx(B) 2. Income derived from property held under trust (i.e. from objects xxx xxxx of the trust) xxxx xxxx 3. Income from business incidental to the attainment of the xxx objectives of the trust Expenditures (Exemption) 1. Accumulation of income stated above for the purposes of trust xxx (maximum 15% of (A)) 2. Accumulation of income more than 15% xxx 3. Income actually applied for purposes of Trust xxx 4. Income deemed to be applied for purposes of trust (a) Money not received during the year xxx (b) Any other reason (e.g. money received in the month xxx xxx of March) (A) – (B) Add: 1. Accumulation of Income more than 15% of past years, taxable xxx now 2. Income deemed to be applied of past year(s), taxable now xxx 3. Anonymous donations xxx Total Income Notes: 1. “Donations with specific direction that they shall form part of the corpus of the trust” means that such amount received by the trust cannot be expended by the trust but trust has to accumulate the money, and money earned from such money shall be utilised for the purposes of the trust. 2. Trust can accumulate income more than 15% subject to certain conditions as follows {Section 11(2)}: (a) Such intention of accumulation shall be intimated to the AO on or before due date of ROI u/s 139(1) along with purposes of accumulation & period for which it is being accumulated (period of accumulation should not be more than 5 years). (b) Such amount, till the date it is being utilised for declared purposes, shall remain invested in prescribed forms/modes {Section 11(5)}. (c) In case of any violation of any of the conditions stated above, amount accumulated shall be treated as income of the trust for the year in which violation takes place. 369

3. Examples of income actually applied for purposes of the trust: revenue expenses, purchase of building, loan for higher studies, etc.If cost of any asset has been claimed as application of income, then depreciation on such asset cannot be claim again as application of income. 4. In case trust is not able to apply the money because of the reason that money has not been actually received by the trust during the year (e.g. PY 2018-19), then the same shall be deemed to be applied during the year (i.e. PY 2018-19) and accordingly exemption can be claimed in the RPY (i.e. PY 2018-19). In this case, such money shall be applied during the year (e.g. PY 2019-20) in which it is actually received or in the next year (i.e. PY 2019-20), otherwise same shall be treated as income of the PY next to the year in which it is received (i.e. PY 2019-20). 5. In case trust is not able to apply the money during the year (e.g. PY 2018-19) because of any other genuine reason, then the same shall be deemed to be applied during the year (i.e. PY 2018-19) and accordingly exemption can be claimed in the RPY (i.e. PY 2018-19). In this case, such money shall be applied during the next year (i.e. PY 2019-20), otherwise same shall be treated as income of such next PY (i.e. PY 2019-20). 6. “Anonymous donation” means any voluntary contribution, where a person receiving such contribution does not maintain a record of the identity indicating the name and address of the person making such contribution and such other particulars as may be prescribed. Anonymous donations may be with direction or without direction. {Section 115BBC} Anonymous donations to the extent of higher of the following are exempt: (a) 5% of total donations received (total of anonymous & other, total of with direction or without direction) (b) ₹1,00,000 Balance anonymous donations are taxable at flat rate of tax @ 30% and no adjustment can be made from such donations. Income excluding the anonymous donations (which are made taxable at the rate of 30%) shall be taxable at the tax rates applicable for an individual i.e. slab rates of ₹2,50,000. Concept of anonymous donations is applicable for charitable trusts and not for religious trusts. i.e. for religious trusts, anonymous donations shall be treated as manner similar to general purposes donations. 7. In following cases, no exemption u/s 11 shall be available to trust: (a) Income from the property held under a trust for private religious purposes (b) Charitable trust established for the benefit of any particular religious community Trust established for Scheduled Castes, backward classes, Scheduled Tribes or women and children shall not be called trust established for the benefit of any particular religious community. i.e. such trusts can enjoy benefit of exemption u/s 11. (c) Income of charitable or religious trust is applied for benefit of: 370

(i) Author/founder of the trust (ii) Donor making donations > ₹50,000 (iii) Member of HUF, if such author/founder/donor is a HUF (iv) Trustee/manager of the trust (v) Relative of abovesaid persons (relative has same definition as defined under provisions of gift u/s 56(2)(vii) including nephew & niece) (vi) Any organisation in which any person referred above has substantial interest. If educational or medical facilities are provided to such persons, then exemption shall not be withdrawn. In all the above 3 cases, income shall be taxable at maximum marginal rate (\"maximum marginal rate\" means the rate of income-tax (including surcharge on income-tax, if any) applicable in relation to the highest slab of income in the case of an individual i.e. 30% + 10%). Definition of Charitable Purpose – Section 2(15) “Charitable purpose” includes 1. relief of the poor, 2. education, 3. medical relief, 4. preservation of environment (including watersheds, forests and wildlife) and preservation of monuments or places or objects of artistic or historic interest, and 5. the advancement of any other object of general public utility. The advancement of any other object of general public utility shall not be a charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce or business and having receipts from such activities > ₹25,00,000 in the previous year. e.g. If along with “Dharamshala”, services of food is also provided, and receipts of the previous year exceeds ₹25,00,000, then, for that year, no exemption shall be provided. Similar condition is not applicable in case of first four charitable purposes. e.g. souvenirs of Taj Mahal are sold by the organisation looking after preservation of Taj Mahal. Even if receipts from sale of such souvenirs is more than ₹25,00,000, such organisation shall continue to enjoy exemption. Registration of Trust – Section 12A & 12AA 1. To claim exemption u/s 11, every trust shall get itself registered by making application to CIT (Commissioner of Income-tax). 2. Further, to claim exemption, trust shall get its accounts audited by a CA, in a case, where before claiming any exemption u/s 11, its total income exceeds ₹2,50,000. 3. On receipt of application for registration from trust, CIT may make enquiries, may call for further information or documents, and after satisfaction may pass an order: 371

(a) Registering the trust, or (b) Refusing to register the trust (in this case an opportunity of being heard must be provided to the assessee before refusing) Such order must be passed within 6 months from the end of the month in which such application was received by the CIT. In case CIT does not pass the order within above said 6 months period, then trust shall be deemed to be registered. Exemption u/s 11 to 13 is available to a trust from the year from which registration is effective i.e. prospective. Now exemption can also be claimed for the preceding years provided: (a) Assessment of such preceding year is pending with AO on the date of registration (b) The objects and activities of such trust remain the same for such preceding assessment year. 4. If later on CIT is satisfied that the activities of such trust (a) are not genuine or (b) are not being carried out in accordance with the objects of the trust or (c) Income from the property held under a trust for private religious purposes or (d) Charitable trust established for the benefit of any particular religious community or (e) Income of charitable or religious trust is applied for benefit of specified person he may cancel the registration of such trust after providing the assessee an opportunity of being heard. In any case, AO cannot withdraw the exemption on the ground that the objects of the trust are not genuine. 5. Trust registered u/s 12AA cannot claim any exemption u/s 10 except 10(1) {agricultural income}. Return of Income – Section 139(4A) If total income of the trust, before claiming any exemption u/s 11, exceeds ₹2,50,000, then trust is required to file return of income mandatorily on or before due date specified u/s 139(1). In such a situation due date of ROI shall be September 30th only, because under same conditions, audit is also mandatory. 2.6.7. Companies Companies residents in India are taxed on their worldwide income arising from all sources in accordance with the provisions of the Income Tax Act. Non-resident corporations are essentially taxed on the income earned from a business connection in India or from other Indian sources. A corporation is deemed to be resident in India if it is incorporated in India or if it’s control and management is situated entirely in India. 372

Domestic corporations are subject to tax at a basic rate of 35% and a 2.5% surcharge. Foreign corporations have a basic tax rate of 40% and a 2.5% surcharge. In addition, an education cess at the rate of 2% on the tax payable is also charged. Corporates are subject to wealth tax at the rate of 1%, if the net wealth exceeds ₹1.5 mn (appox. $ 33333). Domestic corporations have to pay dividend distribution tax at the rate of 12.5%, however, such dividends received are exempt in the hands of recipients. Corporations also have to pay for Minimum Alternative Tax at 7.5% (plus surcharge and education cess) of book profit as tax, if the tax payable as per regular tax provisions is less than 7.5% of its book profits. 2.6.8. Others General Principles of Mutuality 1. The first principle of mutuality is that no person can trade with himself or make income out of himself. A mutual association arises where persons forming a group associate together with a common object and contribute monies for achieving that object and divide the surplus amongst themselves in the character. The cardinal requirement in the case of mutual association is that all the contributors to the common fund must be entitled to participate in the surplus and all the participators to the surplus must be contributors to the common fund. In other words, there must be complete identity between the contributors and the participators. 2. The participation in the surplus need not be immediate but it may assume the shape of a reduction in the future contribution or a division of the surplus on dissolution. 3. It does not make any difference whether the persons joining together form an association or incorporate a company because the fact of incorporation does not destroy the identity of the contributors and participators. 4. Where there is mutuality, the fact that some members alone take advantage of the mutual enterprise would not affect the mutual character of the association. 5. There is nothing in law which prohibits a mutual association from carrying on a trade so long as it is confined to its own members. 6. It is not necessary that the surplus should be returned to every member of the association pro rata. The identification between the contributors and the participators should be regarded as one whole and not in relation to each individual. 7. It is not necessary that all the activities of such an association should be mutual in character. There may be activities of a non-mutual character but the exemption from tax will apply to the surplus arising out of the mutual enterprise. 373

From the above principles we can conclude that one cannot trade with one self and earn taxable profits thereby. Hence if there is a mutual concern, ordinarily there should be no tax on the profits arising out of mutual operations. But the Income-tax Act, 1961 provides for assessment of the income of a mutual concern in the following circumstances:  Where the mutual concern is a mutual insurance society and the income is derived from the carrying on of any business of insurance.  Where the mutual concern is a trade, professional or similar association and the income in question is derived from specific service performed for its members. However, if mutual concern is a resident welfare association, sports club, etc. then income derived from specific services performed for its members is not taxable.  Income received from non-members. In the case of a mutual concern, if income is derived both from mutual activity as well as from non-mutual activity, the exemption applies only to the income from the mutual activity. The income attributable to the non-mutual activity will be liable to tax. (Sports Club of Gujarat Ltd. 1987 – Guj. HC) 374

ANALYSIS 1. Question ABC Club, a members’ club, registered as a society under Orissa State Societies Registration Act, derived surplus from the sale of refreshments, beverages, etc. and letting out rooms to its members. The club provided these facilities and amenities to its members as part of advantage attached to the membership. The club claims that the said surplus accruing to it is not income at all for the purpose of the Income-tax Act, 1961. Examine the validity of the claim made by the club. Would your answer be different, if the club was incorporated as a company or if some members alone took advantage of the facilities and amenities it provided? Answer ABC Club can claim that the surplus derived by it from the various facilities and amenities provided to its members does not constitute income on the basis of the principle of mutuality. The basic principle of mutuality is that no one can trade with himself and no one can make profit out of himself. The essence of mutuality is complete identity between the contributors and the participators. A mutual concern or association stands on this principle. ABC Club provided various facilities to its members as part of the usual privileges attached to the membership of the club and derived surplus from such activity. Such surplus cannot be called as income for the purpose of the Income-tax Act, 1961. The Supreme Court has, in CIT v. Bankipur Club Ltd. (1997) 226 ITR 97 and Chelmsford Club v. CIT (2000) 243 ITR 89, where the facts were similar, held that such surplus was not taxable as income on the principle of mutuality. The claim of ABC Club is, therefore, valid. The answer would be the same even if the club was incorporated as a company as the incorporation does not destroy the identity of the contributors and the participators. The answer would also not be different even if some members of the club alone took advantage of the facilities offered by it. In fact, the Supreme Court in the two decisions cited above, has observed that if there is complete identity between the contributors and the participators, it is immaterial what particular form the association takes and where the activity is mutual, the fact that, as regards certain activities, only certain members of the association take advantage of the facilities which it offers, does not affect the mutuality of the enterprise. 2. Would the interest earned on surplus funds of a club deposited with institutional members satisfy the principle of mutuality to escape taxability? Madras Gymkhana Club v. DCIT (2010) 328 ITR 348 (Mad.) The assessee-club providing facilities like gym, library, etc., to its members earned interest from fixed deposits which it had made by investment of its surplus funds with its corporate members. 375

The High Court held that interest earned from investment of surplus funds in the form of fixed deposits with institutional members does not satisfy the principle of mutuality and hence cannot be claimed as exempt on this ground. The interest earned is, therefore, taxable. 3. Assessee society having been formed for the mutual benefit of its members, income earned by it by way of interest and dividend by making investment of surplus fund which is wholly contributed by the members is governed by the principle of mutuality and is not taxable. (Canara Bank Golden Jubilee Staff Welfare Fund 2009 – Karn.) 4. Transfer fee and non-occupancy charges received from the members are not taxable on the principle of mutuality. (Mittal Court Premises Co-operative Society Ltd. 2009 – Bom.) 5. Assessee, a co-operative housing society, was formed for the development and construction of residential houses/flats for its members and to provide them necessary common amenities and facilities, and therefore, the principle of mutuality would apply to the income of the society, including the income from sale of shops. Principle of mutuality is attracted also to the interest derived from deposits made by the society out of contribution made by its members. (Talangang Co-operative Group Housing Society Ltd. 2010 – Del.) 6. When the income is exempt under the principle of mutuality, said income cannot be brought to tax under the provisions of section 115JB. (Delhi Gymkhana Club Ltd. 2010 – Delhi ITAT) 7. Money received by assessee co-operative society from its member / director and their relatives by way of deposits and sums repaid to them as part of its banking activities cannot be considered as “loan” or “deposit” so as to attract section 269SS or 269T, as the assessee is working on the concept of mutuality and its directors or members are not covered by the expression “any other person” occurring in section 269SS, more so when the assessing officer has accepted the genuineness of such deposits and the assessee was under bonafide belief the provisions of section 269SS and 269T are not applicable. (Citizen Co-operative Society Ltd. 2010 – Hyd.) 8. Can transfer fees received by a co-operative housing society from its incoming and outgoing members be exempt on the ground of principle of mutuality? Sind Co-operative Housing Society v. ITO (2009) 317 ITR 47 (Bom) On this issue, the High Court observed that under the bye-laws of the society, charging of transfer fees had no element of trading or commerciality. Both the incoming and outgoing members have to contribute to the common fund of the assessee. The amount paid was to be exclusively used for the benefit of the members as a class. The High Court, therefore, held that transfer fees received by a co-operative housing society, whether from outgoing or from incoming members, is not liable to tax on the ground of principle of mutuality since the predominant activity of such co-operative society is maintenance of property of the society and there is no taint of commerciality, trade or business. Further, section 28(iii), which provides that income derived by a trade, professional or similar association from specific services performed for its members shall be treated as business 376

income, can have no application since the co-operative housing society is not a trade or professional association. Insurance Business Section 2(24)(vii) “income” includes the profits and gains of any business of insurance carried on by a mutual insurance company or by a co-operative society, computed in accordance with section 44 or any surplus taken to be such profits and gains by virtue of provisions contained in the First Schedule. Section 44 - Insurance Business Notwithstanding anything to the contrary contained in the provisions of this Act relating to the computation of income chargeable under the head “Income from house property”, “Capital gains” or “Income from other sources”, or in section 199 (i.e. credit for tax deducted) or in sections 28 to 43B, the profits and gains of any business of insurance, including any such business carried on by a mutual insurance company or by a co-operative society, shall be computed in accordance with the rules contained in the First Schedule. Clubs The consensus of judicial opinion is that any surplus accruing to a members’ club from the subscriptions and charges for various conveniences paid by members is not income or profit at all, nor can a social club be deemed to trade as far as its dealings with its own members are concerned. The position would be the same even though the club may be incorporated as a company or registered as a society. But a club is taxable on the profit derived from subscriptions and charges paid by non- members and on the income derived from its capital assets. Where a club is an incorporated company carrying on business it may be taxable on the money received from its members as well as non- members in the course of its business. However, if the club is not a member’s club but is a proprietary club i.e. if the club is owned by an outsider and not by the members themselves, the proprietor would be taxable on the profits earned by running the club. The position would not in any way be affected by the fact that the proprietor is a limited company and some of the shareholders are members of the club. Co-operative Societies In the case of a co-operative society, the liability to tax depends upon whether (a) it is a mutual concern earning non-taxable surplus or (b) it is a non-mutual concern earning taxable profits. Exemption u/s 80P is available to cooperative societies. However, this benefit is not available to co-operative banks, other than primary agricultural credit societies and primary co-operative agricultural and rural development banks. The definition of income has been enlarged to include within its scope, the profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members. Therefore, the concept of mutuality no longer applies to a co-operative society carrying on any business of banking. 377

Section 2(24) (viia) “income” includes the profits and gains of any business of banking (including providing credit facilities) carried on by a co-operative society with its members. Profits and Gains of Business or Profession – Section 28(iii) The following income shall be chargeable to income-tax under the head “Profits and gains of business or profession”, -income derived by a trade, professional or similar association from specific services performed for its members. 378

ANALYSIS Section 28(iii) taxes the profit accruing only on specific services rendered by an association to its members. Any surplus arising to a mutual association in other way e.g. from entrance fees or members’ periodic subscriptions would be outside the scope of this clause and would be non-taxable on the general principles stated above. Special provision for deduction in the case of trade, professional or similar association – Section 44A (1) Notwithstanding anything to the contrary contained in this Act, where the amount received during a previous year by any trade, professional or similar association (other than an association or institution referred to in section 10(23A)) from its members, whether by way of subscription or otherwise (not being remuneration received for rendering any specific services to such members) falls short of the expenditure incurred by such association during that previous year (not being expenditure deductible in computing the income under any other provision of this Act and not being in the nature of capital expenditure) solely for the purposes of protection or advancement of the common interests of its members, the amount so fallen short (hereinafter referred to as deficiency) shall, subject to the provisions of this section, be allowed as a deduction in computing the income of the association assessable for the relevant assessment year under the head “Profits and gains of business or profession” and if there is no income assessable under that head or the deficiency allowable exceeds such income, the whole or the balance of the deficiency, as the case may be, shall be allowed as a deduction in computing the income of the association assessable for the relevant assessment year under any other head. (2) In computing the income of the association for the relevant assessment year under sub-section (1), effect shall first be given to any other provision of this Act under which any allowance or loss in respect of any earlier assessment year is carried forward and set off against the income for the relevant assessment year. (3) The amount of deficiency to be allowed as a deduction under this section shall in no case exceed one-half of the total income of the association as computed before making any allowance under this section. (4) This section applies only to that trade, professional or similar association the income of which or any part thereof is not distributed to its members except as grants to any association or institution affiliated to it. 379

ANALYSIS 1. Tax rate applicable to mutual concern shall be that of individual except where same is incorporated as company. 2. Deficiency = Amount received from members as subscription or otherwise less expenditure incurred for the purpose of protection or advancement of the common interests of its members (i.e. general expenditure on members). 3. In case there is surplus, same shall be exempt. 4. Deficiency shall be adjusted from income from specific services rendered to its members and balance, if any, shall be adjusted from other incomes of association. 5. Deficiency to be adjusted cannot exceed 50% of the total income of the association before reducing any such deficiency but after applying all other provisions of the Act. In case such deficiency (maximum 50% of total income) is not adjustable in current year, same cannot be carried forward to next year. 6. Section 10(23A) In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included - any income (other than income chargeable under the head “Income from house property” or any income received for rendering any specific services or income by way of interest or dividends derived from its investments) of an association or institution established in India having as its object the control, supervision, regulation or encouragement of the profession of law, medicine, accountancy, engineering or architecture or such other profession as the Central Government may specify in this behalf, from time to time, by notification in the Official Gazette: Provided that - (i) the association or institution applies its income, or accumulates it for application, solely to the objects for which it is established; and (ii) the association or institution is for the time being approved for the purpose of this clause by the Central Government by general or special order: Provided further that where the association or institution has been approved by the Central Government and subsequently that Government is satisfied that - (i) such association or institution has not applied or accumulated its income in accordance with the provisions contained in the first proviso; or (ii) the activities of the association or institution are not being carried out in accordance with all or any of the conditions subject to which such association or institution was approved,it may, at any time after giving a reasonable opportunity of showing cause against the proposed withdrawal to the concerned association or institution, by order, withdraw the approval and forward a copy of the order withdrawing the approval to such association or institution and to the Assessing Officer. 380

7. Question A is an association governed by the provisions of Section 44A of the Income-tax Act. The subscription receipts for the year ended 31st March, 2020 were ₹3,60,000. The expenditure in the normal course of its activities was ₹3,85,000. Its other income taxable under the Act works out to ₹1,75,000. On these facts, you are consulted as to how A’s taxable income will be determined for assessment year 2020-21. Answer U/s 44A, the income from subscriptions shall be set off against expenditure incurred solely for the protection or advancement of the interest of its members and if there is a deficiency it shall be first be set off against the association’s income under the head “Profits and gains of Business or Profession” and if there is still a deficiency it shall be set off against income under any other head. This section supersedes the other provisions of the Act. Income from subscription ₹ Less: Expenses incurred in the course of its activities 3,60,000 Balance deficiency 3,85,000 Less: Other income (-)25,000 Taxable income 1,75,000 1,50,000 There is a ceiling on the deduction admissible by way of deficiency being that it shall not exceed one-half of the income of the association. This ceiling has not been exceeded above (vide section 44A(3)). 381

Assessment of Local Authority General meaning: The expression “local authority” has been defined not by the Income-tax Act but by section 2(31) of the General Clauses Act. A local authority is a person under section 2(31) of the Income-tax Act and thus constitutes a separate unit of assessment. It is chargeable to tax on its total income in respect of the previous year, computed in accordance with and under the basic provisions of the Act, which apply to other taxable entities and for all purposes of the Act, this entity is included in the term’ person’. All municipal corporations, or councils, committees, panchayat boards, port trusts, district boards and other authorities legally entitled to or entrusted by the Central or State Government with the control and/or management of a municipal or local fund are covered by the expression ‘local authority’. Exemptions: Under section 10(20), the income of a local authority which is chargeable to tax under the heads ‘Income from house property,’ ‘Capital gains’ and ‘Income from other sources’ accruing or arising to it anywhere in or outside India and income from a trade or business carried on by it which accrues or arises to it from the supply of a commodity or service with its own jurisdiction or from the supply of water or electricity within or outside its own jurisdictional area are totally exempt from tax. In other words, a local authority is taxable only in respect of the income arising to it from any business carried on by it provided that such income arises from the supply of any commodity or service, not being water or electricity outside its jurisdictional area, i.e., territorial limits. A local authority is said to be resident at the place where the control and management of its affairs are situated and its residential status is governed by section 6(4). A local authority in India is always resident in India, except where the control and management of its affairs is exercised wholly from outside India. Tax rate: After total income, i.e., the income of a local authority chargeable to tax has been determined, the whole of it would attract tax at the rate applicable i.e., the one prescribed by the relevant Finance Act. There is no minimum amount exempt from tax in the case of a local authority: for income tax purposes, local authority is chargeable to tax on the whole of its income at 30%. 382

SECTION-III TAXATION OF VARIOUS andFINANCIAL PRODUCTS, TRANSACTIONS, TAX PLANNING STRATEGIES SUB-SECTIONS 3.1 Estate Planning Overview 3.2 Estate Planning Process 3.3 Methods of Estate Planning 3.4 Will 3.5 Powers of Attorney 383

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Sub-Section - 3.1 Tax Implications for Non-resident Indians (NRIs) 3.1.1. Exempt Income of Non-resident Indians (NRIs) The Act has provided a large number of concessions to foreigners on their income earned in India. Few of them are given below: 1. Interest income as follows, is wholly exempt [Section 10(4)] including income by way of premium on redemption of such securities and bonds. a) In the case of a non-resident, any income by way of interest on such securities or bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf, including income by way of premium on the redemption of such bonds; In the case of an individual, who is a person resident outside India, any income by way of interest on moneys standing to his credit in a NRE Account in any bank in India in accordance with the said Act and the rules made there under. b) Interest on National Savings Certificates (issued by the Central Government in the hands of non-resident Indian citizens u/s 10(4B). 2. Leave Travel Concession: The exemption in respect of value of leave travel concession and passage money presently available to citizens only, is extended to non-citizens also. It has also been provided that the exemption will be limited to the amount actually spent. The ceiling on the number of journeys for going to any place in India on leave and also on the amount of exemption per head is being provided in the rules on the lines of the ceilings in the case of Government servants. 3. Certain incomes of individuals not a citizen of India irrespective of their residential status – Section 10(6)(i) to (vi). 4. Remuneration for service on a foreign ship - Section 10(6)(viii). 5. Remuneration of foreign Government Employees for training - Section 10(6)(xi). 6. Specially low rate of income-tax on dividends other than dividends referred to in Section 115 O, royalties, interest from securities, fees for technical services in the case of foreign companies - Section 115A. 7. Tax paid by a Government or an Indian concern to a non-resident (not being a company) or a foreign company on any income derived pursuant to an agreement entered into by the Central Government with the Government of a foreign state or an international organization is also exempt from tax with effect from 1.4.1988. To be eligible for exemption the income should not constitute salary, royalty or fees for technical services and the tax should be payable to the Central Government under the terms pf the agreement or any other related agreement approved by the Central Government under the terms of the agreement or any other related agreement approved by the Central Government. 385

8. Section 10(15)(iid) provides that interest received by a non-resident Indian from such bonds as are notified by the Central Government or by any individual owning the bonds by virtue of being a nominee or survivor of such non-resident Indian or by an individual to whom the bonds have been gifted by the non- resident, will not be included in computing the total income of such individual. However, the bonds should have been purchased by a non-resident Indian in foreign exchange and the interest and principal received in respect of such bonds whether on their maturity or otherwise, is not allowable to be taken out of India. Also, even where the individual who is non- resident Indian in the previous year in which the bonds are acquired, becomes a resident in India in any subsequent year, the interest received from such bonds will continue to be exempt in the subsequent years as well. In the case of premature encashment of the bonds, the exemption shall stand withdrawn from the year of encashment. Special Provisions relating to certain Incomes of Non-resident Indian. 3.1.2. Special Provisions on Certain Transactions Special provisions relating to certain incomes of non-residents - Chapter XII A: This Chapter seeks to lay down a concessional method of taxation of certain specified income of non-residents. For this purpose, A non-resident Indian means a non-resident individual who may either be an Indian citizen or a person of Indian origin. A person shall be deemed to be Indian origin if he or either of his parents or any of his grand- parents was born in undivided India. ‘Foreign exchange asset’ means any ‘specified asset’ which the assessee has acquired, purchased with or subscribed to in convertible foreign exchange. Such ‘specified assets ‘are as follows:  shares in an Indian company.  debentures issued by an Indian company which is not a private company as defined in the Companies Act, 1956.  deposits with a non-private Indian company.  any specified securities of Central Government.  units of the Unit Trust of India.  such other assets as may be notified by the Central Government. 386

The income derived from such a foreign exchange asset is called investment income. “Investment income” means any income derived (other than dividends referred to in section 115-O) from a foreign exchange asset. “Long-term capital gains” means income chargeable under the head “Capital Gains “relating to a capital asset, being a foreign exchange asset which is not a short-term capital asset. Flat Rate for Investment Income and Long-term Capital Gains [Section 115E]: Where the total income of a non-resident Indian consists only of investment income and capital gains arising out of the transfer of long-term foreign exchange assets, tax payable by him shall be the aggregate of:  income-tax on investment income at the rate of 20%;  income-tax on long-term capital gains at the rate of 10%; and  income-tax on his other total income. Exemption on capital gains arising from transfer of long-term foreign exchange asset [Section 115F]: Where the non-resident Indian transfers the original foreign exchange asset and within a period of six months of such a transfer deposits or invests the whole or part of the net consideration in:  any specified asset or  any notified savings certificates referred to in section 10(4B) then,  the capital gains arising on such a transfer will be dealt with as follows : If the cost of the new asset, referred to in (a) or (b) above, is not less than the net consideration in respect of the original asset the whole of such capital gain shall be exempt. If such cost is less than the net consideration, the exemption will be limited to: Total capital gain * Cost of new asset /Net Consideration Note:  When the new asset consists of deposits, the cost means the amount of such deposits.  Net consideration means the full value of the consideration received or accruing as a result of the transfer as reduced by any expenditure incurred wholly and exclusively in connection with such transfer.  Where the new asset is transferred or converted (otherwise than by transfer) into money, within a period of three years from the date of its acquisition, the capital gain, exempted as above, shall be chargeable as long term capital gain of the previous year in which the new asset is transferred or converted. 387

Short Term Capital Gains 1. Referred to in section 111A @ 15% - No slab benefit is available 2. Other short term capital gains taxable at the normal applicable rates non-residents at normal rates applicable to an individual. Flat Rate of Tax on Winnings from Lotteries, Crossword Puzzles etc. [Section115BB]: Under section 115BB, gross winnings from lotteries, crossword puzzles, races including horse races (other than income from the activity of owning and maintaining racehorses), card games and other games of any sort or from gambling or betting of any nature whatsoever shall be chargeable to income-tax at a flat rate of 30% on the gross winnings. Tax on Non-resident Sportsmen or Sports Associations [Section 115BBA]: This section is applicable where the total income of an assessee,   being a sportsman (including an athlete), who is not a citizen of India and is a non-resident, Includes any income received or receivable by way of participation in any game or sport or advertisement or contribution of articles in relation to any game or sport in India in newspapers, magazines, journals   being a non-resident sports association or institution, includes any amount guaranteed to be paid or payable to such association or institution in relation to any game or sport played in India. The income-tax payable shall be the aggregate of -  The amount of income-tax calculated on the income referred to in clause (a) or clause (b) at the rate of 20%;  the amount of income-tax with which the assessee would have been chargeable had the total income of the assessee been reduced by the amount of income in clause (a) and (b) No deduction in respect of any expenditure or allowance shall be allowed under any provision of this Act in computing the income referred to in clause (a) or clause (b). Return Need not be Filed [Section 115G]: Where the total assessable income of the non-resident during the previous year consisted only of investment income and long-termcapital gains relating to foreign exchange assets and tax on such income has been deducted at source then he need not file a return of income under section 139(1). 388

Benefits Available Even after the Assessee becomes a Resident [Section115H]: Where a person, who is a non-resident Indian in any previous year, becomes assessable as resident in India in respect of the total income in any subsequent year, he may furnish a declaration along with such a return to the effect that the provisions of this chapter shall continue to apply to him in relation to the investment income derived fromany foreign exchange asset being debentures, deposits, securities of Central Government and such other notified assets. If he does so, then these provisions will continue to apply to him till such assets are transferred or otherwise converted into money. Option to the Assessee [Section 115-I]: A non-resident Indian may elect not to be governed by these provisions. For this purpose he has to declare in the return regarding his option not to be governed by these provisions. In such a case the total income and tax payable there on will be computed in accordance with the other provisions of this Act and consequently, the provisions of this chapter will not apply to such non-resident assessees. Special Concessions in the Case of Individuals not being Citizens of India: Although basically the law of income-tax is applicable alike to both citizens and noncitizens of India, and there is no difference in the general principles for computing the total income under the Income-tax Act, however, on a consideration of the peculiar circumstances in which a foreigner might come to or live in India, certain concessions and reliefs are granted to them. Shipping Business of Non-residents [Section 172]: For the assessment of freight earned in India by ships belonging to or chartered by a non- resident, a special mode of assessment is prescribed under the Act. Under this section, no vessel owned bya non-resident can leave any port in India, unless the port authorities grant a tax clearance certificate. Such a certificate shall not be granted unless the master of the vessel produces a certificate from the Income-tax Authorities showing that the taxes payable have been paid or satisfactory arrangements for their payment have been made. Where the non-resident owner has an agent in India from whom tax is recoverable on a regular assessment, the Assessing Officer in such cases, may grant a port clearance certificate, valid for one year on receipt of an application in his behalf. If the Assessing Officer is not satisfied that there is an agent in India who can be assessed on behalf of non-resident, he shall make a separate assessment in respect of the income of each vessel, before it leaves the port. In such cases, 7½% of the amount paid or payable in or out of India on account of carriage of passengers or goods to the owner or charterer, is deemed to be his income accruing in India in respect of the carriage. The income of the non-residents from shipping business must be computed under section 44B. 389

It is the responsibility of the master of the ship to prepare and furnish to the Assessing Officer return of the full amounts paid or payable to the owner or the charterer, on account of the carriage of goods or passengers. On receipt of such a return the Assessing Officer assesses the income and determines the amount of tax payable thereon, at the rates applicable to a company which has not made prescribed arrangement for the declaration and payment of dividends within India. This sum is payable by the master of the ship. The time limit for completing such assessments is 9 months from the end of the financial year in which the return under section 172(3) is furnished. However, in respect of returns filed on or before 1.4.2007, assessments are required to be completed on or before 31.12.2008. After the close of the previous year, it is permissible for a non-resident person on whom tax has been charged on an adhoc basis in respect of the income of a vessel to apply along with a return of his income that he may be assessed on the basis of the business income that actually arose to him in the previous year. On completion of the regular assessment the tax paid towards the adhoc assessment shall be adjusted against the amount due from the assessee and the excess or deficiency if any, shall be refunded to or recovered from the non-resident. Recovery of Tax in Respect of the Income of a Non-resident [Section 173]: In the case of the non-resident the tax on the income which is deemed under section (9)(l)(i)to accrue or arise in India and is taxable as such may be recovered - (i) by deduction of tax at source; or (ii) by an assessment on the non-resident directly or (iii) by an assessment on the non- resident’s agent in his representative capacity. Any arrears of such tax may also be recovered from any of the assets which may at any time come within India. But the arrears cannot be recovered by +`filing a suit in the foreign country where the non-resident principal resides since the Courts of one country have no authority to enforce the revenue laws of another. Generally the proceedings for the recovery of tax cannot be commenced after the expiry of one year from the last day of the financial year in which the demand is made. But section 231 specifically provides that this one year period of limitation does not apply to recovery of tax under this section from the non-residents’ assets in India. This section applies only where the income is covered by section (9)(1)(i); it cannot be made to apply for the recovery of taxes in respect of the income which is not deemed to accrue in India. 3.1.3. Double Taxation Relief Double taxation arises where various sovereign countries exercise their power to subject the same person to taxes of a similar character on the same income. This may happen when he is taxed on the basis of his personal status, i.e., his nationality, domicile or residence as well as on the basis of place where the income is earned or received. To avoid double taxation of the same income in two countries, the Central Government may enter into an agreement with the Government of any Country outside India: for the grant of relief in respect of income on which income-tax has been paid both under this Act and Income-tax Act in that country, or for the 390

avoidance of double taxation of income under this Act and under the corresponding law in force in that country. Income not Taxable in the hands of Non-Resident 1. Income accruing to the non-resident on the sale of plant and machinery on instalment basis is not taxable. 2. Foreign Agent of an Indian Exporter: He is not liable to income-tax in India for the commission remitted to him by Indian exporter because he operates in his own country and no part of his income arises in India. 3. Non-resident person purchasing goods in India: A non-resident will not be liable to tax in India on any income attributable to operations confined to purchase of goods in India for export even though the non-resident has an office or an agency in India for this purpose. 4. Sale by a non-resident to Indian customer: Where the contracts to sell are made outside India and the sales are made on principal to principal basis, a non-resident is not assessable if he extends credit facilities. In cases where the non-resident has an agent in India but he sells directly to Indian customers, he will not be assessable notwithstanding that he pays an over-riding commission on all sales in India. 391

Sub-Section - 3.2 Tax Implications – Various Avenues and Techniques 3.2.1. Need and Importance of Tax Planning Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. Need and Importance of Tax Planning Tax Planning is needed for following reasons: Reduction of tax liability. (i) Minimization of litigation. (ii) Productive investment. (iii) Healthy growth of economy. (iv) Economic stability. (i) Reduction of tax liability: One of the supreme objectives of tax planning is the reduction of the tax liability of the taxpayer and the resultant saving of the earnings for a better enjoyment of the fruits of the hard labour. By proper tax planning, a taxpayer can oblige the administrators of the taxation laws to keep their hands off from his earnings. (ii) Minimization of litigation: Where a proper tax planning is resorted to by the taxpayer inconformity with the provisions of the taxation laws, the chances of unscrupulous litigation are Certainly to be minimized and the tax-payer may be saved from the hardships and inconveniences caused by the unnecessary litigations which more often than not even knock the doors of the supreme judiciary. 392

(iii) Productive investment: The planning is a measure of awareness of the taxpayer to the intricacies of the taxation laws and it is the economic consciousness of the income earner to find out the ways and means of productive investment of the earnings which would go a long way to minimize his tax burden. The taxation laws offer large avenues for the productive investment of the earnings granting absolute or substantial relief from taxation. A taxpayer has to be constantly aware of such legal avenues as are designed to open floodgates of his well-being, prosperity and happiness. When earnings are invested in the avenues recognized by law, they are not only relieved of the brunt of taxation but they are also converted into means of further earnings. (iv) Healthy growth of economy: The saving of earnings is the only basement upon which the economic structure of human life is founded. A saving of earnings by legally sanctioned devices is the prime factor for the healthy growth of the economy of a nation and its people. An income saved and wealth accumulated in violation of law are the scours on the economy of the people. Generation of black money darkens the horizons of national economy and leads the nation to avoidable economic destruction. In the suffocating atmosphere of black money, a nation sinks with its people. But tax planning is the generator of a superbly white economy where the nation awakens in the atmosphere of peace and prosperity, a phenomenon undreamt of otherwise. (v) Economic stability: Under tax planning, taxes legally due are paid without any headache either to the taxpayer or to the tax collector. Avenues of productive investments are largely availed of by the taxpayers. Productive investments increase contours of the national economy embracing in itself the economic prosperity of not only the taxpayers but also of those who earn the income not chargeable to tax. The planning thereby creates economic stability of the nation and its people by even distribution of economic resources. 3.2.2. Tax Planning vs. Tax evasion and Avoidance Tax Evasion Unscrupulous citizens evade their tax liability by dishonest means. Some of which are: (i) Concealment of income; (ii) Inflation of expenses to suppress income; (iii Falsification of accounts; (iv) Conscious violation of rules. 393

These devices are unethical and have to be condemned. The courts also do not favour such unethical means. Evasion, once proved, not only attracts heavy penalties but may also lead to prosecution. Such an evader of tax is not a good citizen and tax evasion as a means to reduce tax liability cannot be advocated by any one. Tax Avoidance Tax avoidance is minimizing the incidence of tax by adjusting the affairs in such amanner that although it is within the four comers of the taxation laws but the advantage is taken by finding out loopholes in the laws. The shortest definition of tax avoidance is that it is the art of dodging tax without breaking the law. In the case of tax avoidance, the tax payer apparently circumvents the law, without giving rise to a criminal offence, by the use of a scheme, arrangement or device, often of a complex nature but where the main purpose is to defer, reduce or completely avoid the tax payable under the law. The evil consequences of tax avoidance are manifold and may be summarized as under: Substantial loss of much needed public revenue, particularly in a welfare State like ours. a) Serious disturbance caused to the economy of the country by piling up of mountains of black money directly causing inflation. b) Large hidden loss to the community by some of the best brains in the country being involved in the perpetual war waged between tax avoider and his expert team of advisers, lawyers and accountants on one side, and the Tax Officer and his perhaps not so skillful advisers on the other side. c) Sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it. d) Ethics (or lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of artful dodgers. Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. 394

Distinction Between Tax Planning, Tax Avoidance and Tax Evasion Tax planning, tax avoidance and tax evasion are three different approaches to the same objective viz., to reduce tax liability. However, they have different characteristics.  Tax planning is perfectly legal as the-object of tax reduction is achieved by making use of the beneficial provisions in the tax laws.  On the other hand, tax avoidance is also legal though technically satisfying the requirements of law.  Tax evasion is a method of evading tax liability by dishonest means like suppression, conscious violation of rules, inflation of expenses, etc. Tax planning imply compliance with the taxing provisions in such a manner that full advantage is taken of all exemptions, deductions, concessions, rebates and reliefs permissible under the Act so that the incidence of tax is the least. Tax planning, therefore, cannot be equated to tax evasion or tax avoidance. Tax planning may be regarded as a method of intelligent application of expert knowledge of planning corporate affairs with a view to securing consciously provided tax benefits on the basis of the national priorities in keeping with the interest of the State and the public. 'Tax avoidance' is when the tax payer apparently circumvents the law, without giving rise to a critical offence by the use of a scheme, arrangement or devise often of a complex nature whose sole purpose is to defer, reduce or completely avoid the tax payable under the law. In other words tax avoidance is a method of reducing incidence of tax by taking advantage of certain loopholes in tax laws. Tax evasion is a dubious way of attempting to solve tax problems by suppression of income, conscious violation of rules inflation of expenses, etc. Tax evasion, therefore, cannot be construed as tax planning because it amounts to breaking of law whereas tax planning is devised within the legal framework by availing of what the legislature intended. There is no dispute in accepting tax avoidance is different from tax planning but the subtle difference between tax avoidance and tax planning is often over looked. Thus, any legitimate step taken by an assessee towards maximizing tax benefits keeping in view the intention of law will not only help him but the society also. All those who do the tax planning, could help themselves in efficient and economic conduct of their business affairs without getting entangled in the controversy of tax avoidance or evasion. 395

3.2.3. Tax Planning vs. Tax Management Tax Planning Tax planning is the arrangement of financial activities in such a way that maximum tax benefits are enjoyed by making use of all beneficial provisions in the tax laws. It entitles the assessee to avail certain exemptions, deductions, rebates and relief, so as to minimize his tax liability. This is permitted and not frowned upon. Tax planning may be legitimate provided it is within the framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay taxes honestly without resorting to subterfuges. Tax Management Tax management refers to the compliance with the statutory provisions of law. While tax planning is optional, tax management is mandatory. It includes maintenance of accounts, filling of return, payment of taxes, deduction of tax at source, timely payment of, advance tax, etc. Poor tax management may lead to levy of interest, penalty, prosecution, etc. In some cases it may lead to heavy financial loss if proper compliance is not made, e.g. if a loss return is not filed in time it will result in a financial loss because such loss will not be allowed to be carried forward. Tax Planning v/s Tax Management 1. Tax planning a wider term and includes tax management. Tax management is narrower term and is the first step towards tax planning. 2. Tax planning emphasizes on minimization of tax burden. Tax management emphasizes on compliance of legal formalities for minimization of tax. 3. Every person may not require tax planning. Tax management is essential for every person. 4. Tax planning helps in decision making. Tax management helps in complying the conditions for effective decision making. 5. Tax planning helps to claim various benefits of tax. Tax management helps in complying the conditions for claiming tax benefits. 6. Tax planning involves comparison of various alternative before selecting the best one. Tax management involves maintenance of accounts in prescribed form, filing of return, payment of tax, etc. 396

7. Tax planning looks at future benefits. Tax management relates to past present and future. 3.2.4. Deferral of Tax Liability Investment earnings such as interest, dividends or capital gains that accumulate tax free until the investor withdraws and takes possession of them. The most common types of tax-deferred investments include those in individual retirement accounts (IRAs) and deferred annuities. By deferring taxes on the returns of an investment, the investor benefits in two ways. The first benefit is tax-free growth: instead of paying tax on the returns of an investment, tax is paid only at a later date, leaving the investment to grow unhindered. The second benefit of tax deferral is that investments are usually made when a person is earning higher income and is taxed at a higher tax rate. Withdrawals are made from an investment account when a person is earning little or no income and is taxed at a lower rate. 3.2.5. Maximizations of Exclusions and Credits As you manage your taxes with both the near and distant future in mind, one important, constant goal will be reducing your adjusted gross income (AGI), which equals your gross income (salary, investment earnings, etc.) after your allowable deductions and exemptions. Maximizing your deductions and exemptions, as well as taking advantage of any tax credits available to you, is a great way to start saving money on your next tax bill. Credits vs. Deductions First things first: How is a tax credit different from a tax deduction? A tax credit reduces your tax dollar for dollar—that is, a ₹1,000 tax credit actually saves you ₹1,000 in taxes. By comparison, a tax deduction reduces your taxable income, but it is only worth the percentage equal to your marginal tax bracket. For instance, if you are in the 25% marginal tax bracket, a ₹1,000 deduction saves you ₹250 in tax (.25 x ₹1,000), which is ₹750 less than the savings with a ₹1,000 tax credit. The higher your tax bracket, the more a deduction is worth, but a credit is always worth more than a dollar-equivalent deduction. Tax credits reduce your tax bill, but certain restrictions, such as income limits, may apply. The American Taxpayer Relief Act of 2012 (ATRA) enacted in January 2013 makes permanent or extends some credits for child-related tax relief. If you have dependent children, you may be eligible to claim the ₹1,000 child credit in 2013 for each child under the age of 17. Other family- related credits include the adoption credit and the dependent care tax credit. If you are funding a child’s education, you may be eligible for the American Opportunity Tax Credit (AOTC) through 2017, which is an enhanced, but temporary version of the Hope education tax credit. The AOTC provides a tax credit of 100% of the first ₹2,000 of qualified tuition and related expenses, and 25% of the next ₹2,500 per eligible student applicable to the first four years of post-secondary education. 397

All taxpayers may either claim a standard deduction or itemize deductions for personal expenses such as home mortgage interest. Income limits apply to taxpayers who itemize deductions. In general, a taxpayer claims an itemized deduction when the total of qualified deductible expenses exceeds the standard deduction or if the taxpayer does not qualify for the standard deduction. For tax year 2013, the standard deduction is ₹6,100 for single filers; ₹8,950 for heads of household; and ₹12,200 for married joint filers. How is a deduction different from an exemption? Personal and dependent exemptions are reductions in gross income in addition to the standard deduction or itemized deductions. Every taxpayer may claim a personal exemption for him or herself, unless he or she is claimed as a dependent on another taxpayer’s return. A married couple filing a joint return can claim two personal exemptions, one for each spouse. Even if one spouse has no income, that spouse is not considered the “dependent” of the other spouse for tax purposes. Exemptions will decrease for high-income taxpayers with AGIs above a certain phase-out threshold. Above-the-Line Deductions Retaining as much of your gross income as possible should be an ongoing objective, not something that happens only at tax time. Above-the-line deductions, if you qualify, reduce your adjusted gross income. They are so named because they are taken on your tax form just above the line where you enter your AGI. Possible deductions include contributions to qualified retirement accounts, student loan interest, alimony, early withdrawal penalties, and certain moving expenses. Long-Term Capital Gains and Dividends As an investor, planning your tax strategy can have a significant impact on your tax liabilities, particularly since the passing into law of ATRA. For investors in the top four income tax brackets, the long-term capital gains rate has been raised from 15% to 20% in 2013. That top rate applies to the extent that a taxpayer’s income exceeds the thresholds set for the 39.6% rate ( ₹400,000 for married joint filers and ₹425,000 for heads of household). All other taxpayers will have a capital gains and dividends tax at a maximum rate of 15%; however a 0% will apply to the extent income drops below the top of the 15% income tax bracket: ₹72,500 for joint filers and ₹36,250 for single filers in 2013. To prepare an effective tax strategy, advance planning is key. The sooner you begin, the greater your savings opportunities will be. Be sure to consult your tax professional to create strategies that are right for your unique circumstances. 3.2.6. Managing Loss Limitations If you make a loss when you sell or dispose of an asset, you may be able to deduct it from capital gains you have made. You may be able to deduct it from gains made in the same year or future years. You can deduct some losses from your income instead. The losses must meet certain conditions and you must claim them within a time limit. 398

3.2.7. Deductible Expenditures of Individuals and Business Forms Deducting Business Expenses Business expenses are the cost of carrying on a trade or business. These expenses are usually deductible if the business is operated to make a profit. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary. It is important to separate business expenses from the following expenses:  The expenses used to figure the cost of goods sold,  Capital Expenses, and  Personal Expenses. Cost of Goods Sold If your business manufactures products or purchases them for resale, you generally must value inventory at the beginning and end of each tax year to determine your cost of goods sold. Some of your expenses may be included in figuring the cost of goods sold. Cost of goods sold is deducted from your gross receipts to figure your gross profit for the year. If you include an expense in the cost of goods sold, you cannot deduct it again as a business expense. The following are types of expenses that go into figuring the cost of goods sold.  The cost of products or raw materials, including freight  Storage  Direct labour costs (including contributions to pensions or annuity plans) for workers who produce the products  Factory overhead Under the uniform capitalization rules, you must capitalize the direct costs and part of the indirect costs for certain production or resale activities. Indirect costs include rent, interest, taxes, storage and purchasing, processing, repackaging, handling, and administrative costs. This rule does not apply to personal property you acquire for resale if your average annual gross receipts (or those of your predecessor) for the preceding 3 tax years are not more than $10 million. 399

Capital Expenses You must capitalize, rather than deduct, some costs. These costs are a part of your investment in your business and are called capital expenses. Capital expenses are considered assets in your business. There are, in general, three types of costs you capitalize.  Business start-up cost  Business assets  Improvements Personal Versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part. For example, if you borrow money and use 70% of it for business and the other 30% for a family vacation, you can deduct 70% of the interest as a business expense. The remaining 30% is personal interest and is not deductible. Business Use of Your Home If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Business Use of Your Car If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. Other Types of Business Expenses  Employees' Pay - You can generally deduct the pay you give your employees for the services they perform for your business.   Retirement Plans - Retirement plans are savings plans that offer you tax advantages to set aside money for your own, and your employees' retirement.   Rent Expense - Rent is any amount you pay for the use of property you do not own. In general, you can deduct rent as an expense only if the rent is for property you use in your trade or business. If you have or will receive equity in or title to the property, the rent is not deductible.   Interest - Business interest expense is an amount charged for the use of money you borrowed for business activities. 400