Final Course

Study Material
(Modules 1 to 4)

Paper 4
Direct Tax Laws &
International Taxation
[Direct Tax Laws as amended by the Finance Act, 2025]
Assessment Year 2026-27

Module – 2
(Relevant for May 2026, September 2026
and January 2027 examinations)

BOARD OF STUDIES (ACADEMIC)

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

© The Institute of Chartered Accountants of India

 This Study Material has been prepared by the faculty of the Board of Studies (Academic). The
objective of the Study Material is to provide teaching material to the students to enable them to
obtain knowledge in the subject. In case students need any clarification or have any suggestion for
further improvement of the material contained herein, they may write to the Joint Director, Board of
Studies (Academic).
All care has been taken to provide interpretations and discussions in a manner useful for the
students. However, the Study Material has not been specifically discussed by the Council of the
Institute or any of its committees and the views expressed herein may not be taken to necessarily
represent the views of the Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this material.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or
transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without prior permission, in writing, from the publisher.

Edition : September, 2025

Author : CA. (Dr.) Rashmi Goel

Committee/Department : Board of Studies (Academic)

E-mail : bosnoida@[Link]

Website : [Link]

Price : ` /- (For All Modules)

ISBN No. :

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The Institute of Chartered Accountants of India,
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Printed by :

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 iii

CONTENTS

MODULE – 1
Chapter 1 : Basic Concepts
Chapter 2 : Incomes which do not form part of Total Income
Chapter 3 : Profits and Gains of Business or Profession
Chapter 4 : Capital Gains
Chapter 5 : Income from Other Sources
Chapter 6 : Income of Other Persons included in assessee’s Total Income
Chapter 7 : Aggregation of income, set-off or carry forward of Losses
Chapter 8 : Deductions from Gross Total Income

MODULE – 2
Chapter 9 : Assessment of Various Entities
Chapter 10: Assessment of Trusts and Institutions, Political Parties and Other Special Entities

Chapter 11 : Tax Planning, Tax Avoidance & Tax Evasion

Chapter 12 : Taxation of Digital Transactions

MODULE – 3
Chapter 13 : Deduction, Collection and Recovery of tax
Chapter 14 : Income-tax Authorities

Chapter 15 : Assessment Procedure

Chapter 16 : Appeals and Revision
Chapter 17 : Dispute Resolution

Chapter 18 : Miscellaneous Provisions

Chapter 19 : Provisions to Counteract Unethical Tax Practices
Chapter 20 : Tax Audit and Ethical Compliances

© The Institute of Chartered Accountants of India

 [Link] iv

MODULE – 4
Chapter 21 : Non-resident Taxation
Chapter 22 : Double Taxation Relief
Chapter 23 : Advance Rulings

Chapter 24 : Transfer Pricing

Chapter 25 : Fundamentals of BEPS
Chapter 26 : Application and Interpretation of Tax Treaties

Chapter 27 : Overview of Model Tax Conventions

Chapter 28 : Latest Developments in International Taxation

© The Institute of Chartered Accountants of India

 v

DETAILED CONTENTS : MODULE - 2

CHAPTER 9 – ASSESSMENT OF VARIOUS ENTITITES

Learning Outcomes................................................................................................................. 9.1

Contents:

9.1 Taxation of Companies ................................................................................................ 9.3

9.2 Taxation of other entities ............................................................................................ 9.66
9.3 Liability of successor to business in respect of tax

chargeable from the predecessor [Section 170] ........................................................ 9.134

9.4 Tax planning considerations in relation to business .................................................. 9.135
9.5 Other provisions related to various entities ............................................................... 9.156

Significant Select Cases ..................................................................................................... 9.162

Test Your Knowledge .......................................................................................................... 9.170

CHAPTER 10 – ASSESSMENT OF TRUSTS AND INSTITUTIONS,

POLITICAL PARTIES AND OTHER SPECIAL ENTITIES

Learning Outcomes............................................................................................................... 10.1

Contents:
10.1 Introduction .............................................................................................................. 10.2
10.2 Charitable or Religious Trusts and Institutions ............................................................ 10.6
10.3 Taxation of Discretionary Trusts ............................................................................... 10.80
10.4 Special Provisions relating to income of Political Parties [Section 13A] ...................... 10.84

10.5 Special Provisions relating to voluntary contributions received

by Electoral Trusts [Section 13B] .............................................................................. 10.87

10.6 Taxation regime for Securitization Trusts and its investors ........................................ 10.92
10.7 Scheme for taxation of Real Estate Investment Trust (REIT) and
Infrastructure Investment Trust (Invit) [Chapter XII-FA – Section 115UA] ................... 10.94

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 [Link] vi

10.8 Special taxation regime for Investment Funds and income received from
such funds [Chapter XII-FB] [Sections 115UB, 10(23FBA) & 10(23FBB)] ................. 10.107
Significant Select Cases ................................................................................................... 10.114
Test Your Knowledge ........................................................................................................ 10.119

CHAPTER 11 – TAX PLANNING, TAX AVOIDANCE AND TAX EVASION

Learning Outcomes ................................................................................................................ 11.1

Contents:
11.1 Tax planning, Tax avoidance and tax evasion - An Overview ...................................... 11.2
11.2 General Anti-avoidance Rules .................................................................................. 11.14

Test Your Knowledge .......................................................................................................... 11.35

CHAPTER 12 – TAXATION OF DIGITAL TRANSACTIONS

Learning Outcomes ................................................................................................................ 12.1

Contents:
12.1 Introduction ............................................................................................................... 12.2

12.2 What is e-commerce? ................................................................................................ 12.3

12.3 Conduct of business in digital economy ...................................................................... 12.4
12.4 Taxation issues relating to digital economy ................................................................. 12.8
12.5 OECD recommendations under Action Plan 1 of the BEPS Project ............................. 12.8
12.6 Taxation of Virtual Digital Assets .............................................................................. 12.10
Test Your Knowledge .......................................................................................................... 12.21

© The Institute of Chartered Accountants of India

CHAPTER a
9
7
ASSESSMENT OF VARIOUS
ENTITIES

LEARNING OUTCOMES
After studying this chapter, you would be able to -
❑ compute the total income of a company applying general provisions vis-à-vis special tax
regimes under section 115BAA or 115BAB and determine the optimum tax liability;
❑ advise the company whether or not to opt for the special tax regime under section 115BAA;
❑ examine whether alternate minimum tax (AMT) would be applied in the case of persons other
than companies; and compute AMT and determine AMT credit to be carried forward;
❑ compute the total income of a firm and its tax liability; and determine the liability of partners
of a firm and LLP on dissolution;
❑ compute total income and tax liability of a co-operative society applying general provisions
vis-à-vis special tax regimes under section 115BAD or 115BAE and determine the optimum
tax liability;
❑ advise the co-operative society whether or not to opt for the special tax regime under section
115BAD;
❑ compute the total income of an individual, HUF, AOPs/BoIs as per the default regime under
section 115BAC vis-à-vis normal provisions of the Income-tax Act, 1961 and determine the
optimum tax liability;
❑ examine the incidence of taxation on mutual concerns.
 9.2 DIRECT TAX LAWS

CHAPTER OVERVIEW

Taxation of companies
- Total income and tax liability
as per normal provisions of Special provisions Alternate Minimum Tax
Act including MAT relating to shipping for persons other than
companies companies
- Total income and tax liability
as per concessional tax
regimes under section
115BAA or 115BAB, as the
case may be
Taxation of other entites
- Default Regime u/s
Taxation of Co-operative 115BAC
Taxation of firms/LLPs Societies (including
and their partners concessional tax regimes - Taxation of Individuals
u/s 115BAE or 115BAD) - Taxation of HUF
- Taxation of AOPs/BOIs
and their members

Tax planning
Taxation of Mutual Taxation of Local
considerations in relation
Concerns Authority
to business

Taxation of life insurance Tax on income from Tax on income from

business GDR transfer of carbon credits
 a
ASSESSMENT OF VARIOUS ENTITIES 9.3

9.1 TAXATION OF COMPANIES

(1) Meaning of ‘Company’ for purposes of income-tax
Under the Income-tax Act, 1961, the term “Company” has a much wider meaning than what has
been given to it under the Companies Act. The company is considered as a ‘person’ for all purposes
of assessment proceedings [Section 2(31)(iii)].
Section 2(17) of the Income-tax Act, 1961 defines a company for income-tax purposes. Accordingly,
‘company’ means –
(i) any Indian company as defined in section 2(26); or
(ii) any body corporate incorporated by or under the laws of a country outside India, i.e., any
foreign company; or
(iii) any institution, association or body which is/was assessable or was assessed as a company
for any assessment year under the Indian Income-tax Act, 1922 or for any assessment year
commencing on or before 1.4.1970 under the present Act; or
(iv) any institution, association, or body, whether incorporated or not and whether Indian or non-
Indian, which is declared by a general or special order of the CBDT to be a company.
Such institution, association etc. shall be deemed to be a company only for such assessment year(s)
as may be specified in the CBDT’s order.

(2) Classes of Companies

 Domestic and Foreign Company: Companies can be classified into two categories, viz. (1)
Domestic company and (2) Foreign company.
(1) Domestic company means
- an Indian company or
- any other company, which, in respect of its income liable to tax, has made the
prescribed arrangements for the declaration and payment of the dividends
(including dividends on preferential shares) within India, payable out of such
income [Section 2(22A)].
Indian Company [Section 2(26)] - A company has to satisfy the following two
conditions so that it can be regarded as an Indian company –
 9.4 DIRECT TAX LAWS

(a) the company should have been formed and registered under Companies Act,
19561
(b) the registered office or the principal office of the company should be in India.
The expression ‘Indian Company’ also includes the following provided their registered
or principal office is in India:
(i) Company formed and registered under any law in force in any part of India,
excluding Jammu and Kashmir and specific Union territories;
(ii) Corporation established by or under a Central, State, or Provincial Act, such as
Financial Corporation or State Road Transport Corporation;
(iii) Institution, association, or body declared by the Board to be a company under
section 2(17)(iv);

(iv) Company formed and registered under any law in force in Jammu and Kashmir;
(v) Company formed and registered under any law in force in Union territories like
Dadra and Nagar Haveli, Daman and Diu, Pondicherry, or the State of Goa.

Prescribed arrangements for the declaration and payment of dividends within

India [Rule 27]: The arrangements referred to in sections 194 and 236 to be made by
a company for declaration and payment of dividends (including dividends on
preference shares) within India are as follows:
(i) The share register of the company concerned for all its shareholders shall be
maintained regularly at its principal place of business within India in respect of
any assessment year from a date not later than 1st April of such year.
(ii) The general meeting for passing the accounts of the previous year relevant to
the assessment year and for declaring any dividends in respect thereof shall be
held only at a place within India.
(iii) The dividends declared, if any, shall be payable only within India to all the
shareholders.
It is obligatory for Indian companies to make the prescribed arrangements stated above;
non-Indian companies will be treated as domestic companies only if they make the
prescribed arrangements for the declaration and payment of dividends in India.

1The Companies Act, 2013

 a
ASSESSMENT OF VARIOUS ENTITIES 9.5

(2) Foreign Company: A company which is not a domestic company is a foreign company
[Section 2(23A)].
Classes of companies

Domestic Company Foreign company

Company which made arrangement for declaring A company which is

Indian
& paying within India, dividend out of the income not a domestic
company
chargeable to tax in India. company

 Closely held and widely held Company: Domestic companies are again divided into broad
groups, viz
(1) companies in which public are substantially interested - ‘Widely-held companies’
(2) companies in which public are not substantially interested - ‘Closely held companies’
Widely Held Company (Company in which public are substantially interested): A
company is considered to have substantial public interest if it meets any of the following
criteria as outlined in section 2(18) of the Income-tax Act, 1961:
(i) Government or RBI Ownership or participation: A company owned by the Central
or State Government or the Reserve Bank of India (RBI), or where at least 40% of
the shares are held (whether singly or taken together) by the Government or the RBI
or a corporation owned by the RBI.
(ii) Company registered under section 25 of the Companies Act, 1956 3 : A company
registered under section 25 of the Companies Act, 1956 2, which is formed to promote
commerce, art, science, education, research, social welfare, charity, environmental
protection, etc., and does not distribute dividends to their members.
(iii) Companies with No Share Capital and declared by the CBDT: A company which
does not have share capital and is declared by the CBDT to be a company in which
the public are substantially interested for specified assessment years.

(iv) Mutual Benefit Finance Company (Nidhi or Mutual Benefit Society): A company
that primarily accept deposits from its members and is declared by the Central
Government under Section 620A of the Companies Act, 1956, to be a Nidhi or Mutual
Benefit Society.

2 Section 8 of the Companies Act, 2013

 9.6 DIRECT TAX LAWS

(v) Cooperative Society ownership: A company whose equity shares carrying at least
50% of the voting power are unconditionally allotted or acquired and were beneficially
held by one or more cooperative societies throughout the relevant previous year.
(vi) Public Limited Company: A company which is not a private company as defined in
the Companies Act, 1956 3 and which fulfills any of the following conditions:
- its equity shares were listed in a recognized stock exchange in India as on the
last day of the relevant previous year; or
- its equity shares carrying at least 50% (40% in case of an Indian company in
ship construction business or in the manufacture or processing of goods or in
mining or in generation or distribution of electricity or any other form of power)
voting power have been unconditionally allotted to or acquired by and should
have been beneficially held throughout the relevant previous year by
(a) Government or
(b) a Statutory Corporation or

(c) a company in which public are substantially interested or

(d) any wholly owned subsidiary of company mentioned in (c).
Closely Held Company (Company in which public are not substantially interested):
Any company that does not meet the criteria for being classified as widely held company is
considered closely held company. Thus, all private limited companies will be treated as
companies in which public are not substantially interested.
Relevance of the above classification:
(1) The distinction between domestic and foreign companies is significant owing to, inter
alia, the rates of tax.
Domestic companies are taxed at
- 25% - where total turnover or gross receipt in the previous year 2023-24 does not
exceed ` 400 crore
- 30% - in any other case

Section 406 of the Companies Act, 2013 3

 a
ASSESSMENT OF VARIOUS ENTITIES 9.7

Foreign companies are taxed at 35%. However, in respect of specified royalties and
fees for technical services received from Government or an Indian concern in
pursuance of an agreement, approved by the Central Government, made by the
foreign company with the Government or Indian concern between 1.4.1961 and
31.3.1976 (in case of royalties) and between 1.3.1964 and 31.3.1976 (in case of FTS),
the rate of tax is 50%.
Surcharge
Surcharge@7% of the tax payable is leviable in the case of domestic companies and
@2% of tax payable in the case of foreign companies if the total income exceeds
` 1 crore but does not exceed ` 10 crore.
Surcharge@12% of the tax payable is leviable in the case of domestic companies and
@5% of tax payable in the case of foreign companies if the total income exceeds ` 10
crore.

Option available with domestic companies to opt for concessional rates of tax
Section 115BAA provides for concessional rate of tax @22% (plus surcharge@10%
and HEC@4%) for domestic companies, subject to certain conditions, like non-
availability of profit-linked deductions and investment-linked tax deduction under the
Act, non-availability of deduction for contribution to research and development,
additional depreciation etc. Domestic Companies have to exercise the option to be
governed by section 115BAA. Once the company exercises such an option under
section 115BAA in a year, it would continue to be governed by the special provision
u/s 115BAA thereafter and cannot opt for regular provisions in any subsequent year.
Section 115BAB provides for concessional rate of tax @15% (plus surcharge@10%
plus HEC@4%) to manufacturing or electricity generating domestic companies
set up and registered on or after 1.10.2019, and commences manufacturing or
generating electricity on or before 31.3.2024, subject to certain conditions, like non-
availability of profit-linked deductions and investment-linked tax deduction under the
Act, non-availability of deduction for contribution to research and development,
additional depreciation etc. The option for section 115BAB could be exercised by the
domestic companies in the very first year in which the eligible company is set up,
failing which it cannot exercise such an option in the future years. Accordingly,
companies who have already opted for concessional tax under section 115BAB
will be governed by the provisions of section 115BAB and a fresh option cannot
 9.8 DIRECT TAX LAWS

be exercised under section 115BAB from A.Y. 2025-26 onwards. The company
who has exercised such an option under section 115BAB, it would continue to be
governed by the special provisions u/s 115BAB thereafter and cannot opt for regular
provisions in any subsequent year.
It may be noted that companies exercising options under section 115BAA or section
115BAB are not liable to minimum alternate tax under section 115JB.
These two sections, namely sections 115BAA and 115BAB have been detailed in the
upcoming paragraphs.

(2) The question as to whether a company is one in which public are substantially
interested or not is relevant for application of certain provisions which are applicable
only to closely held company.
There are certain special provisions which are applicable only to companies in which
public are not substantially interested. Examples of such special provisions are as
follows:
S. No. Section Provision
1 2(22)(e) Advance or loan by a closely held company - deemed
dividend
2 68 Taxation of sum received by closely held company as share
application money, share capital, share premium and the
explanation offered by company is not satisfactory
3 79 Carry forward and set-off of losses in case of closely held
companies
4 179 Liability of directors of private company

(3) 115BAB and 115BAA providing for concessional rate of tax in respect of certain
domestic companies
Sections 115BAB and 115BAA provide for concessional rates of tax and exemption from minimum
alternate tax (MAT) in respect of certain domestic companies. The provisions of these two new
sections are tabulated hereunder –
 a
ASSESSMENT OF VARIOUS ENTITIES 9.9

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
1. Applicability Domestic manufacturing Any domestic company
company/Electricity generation
company
2. Rate of tax 15% 22%
3. Rate of surcharge 10% 10%
4. Effective rate of tax 17.16% 25.168%
(including surcharge [Tax@15% (+) [Tax@22% (+)
& HEC) Surcharge@10% (+) Surcharge@10% (+)
HEC@4%] HEC@4%]
5. Applicability of MAT Not applicable Not applicable
6. Manner of computation of tax liability
Income on which The rate of tax (i.e., 17.16%) is The rate of tax (i.e.,
concessional rate of applicable in respect of income 25.168%) is notwithstanding
tax is applicable derived from or incidental to anything contained in the
manufacturing or production of Income-tax Act, 1961, but
an article or thing or generation subject to the provisions of
of electricity. Chapter XII, other than
[Read with point no. 11 below, section 115BA and 115BAB.
wherein the rate of 34.32%
(i.e., Tax@30% +
surcharge@10% + HEC@4%)
would be applicable in
specified circumstance]
Rate of tax on income Such income would be subject Such income would be
covered under to tax at the rates mentioned in subject to tax at the rates
Chapter XII [For the said sections in Chapter XII. mentioned in the said
example, long-term Surcharge@10% would be sections in Chapter XII.
capital gains chargeable levied on tax computed on such Surcharge@10% is leviable
to tax u/s 112 and 112A, income. HEC@4% would be on tax computed on such
short-term capital gains levied on the income-tax plus income. HEC@4% would be
chargeable to tax u/s surcharge. levied on the income-tax
111A] plus surcharge.
 9.10 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
Rate of tax on other The applicable tax rate is The applicable tax rate is
income in respect of 25.168% (i.e., tax@22%, plus 25.168% (i.e., tax@22%
which no specific surcharge @10% plus plus surcharge@10% plus
rate of tax is HEC@4%), if such income has HEC@4%).
provided in Chapter neither been derived from nor is There is, however, no
XII incidental to manufacturing or restriction regarding claim
production of an article or thing of any deduction or
or generating electricity (For allowance permissible
example, income from house under the relevant provisions
property and income from other of the Act.
sources).
In respect of such income, no
deduction or allowance in
respect of any expenditure or
allowance shall be allowed in
computing such income.
Rate of tax on STCG The applicable rate of tax is The applicable rate of tax is
derived from 25.168% (i.e., tax@22%, plus 25.168% i.e., tax @22%,
transfer of a capital surcharge@10% plus plus surcharge @10% plus
asset on which no HEC@4%). cess@4%.
depreciation is There is, however, no There is no restriction
allowable under the restriction regarding claiming of regarding claiming of
Act deduction or allowance in this deduction or allowance in
regard. this regard.
7. Conditions to be fulfilled for availing concessional rate of tax and exemption from
MAT
Conditions to be (i) The company should be No time limit specified. Both
fulfilled for availing set-up and registered existing companies and new
concessional rate of on or after 1.10.2019. companies can avail benefit.
tax and exemption (ii) It should commence Need not be a manufacturing
from MAT manufacturing or or a production company
production of an article
or thing or business of
generating electricity
on or before 31.3.2024.
(iii) It should not be formed No similar condition has
by splitting up or the been prescribed
reconstruction of a
business already in
existence (except in case
 a
ASSESSMENT OF VARIOUS ENTITIES 9.11

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
of a company, business of
which is formed as a
result of the re-
establishment,
reconstruction or revival
by the person of the
business of any
undertaking referred to in
section 33B in the
circumstances and within
the period specified
therein)
(iv) It does not use any No similar condition has
machinery or plant been prescribed
previously used for any
purpose [Refer Note at
the end]
(v) It does not use any No similar condition has
building previously used been prescribed
as a hotel or a convention
centre [meanings
assigned in section 80-
ID(6)] in respect of which
deduction u/s 80-ID has
been claimed and
allowed.
(vi) It should not be engaged No similar condition has
in any business other been prescribed
than the business of
manufacture or
production of any article
or thing and research in
relation to, or distribution
of, such article or thing
manufactured or
produced by it.
Note – Business of
manufacture or
production of any article
or thing does not include
business of –
 9.12 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
(1) Development of
computer software
in any form or in
any media
(2) Mining
(3) Conversion of
marble blocks or
similar items into
slabs
(4) Bottling of gas into
cylinder
(5) Printing of books
or production of
cinematograph
films
(6) Any other business
as may be notified
by the Central
Govt. in this
behalf.
Note - If difficulty arises
regarding fulfilment of
conditions listed in (iv) to (vi)
above, the CBDT may, with the
approval of the Central
Government, issue guidelines
for the purpose of removing
difficulty and to promote
manufacturing or production of
article or thing using new plant
and machinery.
Every guideline issued by the
CBDT has to be laid before
each House of Parliament, and
shall be binding on the person,
and the income-tax authorities
subordinate to it.
8. Common conditions In case of a company opting for either section 115BAA or
for both sections for 115BAB, the total income should be computed -
 a
ASSESSMENT OF VARIOUS ENTITIES 9.13

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
availing the (i) without providing for deduction under any of the following
concessional rate of sections:
tax and exemption
Section Provision
from MAT
10AA Exemption of profits and gains derived from
export of articles or things or from services
by an assessee, being an entrepreneur from
his Unit in SEZ.
32(1)(iia) Additional depreciation @20%, as the case
may be, of actual cost of new plant and
machinery acquired and installed by
manufacturing undertakings.
33AB Deduction@40% of profits and gains of
business of growing and manufacturing tea,
coffee or rubber in India, to the extent
deposited with NABARD in accordance with
scheme approved by the Tea/Coffee/Rubber
Board.
33ABA Deduction@20% of the profits of a business
of prospecting for, or extraction or production
of, petroleum or natural gas or both in India,
to the extent deposited with SBI in an
approved scheme or deposited in Site
Restoration Account.
35(1)(ii)/ Deduction for payment to any research
(iia)/(iii) association, company, university etc. for
undertaking scientific research or social
science or statistical research.
35(2AA) Deduction of payment to a National
Laboratory or University or IIT or approved
specified person for scientific research
35(2AB) Deduction of in-house scientific research
expenditure incurred by a company engaged
in the business of bio-technology or in the
business of manufacture or production of an
article or thing.
35AD Investment-linked tax deduction for specified
businesses.
 9.14 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
35CCC Deduction of expenditure incurred on notified
agricultural extension project
35CCD Deduction of expenditure incurred by a
company on notified skill development
project.
80C to Deductions from gross total income under
80U Chapter VI-A other than the provisions of
section 80JJAA or section 80M.
(ii) without set-off of any loss or allowance for unabsorbed
depreciation deemed so u/s 72A, where such loss or
depreciation is attributable to any of the deductions listed
in (i) above [Such loss and depreciation would be
deemed to have been already given effect to and no
further deduction for such loss shall be allowed for any
subsequent year]
(iii) by claiming depreciation u/s 32 determined in the
prescribed manner (i.e., in respect of depreciation of any
block of assets entitled to more than 40% shall be
restricted to 40% on the written down value of such block
of assets). However, additional depreciation u/s
32(1)(iia) cannot be claimed.
Note – Additional points relevant in the context of section
115BAA:
(1) In case of a company opting for section 115BAA, total
income should be computed without set-off of any loss
carried forward or depreciation from any earlier
assessment year, where such loss or depreciation is
attributable to any of the deductions listed in (i) above
[Such loss and depreciation would be deemed to have
been already given effect to and no further deduction for
such loss or depreciation shall be allowed for any
subsequent year]
(2) In the case of a person having a Unit in the IFSC, referred
to in section 80LA(1A), which has exercised option for
section 115BAA, deduction u/s 80LA would be allowed
subject to fulfilment of the conditions specified in that
section.
(3) Since there is no time line within which option under
section 115BAA can be exercised, a domestic company
 a
ASSESSMENT OF VARIOUS ENTITIES 9.15

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
having brought forward losses and depreciation on
account of deductions listed in (i) above may, if it so
desires, postpone exercise the option under section
115BAA to a later assessment year, after set off of the
losses and depreciation so accumulated.
9. Failure to satisfy On failure to satisfy the On failure to satisfy the
conditions conditions mentioned in point conditions mentioned in point
no. 7 and 8 above in any P.Y., no. 8 above in any P.Y., the
the option exercised would be option exercised would be
invalid in respect of the invalid in respect of the
assessment year relevant to that assessment year relevant to
previous year and subsequent that previous year and
assessment years; subsequent assessment
Consequently, the other years;
provisions of the Act would apply Consequently, the other
to the person as if the option had provisions of the Act would
not been exercised for the apply to the person as if the
assessment year relevant to that option had not been exercised
previous year and subsequent for the assessment year
assessment years. relevant to that previous year
Note – Where option exercised and subsequent assessment
under section 115BAB is years.
rendered invalid due to violation
of conditions stipulated in point
no.7 [(iv) to (vi)] above, such
person may exercise option
under section 115BAA.
10. Availability of set-off No brought forward MAT credit Brought forward MAT credit
of MAT credit cannot be set-off against
brought forward income u/s 115BAA.
from earlier years Note - If a company has b/f
MAT credit, it can first
exhaust the MAT credit, and
thereafter opt for section
115BAA in a subsequent
previous year.
11. Adjustments for If the Assessing Officer opines No such requirement to
transactions with that the course of business make any adjustment
persons having between the company and any
close connection other person having close
connection therewith is so
 9.16 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
arranged that the business
transacted between them
produces more than the ordinary
profits to the company, he is
empowered to take into account
the amount of profits as may be
reasonably deemed to have
been derived therefrom, while
computing profits and gains of
such company.
In case the arrangement
referred above involves a
specified domestic transaction
referred to in section 92BA,
then, the amount of profits from
such transaction would be
determined by considering the
arm’s length price (ALP).
The amount, being profits in
excess of the amount of the
profits determined by the
Assessing Officer, shall be
deemed to be the income of
the person.
The income-tax on the
income so deemed shall be
subject to tax @ 34.32% (i.e.,
tax @ 30% + surcharge @10%
+HEC @ 4%).
Note – The scope of “specified
domestic transaction” referred
to in section 92BA has been
expanded to include within its
ambit, any business transacted
between such persons with
close connection, where one
such person is a company
claiming benefit under section
115BAB.
12. Exercise of option The beneficial provisions of this The beneficial provisions of
by the company section would apply only if this section would apply if
 a
ASSESSMENT OF VARIOUS ENTITIES 9.17

(1) (2) (3) (4)

Particulars Section 115BAB Section 115BAA
within the option is exercised in the option is exercised in the
prescribed time prescribed manner on or before prescribed manner on or
the due date u/s 139(1) for before the due date u/s
furnishing the first of the 139(1) for furnishing the
returns of income for any return of income for any
previous year relevant to previous year relevant to
assessment year or any assessment year or any
subsequent assessment year. subsequent A.Y.
Such option, once exercised, Such option, once exercised,
would apply to subsequent would apply to subsequent
assessment years. assessment years.
Further, once the option has
been exercised for any previous Further, once the option has
year, it cannot be subsequently been exercised for any
withdrawn for the same or any previous year, it cannot be
other previous year. subsequently withdrawn
Notes – (1) The option has to for the same or any other
be exercised at the time of previous year.
furnishing the first of the Note – The option can be
returns of income for any exercised even in a later
previous year. Accordingly, year, but once exercised,
companies who have already cannot be withdrawn
opted for concessional tax subsequently.
under section 115BAB will be
governed by the provisions of
section 115BAB and a fresh Further, where the person
option cannot be exercised exercises option under
under section 115BAB from section 115BAA, the option
A.Y. 2025-26 onwards. under section 115BA may be
(2) In case of amalgamation, withdrawn.
the option exercised u/s
115BAB shall remain valid in
the case of the amalgamated
company only and if the
conditions mentioned in point
no. (7) and (8) are continued to
be satisfied by such company.

Note - For the purpose of point no.7(iv) in column (3) of the above table in relation to a company
exercising option under section 115BAB, any machinery or plant which was used outside India by
 9.18 DIRECT TAX LAWS

any other person shall not be regarded as machinery or plant previously used for any purpose, if all
the following conditions are fulfilled, namely:—
(a) such machinery or plant was not, at any time previous to the date of the installation, used in India;
(b) such machinery or plant is imported into India from any country outside India;
(c) no deduction on account of depreciation in respect of such machinery or plant has been
allowed or is allowable under the provisions of the Income-tax Act, 1961 in computing the
total income of any person for any period prior to the date of installation of the machinery or
plant by the person.

Further, where in the case of a person, any machinery or plant or any part thereof previously used
for any purpose is put to use by the company and the total value of the machinery or plant or part
so transferred does not exceed 20% of the total value of the machinery or plant used by the company,
then, the condition specified that the company does not use any machinery or plant previously used
for any purpose would be deemed to have been complied with.

(4) Minimum Alternate Tax on companies [Section 115JB]

(i) Applicability of MAT
As per section 115JB(1), in case of company (domestic or foreign), if the income-tax payable
on the total income computed under the Income-tax Act, 1961 is less than, 15% of its book
profit, such book profit shall be deemed to be the total income of the assessee and the tax
payable by the assessee on such total income shall be the amount of income -tax at the rate
of 15% (add surcharge, if applicable, i.e., 7% for domestic companies and 2% for foreign
companies, where the total income exceeds ` 1 crore but does not exceed ` 10 crore, and
12% for domestic companies and 5% for foreign companies where the total income exceeds
` 10 crore). Further, health and education cess @4% shall be added on the aggregate of
income-tax and surcharge.
(ii) Maintenance of statement of profit and loss [Section 115JB(2)]
(a) Every company other than a company referred to in section 115JB(2)(b) shall for the
purpose of this section, prepare its statement of profit and loss for the relevant
previous year in accordance with the provisions of Schedule III to the Companies Act,
2013 [Section 115JB(2)(a)].
(b) Insurance companies, banking companies, companies engaged in generation or
supply of electricity or any other class of company for which a form of financial
statement has been specified in or under the Act governing such class of company,
 a
ASSESSMENT OF VARIOUS ENTITIES 9.19

shall for the purposes of this section, prepare its statement of profit and loss for the
relevant previous year in accordance with the provisions of the Act governing such
company [Section 115JB(2)(b)].
(c) The section also specifies that the statement of profit and loss for the relevant previous
year has to be drawn in accordance with Schedule III to the Companies Act, 2013.
Further, while preparing the annual accounts-
(i) the accounting policies,
(ii) the accounting standards followed for preparing such accounts, including
statement of profit and loss
(iii) the method and rates for calculating depreciation
shall be the same as have been adopted for the purpose of preparing such accounts
including statement of profit and loss and laid before the company at its annual general
meeting.
(d) Where the financial year adopted by the company under the Companies Act, 2013 is
different from the previous year under the Income-tax Act, 1961, the accounting
policies, accounting standards and methods and rates adopted for calculating
depreciation shall correspond to the accounting policies followed for preparing such
accounts including statement of profit and loss for the financial year.
(iii) Computation of book profit [Explanation 1 to section 115JB(2)]
For computing the book profit, the profit shall be increased by the following amounts, if the
amount referred in (a) to (i) is debited to the statement of profit and loss
(a) Income-tax: Income-tax paid or payable, and the provision therefor;
[It may be noted that income-tax includes –
(1) interest;
(2) surcharge;
(3) health and education cess (Explanation 2 to section 115JB)].
(b) Amount carried to Reserves: Amount carried to any reserves, by whatever name called;

(c) Provisions: Amounts set aside to provisions for meeting liabilities other than
ascertained liabilities;
 9.20 DIRECT TAX LAWS

(d) Provisions for losses of subsidiary companies: Amount of provision for losses of
subsidiary companies;
(e) Dividends: Amount of dividends paid or proposed; or
(f) Expenditure relatable to exempt income: Amount of expenditure relatable to any
income to which section 10 or sections 11 or 12 apply;
(fa) Expenditure relatable to share of an assessee in the income of an AOP or BOI:
Amount of expenditure relatable to income, being share of the assessee in the income
of an AOPs or BOIs, on which no income-tax is payable in accordance with the
provisions of section 86;
(fb) Expenditure relatable to income accruing to foreign company: The amount or
amounts of expenditure relatable to income accruing or arising to an assessee, being
a foreign company, from –
(A) the capital gains arising on transactions in securities; or
(B) the interest, dividend, royalty, or fees for technical services chargeable to tax
at the rate or rates specified in Chapter XII i.e., section 115A
if the income-tax payable thereon in accordance with the provisions of the Act, other
than the provisions of this Chapter, is at a rate less than 15%;

(fc) Notional loss on the units of business trust: The amount representing-
- notional loss on transfer of a capital asset, being share of a special purpose
vehicle to a business trust in exchange of units allotted by that trust; or
- notional loss resulting from any change in carrying amount of said units or
- loss on transfer of such units
(fd) Amount of expenditure relatable to income referred under section 115BBF: The
amount or amounts of expenditure relatable to income by way of royalty in respect of
patent chargeable to tax under section 115BBF;
(g) Depreciation: The amount of depreciation;
(h) Deferred tax: The amount of deferred tax and provision therefore;
(i) Provision for diminution in the value of any asset: The amount set aside as
provision for diminution in the value of any asset.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.21

(j) Amount standing in the revaluation reserve: The profit shall also be increased by
the amount standing in revaluation reserve relating to the revalued asset on the
retirement or disposal of such asset, in case the same is not credited to the profit and
loss account.
(k) Amount of gain arise on transfer units of business trust: When units of business
trust are actually transferred, the amount of gain on such transfer has to be added to
compute the book profit, since notional gains on transfer of share of a special purpose
vehicle to a business trust in exchange for the units of the business trust and notional
gains resulting from change in carrying amount of such units would have been
deducted to compute book profit. The amount of gain on such transfer, if any, credited
to statement of profit and loss in the year of transfer will also be reduced.

In a case where the shares are carried at cost: The amount of gain has to be
computed by taking into consideration the cost of shares exchanged with the units of
the business trust.

In a case where the shares are carried at a value other than the cost through
statement of profit and loss: The carrying amount of shares at the time of exchange
would be taken into consideration for computing the amount of gain.

The profit shall be reduced by the following amounts:

(i) Amount withdrawn from any reserve: The amount withdrawn from any reserve or
provision, if any such amount is credited to the statement of profit and loss.
However, the amount withdrawn from reserves/provisions shall not be reduced from
the book profit unless the book profit of that year has been increased by those
reserves/ provisions;
(ii) Exempt income: Amount of income to which section 10 or sections 11 or 12 apply, if
such amount is credited to the statement of profit and loss;
(iia) Depreciation: The amount of depreciation debited to the statement of profit and loss
(excluding the claim of depreciation on account of revaluation of assets);
(iib) Amount withdrawn from the revaluation reserve: The amount withdrawn from the
revaluation reserve and credited to the statement of profit and loss, to the extent it
does not exceed the amount of depreciation on revaluation of assets;
(iic) Share of the assessee in the income of an AOPs or BOIs: The amount of income,
being the share of the assessee in the income of an AOPs or BOIs, on which no
 9.22 DIRECT TAX LAWS

income-tax is payable in accordance with the provisions of section 86, if any such
amount is credited to the statement of profit and loss;
(iid) Income accruing to foreign company: The amount of income accruing or arising to
an assessee, being a foreign company, from, -
(A) the capital gains arising on transactions in securities; or
(B) the interest, dividend, royalty, or fees for technical services chargeable to tax
at the rate or rates specified in Chapter XII i.e., section 115A,
if such income is credited to the statement of profit and loss and the income-tax payable
thereon in accordance with the provisions of the Income-tax Act, 1961 (including DTAAs),
other than the provisions of Chapter XII-B, is at a rate less than 15%.

For example, in case of foreign companies, dividend is taxable @20% as per section
115A. The adjustment in respect of dividend received by a foreign company on its
investment in India and expenditure relatable thereto is required to be made for the
purposes of calculation of book profit in case the tax payable on such dividend income
is less than 15% on account of concessional tax rate provided in the applicable Double
Taxation Avoidance Agreement (DTAA).
(iie) Notional gain on the units of business trust: The amount representing –

(A) the notional gain on transfer of a capital asset, being a share of a SPV to a
business trust in exchange of units allotted by the business trust;
(B) notional gain resulting from any change in carrying amount of said units;
(C) gain on transfer of such units,
if any, credited to statement of profit and loss;
(iif) Loss on transfer of units: The amount of loss on transfer of units acquired in
exchange of shares of SPV computed by taking into account the cost of the shares
exchanged with the units, where the shares are carried at cost. In case shares are
carried at a value other than cost through statement of profit and loss, the amount of
loss on transfer of such units has to be computed by taking into account the carrying
amount of the shares at the time of exchange;
(iig) Income by way of royalty taxable under section 115BBF: The amount of income
by way of royalty in respect of patent chargeable to tax under section 115BBF;
 a
ASSESSMENT OF VARIOUS ENTITIES 9.23

(iih) Brought forward loss and unabsorbed depreciation: Aggregate amount of

unabsorbed depreciation and loss brought forward in case of a –
(A) company, and its subsidiary and the subsidiary of such subsidiary, where, the
Tribunal, on an application moved by the Central Government under section
241 of the Companies Act, 2013 has suspended the Board of Directors of such
company and has appointed new directors who are nominated by the Central
Government under section 242 of the said Act;
(B) company against whom an application for corporate insolvency resolution
process has been admitted by the Adjudicating Authority under section 7 or
section 9 or section 10 of the Insolvency and Bankruptcy Code, 2016 .
It may be noted that loss does not include depreciation.

A company would be a subsidiary of another company if such other company holds

more than half in the nominal value of equity share capital of the company.
(iii) Brought forward loss or unabsorbed depreciation in case of other companies:
Amount of brought forward loss or unabsorbed depreciation, whichever is less, in case
of other companies as per books of account.
The loss shall not include depreciation; if either the figure of brought forward loss or
unabsorbed depreciation is “NIL”, no deduction will be allowed from the book profit of
the relevant year;
(vii) Profits of sick industrial company: The amount of profits of a sick industrial
company (BIFR company) commencing from the previous year in which the company
became sick and ending with the assessment year during which the entire net worth
of such company becomes equal to or exceeds the accumulated losses . For this
purpose, “net worth” shall have the same meaning as assigned under section 3(1)(ga)
of the Sick Industrial Companies (Special Provisions) Act, 1985.
(viii) Deferred tax: The amount of deferred tax, if any such amount is credited to the
statement of profit and loss.
(iv) Computation of Book Profit for Ind AS compliant companies:
The Central Government has notified the Indian Accounting Standards (Ind AS) which are
converged with International Financial Reporting Standards (IFRS) and prescribed the
Companies (Indian Accounting Standards) Rules, 2015 which lay down the roadmap for
implementation of these Ind AS.
 9.24 DIRECT TAX LAWS

As the book profit based on Ind AS compliant financial statements is likely to be different from
the book profit based on existing Indian GAAP, sub-sections (2A), (2B) and (2C) of section
115JB provides the framework for computation of book profit for Ind AS compliant companies
in the year of adoption and thereafter.

Adjustment in the book profit due to adoption of Ind AS

Annual Adjustment [Section 115JB Transitional adjustments at the

(2A) & (2B)] convergence date [Section 115JB(2C)]

I. MAT on Ind AS compliant financial statement [Section 115JB(2A)]

In case of a company whose financial statements are drawn up in compliance with the
Indian Accounting Standards (Ind ASs) specified in Annexure to the Companies
(Indian Accounting Standards) Rules, 2015, the following additional adjustments shall
be done to the book profit as computed above in point no. (iii) as per section 115JB(2)
read with Explanation 1 -
(a) increased by all amounts credited to other comprehensive income in the
statement of profit and loss under the head "Items that will not be re -classified
to profit or loss";
(b) decreased by all amounts debited to other comprehensive income in the
statement of profit and loss under the head "Items that will not be re -classified
to profit or loss";
However, no adjustment shall be made where the amount credited or debited to
other comprehensive income under the head "Items that will not be re -classified to
profit or loss", in respect of —
(i) Revaluation surplus for assets in accordance with the Indian Accounting
Standards 16 and Indian Accounting Standards 38; or
(ii) Gains or losses from investments in equity instruments designated at fair value
through other comprehensive income in accordance with the Indian Accounting
Standards 109. [First proviso to section 115JB(2A)]
However, the book profit of the previous year, in which such asset or investment is
retired, disposed, realised or otherwise transferred, shall be increased or decreased,
as the case may be, by the amount or the aggregate of the amounts as referred to
in the first proviso for the previous year or any of the preceding previous years and
relatable to such asset or investment [Second proviso to section 115JB(2A)].
 a
ASSESSMENT OF VARIOUS ENTITIES 9.25

The other comprehensive income (OCI) includes certain items that will permanently
be recorded in reserves and hence, never be reclassified to the statement of profit
and loss included in the computation of book profits. These items shall be included
in book profit for MAT purposes at the point of time as specified below-
Sl. No Items Point of time
1 Changes in revaluation To be included in book profits at the
surplus of Property, Plant or time of realization/ disposal/ retirement
Equipment (PPE) and or otherwise transferred
Intangible assets (Ind AS 16
and Ind AS 38)
2 Gains and losses from To be included in book profits at the
investments in equity time of realization/ disposal/ retirement
instruments designated at fair or otherwise transferred
value through other
comprehensive income (Ind
AS 109)
3 Remeasurements of defined To be included in book profits every
benefit plans (Ind AS 19) year as the re-measurements gains and
losses arise
4 Any other item To be included in book profits every
year as the gains and losses arise

(c) Increased by amounts or aggregate of the amounts debited to the statement of

profit and loss on distribution of non-cash assets to shareholders in a demerger
in accordance with Appendix A of the Indian Accounting Standards 10;
(d) Decreased by all amounts or aggregate of the amounts credited to the
statement of profit and loss on distribution of non-cash assets to shareholders
in a demerger in accordance with Appendix A of the Indian Accounting
Standards 10;

Appendix A of Ind AS 10 provides that any distributions of non-cash assets to

shareholders in a demerger shall be accounted for at fair value. The difference
between the carrying value of the assets and the fair value is recorded in the
statement of profit and loss.
Correspondingly, the reserves are debited at fair value to record the distribution
as a 'deemed dividend' to the shareholders. As there is a corresponding
adjustment in retained earnings, this difference arising on demerger shall be
excluded from the book profits.
 9.26 DIRECT TAX LAWS

II. In case of demerger [Sub-section (2B)]: In the case of a resulting company, the
property and the liabilities of the undertaking or undertakings being received by it are
recorded at values different from values appearing in the books of account of the
demerged company immediately before the demerger, any change in such value shall
be ignored for the purpose of computation of book profit of the resulting company
under this section.
III. MAT on first time adoption [Section 115JB(2C)]:
In case of Ind AS compliant company, the book profit of the year of convergence and
each of the following four previous years, shall be further increased or decreased, as
the case may be, by one-fifth of the transition amount.

In the first year of adoption of Ind AS, the companies would prepare Ind AS financial
statement for reporting year with a comparative financial statement for immediately
preceding year. As per Ind AS 101, a company would make all Ind AS adjustments on
the opening date of the comparative financial year. The entity is also required to
present an equity reconciliation between previous Indian GAAP and Ind AS amounts,
both on the opening date of preceding year as well as on the closing date of the
preceding year.
For the purposes of computation of book profits of the year of adoption and for
adjustments, the amounts adjusted as on the opening date of the first year of adoption
shall be considered.
Example: Companies which adopt IndAS with effect from 1 st April 2025 are required
to prepare their financial statements for the year 2025-26 as per the requirements of
Ind AS. Such companies are also required to prepare an opening balance sheet as o f
1st April 2024 and restate the financial statements for the comparative period 2024-25.
In such a case, the first-time adoption adjustments as of 31 March 2025 shall be
considered for computation of MAT liability for previous year 2025-26 (Assessment
year 2026-27) and thereafter.

Further, in this case, the five years period shall be previous years 2025-26, 2026-27,
2027-28, 2028-29 and 2029-30.

However, the book profit of the previous year in which the asset or investment referred
to in sub clauses (B) to (E) of clause (iii) of the Explanation is retired, disposed,
realised or otherwise transferred shall be increased or decreased, as the case may
 a
ASSESSMENT OF VARIOUS ENTITIES 9.27

be, by the amount or the aggregate of the amounts referred to in the said sub-clause
relatable to such asset or investment [First proviso to section 115JB(2C)].
Further, the book profit of the previous year in which the foreign operation referred to
in sub clause (F) of clause (iii) of the Explanation is disposed or otherwise transferred,
shall be increased or decreased, as the case may be, by the amount or the aggregate
of the amounts referred to in the said sub-clause relatable to such foreign operations
[Second proviso to sub-section (2C)].
Meaning of certain terms [Explanation to Section 115JB(2C)]
Clause Term Meaning
(i) Year of convergence the previous year within which the convergence
date falls.
(ii) Convergence date the first day of the first Indian Accounting
Standards reporting period as defined in the Ind
AS 101.
(iii) Transition amount the amount or aggregate of the amounts adjusted
in other equity (excluding capital reserve and
securities premium reserve) on convergence date
but not including the following:
(A) Amount or aggregate of the amounts
adjusted in the other comprehensive income
on the convergence date which shall be
subsequently re-classified to the profit and
loss;
(B) Revaluation surplus for assets in
accordance with the Indian Accounting
Standards 16 and Indian Accounting
Standards 38 adjusted on the convergence
date;
(C) Gains or losses from investments in equity
instruments designated at fair value through
other comprehensive income in accordance
with the Indian Accounting Standards 109
adjusted on the convergence date;
(D) Adjustments relating to items of property,
plant and equipment and intangible assets
recorded at fair value as deemed cost in
accordance with paragraphs D5 and D7 of
the Indian Accounting Standards 101 on the
convergence date;
9.28 DIRECT TAX LAWS

(E) Adjustments relating to investments in

subsidiaries, joint ventures and associates
recorded at fair value as deemed cost in
accordance with paragraph D15 of the
Indian Accounting Standards 101 on the
convergence date; and
(F) Adjustments relating to cumulative
translation differences of a foreign operation
in accordance with paragraph D13 of the
Indian Accounting Standards 101 on the
convergence date.
Transitional adjustments: Analysis
(i) The adjustments arising on account of transition to Ind AS from existing Indian
GAAP is required to be recorded directly in Other Equity at the date of
transition to Ind AS. These adjustments have to be made in the following
manner:
(a) The book profit of the year of convergence and the following four
previous years shall be increased or decreased with the transitional
adjustments recorded directly in Other Equity excluding capital reserve
and securities premium reserve and excluding the amounts referred in
(A) to (F) (in the definition of Transition Amount), on the convergence
date.
(b) Those adjustments recorded in other comprehensive income referred
in (A) above (in the definition of Transition Amount) and which would
subsequently be reclassified to the profit and loss, shall be included in
book profits in the year in which these are reclassified to the profit and
loss, therefore these amounts are excluded from the transition amount.
(c) Those adjustments recorded in other comprehensive income referred
in (B) and (C) (in the definition of Transition Amount) above and which
would never be subsequently reclassified to the profit and loss shall be
included in book profits as specified hereunder:
Sl. Items Point of time
No
1 Changes in revaluation To be included in book profits at
surplus of Property, Plant or the time of realisation/ disposal/
Equipment (PPE) and retirement or otherwise
Intangible assets (Ind AS transferred
16 and Ind AS 38)
2 Gains and losses from To be included in book profits at
investments in equity the time of realisation/ disposal/
instruments designated at retirement or otherwise
fair value through other transferred
 a
ASSESSMENT OF VARIOUS ENTITIES 9.29

comprehensive income
(Ind AS 109)
3 Remeasurements of To be included in book profits
defined benefit plans (Ind every year as the re-
AS 19) measurements gains and losses
arise
4 Any other item To be included in book profits
every year as the gains and
losses arise
(d) The other adjustments referred in (D), (E) and (F) (in the definition of
Transition Amount) above shall be made in the following manner:
(I) Property, Plant and Equipment (PPE) and intangible
assets at fair value as deemed cost [referred in (D)(in the
definition of Transition Amount) above]
An entity may use fair value in its opening Ind AS Balance
Sheet as deemed cost for an item of PPE or an intangible
asset as mentioned in paragraphs D5 and D7 of Ind AS 101.
In such cases the treatment shall be as under—
• The existing provisions for computation of book profits
under section 115JB of the Act provide that in case of
revaluation of assets, any impact on account of such
revaluation shall be ignored for the purposes of
computation of book profits. Further, the adjustments in
retained earnings on first time adoption with respect to
items of PPE and Intangible assets shall be ignored for the
purposes of computation of book profits.
• Depreciation shall be computed ignoring the amount of
aforesaid retained earnings adjustment.
Similarly, gain/loss on realization/ disposal/ retirement of such
assets shall be computed ignoring the aforesaid retained
earnings adjustment.
II. Investments in subsidiaries, joint ventures and
associates at fair value as deemed cost [referred in (E)(in
the definition of Transition Amount) above]
An entity may use fair value in its opening Ind AS Balance
Sheet as deemed cost for investment in a subsidiary, joint
venture or associate in its separate financial statements as
mentioned in paragraph D15 of Ind AS 101. In such cases
retained earnings adjustment shall be included in the book
profit at the time of realisation of such investment.
 9.30 DIRECT TAX LAWS

III. Cumulative translation differences [referred in (F) (in the

definition of Transition Amount) above]
• An entity may elect a choice whereby the cumulative
translation differences for all foreign operations are
deemed to be zero at the date of transition to Ind AS.
Further, the gain or loss on a subsequent disposal of any
foreign operation shall exclude translation differences that
arose before the date of transition to Ind AS and shall
include only the translation differences after the date of
transition.
• In such cases, to ensure that such Cumulative translation
differences on the date of transition which have been
transferred to retained earnings, are taken into account,
these shall be included in the book profits at the time of
disposal of foreign operations as mentioned in paragraph
48 of Ind AS 21.
(ii) All other adjustments to retained earnings (recorded as other equity) at the time
of transition (including for example, Decommissioning Liability, Asset retirement
obligations, Foreign exchange capitalisation/decapitalization, Borrowing costs
adjustments etc.) shall be included in book profits, equally over a period of five
years starting from the year of first time adoption of Ind AS.
(iii) Section 115JB of the Act already provides for adjustments on account of
deferred tax and its provision. Any deferred tax adjustments recorded in
Reserves and Surplus on account of transition to Ind AS shall also be ignored.

(v) Clarifications on computation of book profit for the purposes of levy of Minimum
Alternate Tax (MAT) under section 115JB of the Income-tax Act, 1961 for Ind AS
compliant companies [Circular No. 24/2017 4 dated 25.07.2017]
After amendment in section 115JB for computation of book profit for the purposes of levy of
Minimum Alternate Tax (MAT) for Indian Accounting Standards (Ind AS) compliant
companies, CBDT received representations from various stakeholders seeking clarifications
on certain issues arising therefrom.
Accordingly, the CBDT has vide this circular, clarified these issues by way of the following FAQs:
Question 1: The profit for the period may include Marked to market (MTM) gains/ losses on
account of fair value adjustments on various financial instruments recognised through profit
or loss (FVTPL). A situation may arise where the losses on account of fair value adju stments
could be added back in view of clause (i) of Explanation 1 to section 115JB(2) of the Act.

4The year in the FAQs have been modified considering that the transition to Ind AS is taking place in the
P.Y. 2025-26.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.31

Whether the losses on such instruments require any adjustment for computing book p rofits
for the purposes of MAT?
Answer: Since MTM gains recognised through profit or loss on FVTPL classified financial
instruments are included in book profits for MAT computation, it is clarified that MTM losses
on such instruments recognised through profit or loss shall not require any adjust ments as
provided under clause (i) of Explanation 1 to section 115JB(2) of the Act. However, in case
of provision for diminution/ impairment in value of assets other than FVTPL financial
instruments, the existing adjustment of clause (i) of Explanation 1 to section 115JB (2) of the
Act shall apply.
It is further clarified that for financial instruments where gains and losses are recognised through
Other Comprehensive income (OCI), the amended provisions of MAT shall continue to apply.
Question 2: For the purposes of section 115JB of the Act, what shall be the starting point for
computing Book profits for Ind AS compliant companies? Whether Profit before other
comprehensive income [Item number XIII in Part 2 (Statement of Profit and Loss) of Divisio n
II of Schedule III to the Companies Act 2013] or Total Comprehensive Income (including other
comprehensive income) [Item number XV in Part 2 (Statement of Profit and Loss) of Division
II of Schedule III to the Companies Act 2013] shall be the starting point?
Answer: Starting point for computing Book profits for Ind AS compliant companies shall be
Profit before other comprehensive income [Item number XIII in Part 2 (Statement of Profit
and Loss) of Division II of Schedule III to the Companies Act 2013].
Question 3: As per Explanation to Section 115JB(2C) of the Act, the convergence date is defined
as the first day of the first Indian Accounting standards reporting period as defined in Ind AS 101.
The Memorandum explaining the provisions of the Finance Bill 2017 mentions that the adjustment
as on the last day of the comparative period is to be considered. It may be clarified as to what
would be the appropriate manner for computation of transition amount on convergence date, 1st
April i.e., at the start of the day or at the end of the day?
Answer: In the first year of adoption of Ind AS, the companies would prepare Ind AS financial
statement for reporting year with a comparative financial statement for immediately preceding
year. As per Ind AS 101, a company would make all Ind AS adjustments on the opening date
of the comparative financial year. The entity is also required to present an equity
reconciliation between previous Indian GAAP and Ind AS amounts, both on the opening date
of preceding year as well as on the closing date of the preceding year. The amounts as on
start of the opening date of the first year of adoption should be considered for the purposes
of computation of transition amount.
 9.32 DIRECT TAX LAWS

For example, companies which adopt Ind AS with effect from 1st April 2025 are required to
prepare their financial statements for the year 2025-26 as per requirements of Ind AS. Such
companies are also required to prepare an opening balance sheet as of 1st April 20 24 and
restate the financial statements for the comparative period 2024-25. In such a case, the first
time adoption adjustments as of 31st March 2025 should be considered [i.e. the start of
business on 1st April 2025 (or, equivalently, close of business on 31st March 2025)] for
computation of MAT liability for previous year 2025-26 (Assessment year 2026-27) and
thereafter.
Question 4: As per Indian GAAP, proposed dividend was required to be recognized in the
financial statements for the year for which it pertained to even though these were declared in
the subsequent year. Section 115JB of the Act already provides for adjustments for dividend
for computation of book profit. As per Ind AS, the amount of proposed dividend is required to
be recognized in the year in which it has been declared rather than the year for which it pertains
to. Accordingly, on transition to Ind AS, the amount of proposed dividend for F.Y. 2024-25 which
was recognized in profit and loss account in F.Y. 2024-25 is required to be reversed and
credited to Retained Earnings. For the computation of MAT, whether these balances would form
part of the transition amount and thus be adjusted over a period of 5 years?
Answer: Adjustment of proposed dividend shall not form part of the transition amount.

Question 5: Under Ind AS, adjustments on the transition date may have a corresponding
impact on deferred taxes. Should the deferred taxes on such amounts be considered for the
purpose of transition amount?
Answer: Any deferred taxes adjustments recorded on the transition date shall be ignored for
the purpose of computing Transition Amount.
Question 6: As mentioned in Question No.1, clause (i) of Explanation 1 to Section 115JB(2)
of the Act provides for adjustments for computation of book profit for the amount or amounts
set aside as provision for diminution in the value of any asset. Convergence date adjustments
may include adjustment for Provision for Bad and Doubtful Debts (Expected Credit Loss
adjustment) at the time of transition. Whether these adjustments would form part of the
transition amount referred to in section 115JB(2C) of the Act?
Answer: Adjustments relating to provision for diminution in the value of any assets other than
the ones mentioned in Question Number 1 above, shall not be considered for the purpose of
computation of the Transition Amount. Therefore, adjustments relating to provis ion for
doubtful debts shall not be considered for the purpose of computation of the transition
amount.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.33

Question 7: Under Section 115JB of the Act, transition amount has been defined as the
amount or the aggregate of the amounts adjusted in the ‘Other Equity’ (excluding capital
reserve and securities premium reserve) on the convergence date. Whether changes in share
application money on reclassification to ‘Other Equity’ would form part of the Transition
Amount?
Answer: Share application money pending allotment which is reclassified to Other Equity on
transition date shall not be considered for the purpose of computing Transition Amount.
Question 8: Under Ind AS, Investments in preference share is considered to be a liability
and the corresponding dividend expense is debited to Profit and loss account as interest cost.
Should such interest expenses on preference shares be deducted for the purpose of M AT
computation?

Answer: For the purpose of computation of MAT, profit/Transition Amount shall be increased
by dividend/interest on preference share (including dividend distribution taxes) whether
presented as dividend or interest.

Question 9: How do we account for items such as equity component, if any, of financial
instruments like Non-Convertible debentures (NCDs), Interest free loan etc. included in other
equity as per Ind AS for the computation of transition amount under MAT?

Answer: Items such as equity component of financial instruments like NCD’s, Interest free
loan etc. would be included in the Transition Amount.

Question 10: Where revaluation/fair value adjustments have been made to items of Property,
Plant & Equipment (PPE) under Ind AS, as per section 115JB of the Act, the book profit of
the previous year in which the items of PPE are retired, disposed or realised shall be
increased or decreased, as the case may be, by the revaluation amount relatable to such
items of PPE. Whether the revaluation amount to be considered for adjustment should be the
gross amount of the revaluation or the amount after adjustment of the deprecia tion on the
revaluation amount?

Answer: The book profit of the previous year in which the items of PPE are retired, disposed,
realised or otherwise transferred shall be increased or decrease d, as the case may be, by
the revaluation amount after adjustment of the depreciation on the revaluation amount
relatable to such asset. This has been explained by an illustration as under:
 9.34 DIRECT TAX LAWS

Particulars Erstwhile Ind-AS Fair Value/

Indian (considering Revaluation
GAAP fair value/ Adjustments
revaluation and
adjustment corresponding
on PPE) depreciation
WDV/Deemed Cost as on 1 April 2023 100 1000 900
Depreciation @10% for F.Y. 2023-24 10 100 90
WDV as on 1 April 2024 90 900 810
Depreciation @10% for F.Y. 2024-25 9 90 81
WDV as on 1 April 2025 81 810 729*
Sale value as on 1 April 2025 900 900
Profit on sale credited to P&L 819 90
Adjustment for MAT - revaluation amount 0 729*
after adjustment of the depreciation
Profit on sale to be considered for 819 819
MAT

Question 11: How should adjustments for service concession arrangements be treated for
the purpose of computation of book profit under MAT?
Answer: Adjustments on account of Service Concession arrangements would be included in
the Transition Amount and also on an ongoing basis.
Question 12: Existing clause (iii) of explanation to section 115JB(2) of the Act provides for
deduction of lower of the amount of loss brought forward or unabsorbed depreciation as per
books of account for computation of book profits. In case where, on adjustment of tr ansition
amount, the losses as per books of account gets wiped off, whether deduction for the said
amount would be available for assessment year 2026-27 onwards?
Answer: For assessment year 2026-27, the deduction of lower of depreciation or losses shall
be allowed based on the position as on 31 st March 2025. For the subsequent periods, the
position as per books of account drawn as per Ind AS shall be considered for computing lower
of loss brought forward or unabsorbed depreciation.

Question 13: How Capital Reserves or Securities Premium existing as per old Indian GAAP
reclassified to Retained Earnings/ Other Reserves on Convergence dat e be treated for MAT
purpose.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.35

Answer: The Capital Reserves or Securities Premium existing as on the convergence date
as per the erstwhile Indian GAAP which are reclassified to Retained Earnings/ Other
Reserves under Ind AS and vice versa, shall not be considered for the purposes of Transition
Amount.
It is further clarified, that even after such reclassifications, the amount of revaluation reserve
shall continue to be considered as revaluation reserve for the purposes of computation of
book profit and shall also include transfer to any other reserves by whatever name called or
capitalised.
Question 14: Companies which follow accounting year other than March 2026 ending for
Companies Act purposes and are required to transition to Ind AS will have to prepare financial
statements for MAT purposes for F.Y. 2025-26 partly under Indian GAAP and partly under
Ind AS. How should such companies compute MAT on transition to Ind AS?
Answer: In view of second proviso to section 115JB(2) of the Act, companies will be required
to follow Indian GAAP for the pre-convergence period and Ind AS for the balance period.

For example, a Company following December ending will be required to prepare, accounts
for MAT purposes under Indian GAAP for 9 months upto December 2025 and under Ind AS
for 3 months thereafter. The transition amount will be calculated with reference to
1st January 2026.
(vi) Adjustment in tax payable on book profit u/s 115JB(1) on account of Advance Pricing
Agreement (APA) under section 92CC or secondary adjustment under section 92CE
[Section 115JB(2D)]: Where there is an increase in book profit of the previous year due to
inclusion of past year(s) income in books of account on account of
(1) an APA entered into by the assessee under section 92CC; or
(2) secondary adjustment, required to be made under section 92CE, and
the assessee makes an application to the Assessing Officer in this behalf, the Assessing
Officer shall recompute

- the book profit of the past year or years and

- tax payable, if any, by the assessee during the previous year under section 115JB(1),
in such manner as may be prescribed.
 9.36 DIRECT TAX LAWS

In such case, the provisions of section 154 [i.e., rectification of mistake apparent from record]
would apply; and the period of four years would be reckoned from the end of the financial
year in which the said application is received by the Assessing Officer.
Accordingly, Rule 10RB(1) has been inserted to provide that the tax payable by the assessee
company under section 115JB(1), for the previous year, shall be reduced by the following
amount:

(A-B) – (D-C)
A tax payable by the assessee company under section 115JB(1) on the book profit of
the previous year including the past income. However, where no tax is payable
under section 115JB(1) on book profit of that previous year including past income,
the value of A would be deemed to be zero.
B tax payable by the assessee company under section 115JB(1) on the book profit of
the previous year after reducing the book profit with the past income. However,
where no tax is payable under section 115JB(1) on the resultant figure, the value of
B would be deemed to be zero.
C Aggregate of tax payable by the assessee company under section 115JB(1) on the
book profit of those past year or years to which the past income belongs. However,
where no tax is payable under section 115JB(1) on the book profit of that year or
years, the tax payable for that year or years would be deemed to be zero.
D Aggregate of tax payable by the assessee company under section 115JB(1) on the
book profit of past year or years, referred to in item C, after increasing the book
profit with the relevant past income of such year or years. However, where no tax
is payable under section 115JB(1) on the amount so increased, the tax payable for
that year or years would be deemed to be zero.
It may be noted that if the value of (A-B)-(D-C) in the formula is negative, its value would
be deemed to be zero.
Meaning of Past income means the amount of income of past year or years
past income included in the book profit of the previous year on account of an APA
[Rule 10RB(2)] entered into by the assessee under section 92CC or on account of
secondary adjustment required to be made under section 92CE.
MAT credit to The tax credit allowed to the assessee under section 115JAA would
be reduced be reduced by the amount which is equal to the amount of reduction
[Rule 10RB(3)] that has been allowed under Rule 10RB(1).

The adjustment in the book profit shall be made only if the assessee has not utilised the credit
of tax paid in any subsequent assessment year under section 115JAA.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.37

The provisions of this sub-section have been inserted w.e.f. A.Y. 2021-22. However, these
provisions would also be applicable for the A.Y. 2020-21 or any earlier assessment year.
However, no interest shall be payable to such assessee on the refund arising on account of
re-computation of book profits of the previous year.
(vii) Compulsory filing of return of income and furnishing of report from Chartered
Accountant
The section also provides that every company to which this section applies shall furnish, a
report from a chartered accountant certifying that the book profit has been computed in
accordance with the provisions of this section, on or before the specified date referred to in
section 44AB (i.e., one month prior to the due date for filing return of income ) or in response
to a notice under section 142(1)(i), [Section 115JB(4)].
(viii) Allowability of carry forward of losses
In respect of the relevant previous year, the amounts determined under the provisions of
section 32(2) or section 72(1)(ii) or section 73 or section 74 or section 74A(3), shall be allowed
to be carried forward [Section 115JB(3)].
(ix) Applicability of other provisions of the Act
All other provisions of the Act shall apply to every assessee, being a company mentioned in
this section [Section 115JB(5)].
(x) Non-applicability of MAT [Section 115JB(5A)].
The provisions of MAT u/s 115JB shall not apply
- to any income accruing or arising to a company from life insurance business referred
to in section 115B.
- a company who has exercised the option under section 115BAA or section 115BAB.
(xi) Non-applicability of MAT in respect of certain foreign companies
Explanation 4 to section 115JB(2) with retrospective effect from 01.04.2001 provides for non-
applicability of levy of MAT under section 115JB in the following cases:
Existence of DTAA with the country of Additional condition to be
residence of the foreign company satisfied for non-applicability of
MAT
(i) The foreign company is a resident of a country It should not have a permanent
or a specified territory with which India has a establishment in India in accordance
DTAA under section 90(1) or the Central with the provisions of such
Government has adopted any agreement Agreement
between specified associations for double
taxation relief under section 90A(1)
 9.38 DIRECT TAX LAWS

(ii) The foreign company is a resident of a country It is not required to seek registration
with which India does not have an agreement under any law for the time being in
of the nature referred to in clause (i) above force relating to companies.

Explanation 4A to section 115JB has been inserted with retrospective effect from 01.04.2001
to clarify that MAT provisions shall not be applicable to an assessee, being a foreign
company, where its total income comprises solely of profits and gains from business referred
to in section 44B or section 44BB or section 44BBA or section 44BBB and such income has
been offered to tax at the presumptive rates specified in these sections.
(xii) Concessional rate of MAT for unit located in IFSC
In case of a company, being a unit located in International Financial Services Centre and
deriving its income solely in convertible foreign exchange, the minimum alternate tax shall be
chargeable at the rate of 9% instead of 15%. [Section 115JB(7)]
ILLUSTRATION 1
A domestic company, ABC Ltd., furnishes the following particulars in respect of Assessment
Year 2026-27 and seeks your opinion on the application of section 115JB. You are also
required to compute the total income and tax payable.
(1) Profits as per Statement of profit and loss as per the Companies ` 215 lakhs
Act, 2013
(2) Statement of Profit and Loss includes:
(a) Credits: Dividend income from Indian companies ` 20 lakhs
Excess realized on sale of land held as investment ` 30 lakhs
(b) Debits: Depreciation on straight line method basis ` 100 lakhs
Provision for loss of subsidiary company ` 60 lakhs
(3) Depreciation allowable as per the Income-tax Rules, 1962 ` 150 lakhs
(4) Short term capital gains on sale of land mentioned above as ` 40 lakhs
computed under Income-tax Act, 1961
(5) Losses brought forward as per books of account and as per Income-tax Act, 1961:
Business loss ` 50 lakhs
Unabsorbed depreciation ` 60 lakhs

You will have to deal with this issue assuming that ABC Ltd. is not required to comply with
the Indian Accounting Standards. Ignore the provisions of section 115BAA.
Note - The turnover of ABC Ltd. for the P.Y. 2023-24 was ` 390 crore.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.39

SOLUTION
In the case of a company, it has been provided that where tax @15% of book profit exceeds
tax on total income computed as per normal provisions, the book profit shall be deemed to
be the total income for tax purposes.
It is therefore necessary to compute total income as per Income-tax Act, 1961 as well as book
profits.
I. Computation of Total Income as per the normal provisions of the Income-tax Act,
1961
Particulars ` (in Lakhs)
Net profit as per statement of profit and loss 215
Add: Depreciation debited to statement of profit and loss 100
Provision for losses of subsidiary company 60 160
375
Less: Dividend income from Indian companies 20
Excess realized on sale of land (considered separately) 30
Depreciation allowable as per Income-tax Rules, 1962 150 200
Business Income 175
Less: Set-off of brought forward business loss 50
125
Capital gains (Short term capital gains) 40
Income from other sources (Dividend income chargeable to 20
tax in the hands of shareholders)
185
Less: Set-off of unabsorbed depreciation 60
Total Income as per Income-tax Act, 1961 125

II. Computation of book profit under section 115JB

Particulars (` in Lakhs)
Net profit as per statement of profit and loss 215
Add: Provision for loss of subsidiary 60
Depreciation as per books of account 100
375
 9.40 DIRECT TAX LAWS

Less: Depreciation as per books of account 100

Business loss which is less than unabsorbed 50 150
depreciation
“Book Profit” 225

III. Computation of tax payable under the normal provisions of the Income-tax
Act, 1961
Total income as per the Income-tax Act, 1961 is ` 125 lakhs,
Particulars `
Tax payable ` 125 lakhs @25% since the turnover of the company 31,25,000
for the previous year 2023-24 ≤ ` 400 crore.
Add: Surcharge @ 7% 2,18,750
33,43,750
Add: Health and education cess @4% 1,33,750
Total Tax payable 34,77,500

IV. Computation of Minimum Alternate Tax

Particulars `
Tax @ 15% of book profit of ` 225 lakhs 33,75,000
Add: Surcharge @ 7% 2,36,250
36,11,250
Add: Health and education cess@4% 1,44,450
Minimum Alternate Tax payable 37,55,700

Since 15% of book profit exceeds the tax payable as per normal provisions of the Income -tax
Act, 1961, the book profit of ` 225 lakhs would be deemed to be the total income and the tax
payable on such total income shall be 15% thereof i.e., ` 33,75,000 plus surcharge @7%
being ` 2,36,250 plus health and education cess @4% (of tax and surcharge) being
` 1,44,450. Total tax liability would be ` 37,55,700.
ILLUSTRATION 2
Maitri Jeans (P) Ltd. is in the business of manufacturing jeans. For the assessment year
2026-27, it paid tax @15% on its book profit computed under section 115JB. The Assessing
Officer though satisfied that it is liable to pay book profit tax under section 115JB, wants to
charge interest under sections 234B and 234C as no advance tax was pa id during the
financial year 2025-26. The company seeks your opinion on the proposed levy of interest.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.41

SOLUTION
The issue under consideration is whether interest under sections 234B and 234C can be
levied where a company is assessed on the basis of its book profit under section 115JB.
The Supreme Court, in Joint CIT v. Rolta India Ltd. (2011) 330 ITR 470, observed that there
is a specific provision in section 115JB(5) providing that all other provisions of the Income -
tax Act, 1961 shall apply to every assessee, being a company, mentioned in that section.
Section 115JB is a self-contained code pertaining to MAT, and by virtue of sub-section (5)
thereof, the liability for payment of advance tax would be attracted.
According to section 207, tax shall be payable in advance during any financial year, in
accordance with the provisions of sections 208 to 219 (both inclusive), in respect of the total
income of the assessee which would be chargeable to tax for the assessme nt year
immediately following that financial year.
Under section 115JB(1), where the tax payable on total income is less than 15% of “book profit”
of a company, the “book profit” would be deemed to be the total income and tax would be payable
at the rate of 15%.
Since in such cases, the book profit is deemed to be the total income, therefore, as per the
provisions of section 207, tax shall be payable in advance in respect of such book profit
(which is deemed to be the total income) also.
Therefore, if a company defaults in payment of advance tax in respect of tax payable under
section 115JB, it would be liable to pay interest under sections 234B and 234C.
Therefore, even though Maitri Jeans (P) Ltd. is assessed on the basis of its book profit under
section 115JB for A.Y.2026-27, it is liable to pay advance tax. Since Maitri Jeans (P) Ltd. has
not paid any advance tax during the financial year 2025-26, the levy of interest under section
234B and 234C is valid.
ILLUSTRATION 3
Sona Ltd., a resident company, earned a profit of ` 15 lakhs after debit/credit of the following
items to its Statement of Profit and Loss for the year ended on 31/03/2026.
(i) Items debited to Statement of Profit and Loss:

No. Particulars `
1. Provision for the loss of subsidiary 70,000
2. Provision for doubtful debts 75,000
 9.42 DIRECT TAX LAWS

3. Provision for income-tax 1,05,000

4. Provision for gratuity based on actuarial valuation 2,00,000
5. Depreciation 3,60,000
6. Interest to financial institution (unpaid before filing of return) 1,00,000
7. Penalty for infraction of law 50,000

(ii) Items credited to Statement of Profit and Loss:

No. Particulars `
1. Profit from unit established in special economic zone 5,00,000
2. Share in income of an AOP as a member 1,00,000
3. Income from units of UTI 75,000
4. Long term capital gains on sale of building 3,00,000

Other Information:

(i) Depreciation includes ` 1,50,000 on account of revaluation of fixed assets.

(ii) Depreciation as per Income-tax Rules is ` 2,80,000.

(iii) Brought forward loss as per books of account of the company is of ` 10 lakhs which
includes unabsorbed depreciation of ` 4 lakhs.

(iv) The AOPs, of which the company is a member, has paid tax at maximum marginal rate.

(v) Provision for income-tax includes ` 45,000 of interest payable on income-tax.

Compute minimum alternate tax under section 115JB of the Income-tax Act, 1961, for A.Y.
2026-27, assuming that Sona Ltd. is not required to comply with the Indian Accounting
Standards. Ignore the provisions of section 115BAA.
SOLUTION
Computation of “Book Profit” for levy of MAT under section 115JB for A.Y. 2026-27
Particulars ` `
Net Profit as per Statement of Profit and Loss 15,00,000
Add: Net profit to be increased by the following amounts as per
Explanation 1 to section 115JB
- Provision for the loss of subsidiary 70,000
- Provision for doubtful debts, being the amount set aside as 75,000
provision for diminution in the value of any asset
 a
ASSESSMENT OF VARIOUS ENTITIES 9.43

- Provision for income-tax 1,05,000

[As per Explanation 2 to section 115JB, income-tax shall
include, inter alia, any interest charged under the Act.
Therefore, whole of the amount of provision for income-tax
including ` 45,000 towards interest payable has to be
added]
- Depreciation 3,60,000 6,10,000
21,10,000
Less: Net profit to be decreased by the following amounts as per
Explanation 1 to section 115JB:
- Share in income of an AOP as a member 1,00,000
[In a case, where AOP has paid tax on its total income at
maximum marginal rate, no income-tax is payable by the
company, being a member of AOP, in accordance with the
provisions of section 86. Therefore, share in income of an
AOP on which no income-tax is payable in accordance with
the provisions of section 86, would be reduced while
computing book profit, since the same has been credited
to Statement of Profit and Loss]
- Income from units in UTI -
[Income from units in UTI is taxable in the hands of the
unitholders thus, the same would not be reduced while
computing book profits even though it is credited in the
Statement of Profit and Loss]
- Depreciation other than depreciation on revaluation of 2,10,000
assets (` 3,60,000 – ` 1,50,000)
- Unabsorbed depreciation or brought forward business 4,00,000 7,10,000
loss, whichever is less, as per the books of account.
[Lower of unabsorbed depreciation ` 4,00,000 and brought
forward business loss ` 6,00,000 as per books of accounts
has to be reduced while computing the book profit]
Book Profit 14,00,000
Computation of MAT liability under section 115JB
Particulars `
15% of book profit 2,10,000
Add: Health and education cess@4% 8,400
Minimum Alternate Tax liability 2,18,400
Notes:
(1) It is only the specific items mentioned under Explanation 1 to section 115JB, which
can be adjusted from the net profit as per the Statement of Profit and Loss prepared
 9.44 DIRECT TAX LAWS

as per the Companies Act for computing book profit for levy of MAT. Since the following
items are not specified thereunder, the same cannot be adjusted for computing book
profit:
• Interest to financial institution (unpaid before filing of return) and
• Penalty for infraction of law
(2) Provision for gratuity based on actuarial valuation is an ascertained liability [CIT v.
Echjay Forgings (P) Ltd. (2001) 251 ITR 15 (Bom.)]. Hence, the same should not be
added back to compute book profit.
(3) As per proviso to section 115JB(6), the profits from unit established in special
economic zone cannot be excluded while computing the book profit, and hence, such
income would be liable for MAT.
(xiii) Set-off of credit of tax paid under section 115JB [Section 115JAA]
(1) This section provides that where tax is paid in any assessment year in relation to the
deemed income under section 115JB(1), the excess of tax so paid over and above the
tax payable under the other provisions of the Income-tax Act, 1961, will be allowed as
tax credit in the subsequent years. However, no interest would be payable on the tax
credit allowed.
(2) The tax credit is, therefore, the difference between the tax paid under section 115JB(1)
and the tax payable on the total income computed in accordance with the other
provisions of the Act.
(3) This tax credit is allowed to be carried forward for 15 assessment years succeeding
the assessment year in which the credit became allowable.
(4) Such credit is allowed to be set off against the tax payable on the total income in an
assessment year in which the tax is computed in accordance with the provisions of the
Act, other than 115JB, to the extent of excess of such tax payable over the tax payable
on book profits in that year.
Example:
P.Y. MAT as per Tax as per MAT Credit Actual MAT Credit
section regular Adjustment Tax Paid Balance
115JB provisions
2023-24 4,50,000 3,95,000 - 4,50,000 55,000
2024-25 4,70,000 4,10,000 - 4,70,000 1,15,000
[55,000 +
60,000]
2025-26 3,80,000 4,00,000 20,000 3,80,000 95,000
 a
ASSESSMENT OF VARIOUS ENTITIES 9.45

(5) Where as a result of order passed, the amount of tax payable is reduced or increased,
the amount of tax credit allowed shall also be reduced or increased accordingly.
(6) In case of conversion of a private company or unlisted public company into an LLP,
the tax credit under section 115JAA for MAT paid by the company under section 115JB
would not be allowed to the successor LLP.
(7) Where the amount of tax credit in respect of any income-tax paid in any country or
specified territory outside India, under section 90 or section 90A or section 91, allowed
against the tax payable under the provisions of section 115JB(1) exceeds the amount
of such tax credit admissible against the tax payable by the assessee on its income in
accordance with the other provisions of this Act, then, while computing the amount of
credit under this sub-section, such excess amount shall be ignored.
In other words, the amount of tax credit in respect of MAT shall not be allowed to be
carried forward to subsequent year to the extent such credit relates to the difference
between the amount of foreign tax credit (FTC) allowed against MAT and FTC
allowable against the tax computed under regular provisions of Act other than th e
provisions relating to MAT.
Example:
Particulars Tax as per MAT as per
regular section 115JB
provisions
Tax amount 1,50,000 1,75,000
FTC 1,60,000 1,60,000
Deduction in respect of FTC, being lower of tax 1,50,000 1,60,000
payable in India and FTC
Excess FTC allowed against MAT under section 115JB 10,000
MAT credit 25,000
MAT Credit as reduced by excess FTC allowable against MAT 15,000
liability (` 25,000 – ` 10,000)

(8) A company opting for section 115BAA cannot set-off MAT credit available to it under
section 115JAA from the year in which it exercises such option.

(5) Special provisions relating to income of shipping companies

To make the Indian shipping industry more competitive, a tonnage tax scheme for taxation of
shipping profits was introduced. To further promote inland water transportation in the country and to
encourage investments in this sector, the scope of this scheme has been extended to include Inland
Vessels registered under Inland Vessels Act, 2021.
 9.46 DIRECT TAX LAWS

Chapter XII-G, containing sections 115V to 115VZC, provides for special provisions relating to
taxation of the income of shipping companies. With the introduction of tonnage tax scheme, the
companies have to exercise the option to be assessed under this scheme or under the normal
provisions of the Income-tax Act. The salient features of the scheme are as follows:
• A company owning at least one qualifying ship may join.
• A qualifying ship is one with a minimum tonnage of 15 tons and having a valid certificate.
• If a company is incorporated after the initial period i.e., 31.12.2004 or a company which is
incorporated before the initial period but becomes a qualifying company for the first time after
the initial period, this application is required to be made within three months of the date of
incorporation or the date on which it becomes a qualifying company, as the case may be.
(I) Computation of Tonnage Income from Business of Operating Qualifying Ships
Computation of profits and gains from the business of operating qualifying ships [Section 115VA]
(1) A company has the option to compute the income from the business of operating qualifying
ships in accordance with the provisions of this Chapter.
(2) Such income is deemed to be the income chargeable to tax under the head “Profits and gains
of business or profession” in respect of such business.
Operating ships [Section 115VB]
(1) A company shall be regarded as operating a ship or inland vessel, as the case may be, if it
operates any ship or inland vessel, as the case may be, whether owned or chartered by it.
(2) Even if only a part of the ship or inland vessel, as the case may be, has been chartered in
by it in an arrangement such as slot charter, space charter or joint charter, the company would
be regarded as operating a ship.
(3) However, a company will not be regarded as the operator of a ship or inland vessel, as the
case may be, which has been chartered out on bareboat charter-cum-demise terms or on
bareboat charter terms for a period exceeding three years.
(4) “Bareboat charter” means hiring of a ship or inland vessel, as the case may be, for a stipulated
period on terms which give the charterer possession and control of the ship or inland vessel, as
the case may be, including the right to appoint the master and crew.
(5) “Bareboat charter-cum-demise” means a bareboat charter where the ownership of the ship
or inland vessel, as the case may be, is intended to be transferred after a specified period
to the company to whom it has been chartered.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.47

Meaning of “Qualifying company” [Section 115VC]

(1) A company will be a qualifying company if -
(a) it is an Indian company;
(b) the place of effective management of the company is in India;
(c) it owns at least one qualifying ship; and
(d) the main object of the company is to carry on the business of operating ships.
(2) The expression “place of effective management of the company” has been defined in the
Explanation to the section to mean –
(a) the place where the board of directors of the company or its executive directors make
their decisions; or
(b) in a case where the board of directors routinely approve the commercial and strategic
decisions made by the executive directors or officers of the company, the place where
such executive directors or officers of the company perform their functions.
Meaning of “Qualifying ship” [Section 115VD]
(1) A ship or inland vessel, as the case may be, is a qualifying ship if
(i) it is a seagoing ship or vessel or inland vessel, as the case may be, of 15 net tonnage
or more;
(ii) ship is registered –
(a) under the Merchant Shipping Act, 1958; or
(b) outside India in respect of which a license has been issued by the Director-General
of Shipping under section 406 or 407 of the Merchant Shipping Act, 1958; or
inland vessel is registered –
(c) under the Inland Vessels Act, 2021.
(iii) there is a valid certificate in force indicating the net tonnage of such a ship or inland
vessel, as the case may be;
(2) However, the following ships or inland vessel are not “qualifying ships” –

(i) a seagoing ship or vessel or inland vessel, as the case may be, if the main purpose
for which it is used is for the provision of goods or services of a kind normally provided
on land (“seagoing ship” means a ship which is certified as seagoing by the competent
authority of any country);
 9.48 DIRECT TAX LAWS

(ii) fishing vessels;

(iii) factory ships (which includes a vessel providing processing services in respect of
processing of the fishing produce);
(iv) pleasure craft (i.e. a ship or inland vessel, whose primary use is for the purposes of
sport or recreation);
(v) harbour and river ferries;
(vi) offshore installations;
(vii) a qualifying ship which is used as a fishing vessel for a period of more than thirty days
during a previous year.
Manner of computation of income under tonnage tax scheme [Section 115VE]
(1) A tonnage tax company engaged in the business of operating qualifying ships should compute
the profits from such business under the tonnage tax scheme;
(2) “Tonnage tax company” means a qualifying company in relation to which tonnage tax option
is in force;

(3) “Tonnage tax scheme” means a scheme for computation of profits and gains of business of
operating qualifying ships under the provisions of this Chapter.
(4) The business of operating qualifying ships giving rise to “relevant shipping income” (i.e.
income referred to in section 115V-I(1)) has to be considered as a separate business, distinct
from all other activities or business carried on by the company.
(5) Such profits should be computed separately from the profits and gains from any other business.
(6) The tonnage tax scheme will apply only if an option to that effect is made (in accordance with
the provisions of section 115VP).
(7) The profits and gains from the business of operating qualifying ships of a company engaged
in such business and –
(a) not covered under the tonnage tax scheme or,
(b) which has not made an option to that effect,

have to be computed in accordance with the other provisions of this Act.

 a
ASSESSMENT OF VARIOUS ENTITIES 9.49

Tonnage income [Section 115VF]

(1) “Tonnage income” means the income of a tonnage tax company computed in accordance
with the provisions of this Chapter. The tonnage income has to be computed in accordance
with the provisions of section 115VG given below.
(2) The income so computed is deemed to be the profits chargeable under the head “Profits and
gains of business or profession”.
(3) Where income is so computed under section 115VG, the relevant shipping income (referred
to in section 115V-I(1)) will not be chargeable to tax.
Computation of tonnage income [Section 115VG]
(1) The tonnage income for a previous year is the aggregate of the tonnage income of each
qualifying ship.
(2) The tonnage income of a qualifying ship is to be calculated on the basis of the daily tonnage
income of such ship multiplied by the number of days in the previous year.
(3) In case the ship is operated by the company as a qualifying ship for only part of the previous
year, the tonnage income of the ship will be calculated on the basis of daily tonnage of such
ship multiplied by the number of days in part of the previous year.
(4) The daily tonnage income of a qualifying ship has to be computed as under –

Qualifying ship having net tonnage Amount of daily tonnage income

Up to 1000 ` 70 for each 100 tons
Exceeding 1,000 but not more than 10,000 ` 700 plus ` 53 for each 100 tons exceeding
1,000 tons
Exceeding 10,000 but not more than ` 5,470 plus ` 42 for each 100 tons
25,000 exceeding 10,000 tons
Exceeding 25,000 ` 11,770 plus ` 29 for each 100 tons
exceeding 25,000 tons

(5) “Tonnage” means the tonnage of a ship or inland vessel, as the case may be, indicated in
the “valid certificate” (i.e., referred to in section 115VX) and includes deemed tonnage
computed in the prescribed manner.

(6) “Deemed tonnage” means the tonnage in respect of an arrangement of purchase of slots, slot
charter and an arrangement of sharing of break-bulk vessel.

(7) The tonnage is to be rounded off to the nearest multiple of hundred tons. For this if the last
figure that amount of tonnage is fifty or more, the tonnage shall be increased to the next
 9.50 DIRECT TAX LAWS

higher tonnage which is a multiple of 100, otherwise, shall be reduced to the next lower
tonnage which is a multiple of 100.

(8) No deduction or set-off is allowed in computing the tonnage income under this Chapter.
ILLUSTRATION 4
Calculate tonnage income with respect to each of the following qualifying ships:
Qualifying Ships Q1 Q2 Q3 Q4
Net Tonnage 1,020 8,563 22,368 37,525
Days for which ship operated during the P.Y.2025-26 120 70 250 100

SOLUTION

Qualifying Ships Q1 Q2 Q3 Q4
Net Tonnage (rounded off) 1,000 8,600 22,400 37,500
Daily Tonnage (`) 700 4,728 10,678 15,395
Days for which ship operated during the 120 70 250 100
P.Y.2025-26
Tonnage Income (`) 84,000 3,30,960 26,69,500 15,39,500

Calculation of tonnage income in case of joint operation [Section 115VH]

(1) Where a qualifying ship is operated by two or more companies –
(a) by way of joint interest in the ship or by way of an agreement for the use of the ship
and
(b) their respective shares are definite and ascertainable,
the tonnage income of each such company shall be an amount equal to a share of income
proportionate to its share of interest.

(2) Where two or more companies are operators of a qualifying ship, the tonnage income of each
company shall be computed as if each had been the only operator, if the conditions specified
in (a) and (b) of (1) above are not satisfied.

Meaning of “Relevant shipping income” [Section 115V-I]

(1) The “relevant shipping income” of a tonnage tax company means its profits from core
activities and its profits from incidental activities
 a
ASSESSMENT OF VARIOUS ENTITIES 9.51

(2) Where the aggregate of income from incidental activities exceeds ¼th % of the turnover from
core activities, such excess will not form part of relevant shipping income for the purposes of
this Chapter and shall be taxable under the other provisions of this Act.
(3) The core activities of a tonnage tax company are –
(i) its activities from operating qualifying ships; and
(ii) Other ship-related activities or inland vessel related activities, as the case may be,
being,
(a) shipping contracts in respect of –

(1) earnings from pooling arrangements i.e.

(i) agreement between two or more persons for providing services
through a pool or

(ii) operating one or more ships or inland vessel, as the case may
be, and sharing earnings or operating profits on the basis of
mutually agreed terms;

(2) contracts of affreightment i.e. a service contract under which a tonnage

tax company agrees to transport a specified quantity of specified
products at a specified rate, between designated loading and
discharging ports over a specified period.
(b) Specific shipping trades, being, -
(1) on-board or onshore activities of passenger ships comprising of fares
and food and beverages consumed on board;
(2) slot charters, space charters, joint charters, feeder services, container
box leasing of container shipping.
(4) The incidental activities of the tonnage tax company are the activities which are incidental to
the core activities and which may be prescribed for the purpose.
(5) The Central Government can, by notification, exclude any activity under “other ship -related
activities or inland vessel related activities” mentioned in (3) above or prescribe the limit
up to which such activities can be included in the core activities.
(6) Every notification issued under this Chapter has to be laid before each House of Parliament
to make the same effective.
 9.52 DIRECT TAX LAWS

(7) If both Houses agree in making any modification therein, the notification will have effect in
such modified form.
(8) Similarly, if both Houses agree that the notification should not be issued, then such
notification will be of no effect.
(9) However, such modification or annulment will not affect anything previously done under that
notification.
(10) Where a tonnage tax company operates any ship or inland vessel, as the case may be,
which is not a qualifying ship, then the income attributable to operation of the non-qualifying
ship should be computed in accordance with the other provisions of this Act.
(11) In the following cases, the relevant shipping income is to be computed as if the transfer had
been at market value of the goods and services as on the date of transfer –

(i) Where any goods or services held for the purposes of tonnage tax business are
transferred to any other business carried on by a tonnage tax company, or
(ii) where any goods or services held for the purposes of any other business carried on
by such tonnage tax company are transferred to the tonnage tax business, and
(iii) In both the above cases, the consideration, if any, for such transfer as recorded in the
accounts of the tonnage tax business does not correspond to the market value of such
goods or services as on the date of the transfer,
(12) Market value in relation to any goods and services means the price that such goods or
services would ordinarily fetch on sale in the open market.
(13) Where the computation of the relevant shipping income in the manner specified above
presents exceptional difficulties, the Assessing Officer may compute such income on such
reasonable basis as he may deem fit.
(14) If the Assessing Officer is of the opinion that owing to the close connection between the
tonnage tax company and such other person or for any other reason, the affairs of the
business transacted between the tonnage tax company and any other person are arr anged
in such a manner that the company gets more than the ordinary profits which might be
expected to arise in the tonnage tax business, then he may take into account the amount of
income which may be reasonably deemed to have been derived therefrom for computing the
relevant shipping income.
(15) In case the relevant shipping income of a tonnage tax company is a loss, then, such loss is
to be ignored for the purposes of computing tonnage income.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.53

Treatment of common costs [Section 115VJ]

(1) Where a tonnage tax company also carries on any business or activity other than the tonnage
tax business, the common costs attributable to the tonnage tax business should be
determined on a reasonable basis.
(2) Where any asset, other than qualifying ship, is not exclusively used for the tonnage tax
business by the tonnage tax company, depreciation on such asset has to be allocated
between its tonnage tax business and other business.
(3) Such allocation of depreciation has to be done on a fair proportion to be determined by the
Assessing Officer, having regard to the use of such asset for the purpose of the tonnage tax
business and for the other business.
Depreciation [Section 115VK]
(1) The depreciation for the first previous year of the tonnage tax scheme has to be computed
on the written down value of the qualifying ships.
(2) The written down value of the block of assets, being ships or inland vessel, as the case may
be, as on the first day of the previous year, has to be divided in the ratio of the book written down
value of the qualifying ships (qualifying assets) and the book written down value of the non-
qualifying ships (other assets).
(3) The block of qualifying assets would constitute a separate block of assets.
(4) The manner of computing the book written down value of the block of qualifying assets and
the block of other assets is as follows –
(a) the book written down value of each qualifying asset and each other asset as on the
first day of the previous year is to be determined by taking the book written down value
of each asset appearing in the books of account as on the last day of the prece ding
previous year;
(b) Any change in the value of assets consequent to their revaluation after 10.9.04 is to
be ignored;
(c) The book written down value of all the qualifying assets and other assets are to be
aggregated;
(d) The ratio of the aggregate book written down value of the qualifying assets to the
aggregate book written down value of the other assets has to be determined.
(5) In case an asset forming part of the block of qualifying assets begins to be used for purposes
other than the tonnage tax business, an appropriate portion of the written down value
allocable to such asset i.e., the amount which bears the same proportion to the written down
 9.54 DIRECT TAX LAWS

value of the block of qualifying assets as on the first day of the previous year as the book
written value of the asset beginning to be used for purpose other than tonnage tax business
bears to the book written down value of all the assets forming the block of qualifying assets,
has to be reduced from the written down value of that block and added to the block of other
assets.
(6) In case an asset forming part of the block of other assets begins to be used for tonnage tax
business, an appropriate portion of the written down value allocable to such asset i.e., the
amount which bears the same proportion to the written down value of the block of other assets
as on the first day of the previous year as the book written value of the asset beginning to be
used for tonnage tax business bears to the total book written down value of all the assets
forming the block of other assets, has to be reduced from the written down value of the block
of other assets and has to be added to the block of qualifying asset.
(7) Depreciation computed for the previous year on such asset mentioned in (6) shall be allocated
in the ratio of number of days for which the asset was used for the tonnage tax business and
for purposes other than tonnage tax business.
(8) Depreciation on the block of qualifying assets and block of other assets so created shall be
allowed as if the written down value as on the first previous year has been brought forward
from the preceding previous year.
(9) The expression “book written down value” means the written down value as appearing in the
books of account.
Deemed deduction and set-off and carry forward of losses etc. [Section 115VL]
(1) Any loss/allowance or deduction under sections 30 to 43B relating to or allowable for any of
the relevant previous years, would be deemed to have been given full effect to in that previous
year itself;
(2) No set-off or carry forward of losses referred to in –
(i) sections 70(1) and 70(3); or
(ii) sections 71(1) and 71(2); or
(iii) section 72(1) or
(iv) section 72A(1),

relating to the business of operating qualifying ships of the company is permissible where such
loss relates to any of the previous years when the company is under the tonnage tax scheme;
 a
ASSESSMENT OF VARIOUS ENTITIES 9.55

(3) No deduction under Chapter VI-A is allowable in relation to the profits and gains from the
business of operating qualifying ships;
(4) In computing the depreciation allowance under section 32, the written down value of any
asset used for the purposes of the tonnage tax business has to be computed as if the
company has claimed and has been actually allowed the deduction in respect of depreciation
for the relevant previous year.
Set-off and carry forward of losses of tonnage tax business [Section 115VM]
(1) Any losses attributable to its tonnage tax business that have accrued to a company before its
entry in tonnage tax scheme can be set off only against the relevant shipping income when
the company is under the tonnage tax scheme.
(2) Such losses will not be available for set off against any income other than relevant shipping
income in any previous year beginning on or after the date when the company exercises its
option under section 115VP.
(3) Any apportionment necessary to determine such losses should be made on a reasonable basis.

Capital gains from transfer of tonnage tax assets [Section 115VN]

(1) Profits or gains arising from the transfer of a capital asset being an asset forming part of the
block of qualifying assets is chargeable to income-tax in accordance with the provisions of
section 45, read with section 50.
(2) The capital gains so arising has to be computed in accordance with the provisions of sections
45 to 51.
Book profit or loss to be excluded for the purpose of section 115JB [Section 115VO]
This section seeks to exclude the book profits or loss derived from the activities of a tonnage tax
company (referred to in section 115V-I(1)) for the purposes of section 115JB.
(II) Procedure for Option of Tonnage Tax Scheme
Method and time of opting for tonnage tax scheme [Section 115VP]
(1) A qualifying company may opt for the tonnage tax scheme by making an application to the Joint-
Commissioner having jurisdiction over the company in the prescribed form and manner.
(2) An existing qualifying company should make an application at any time after 30 th September
2004 but before 1st January 2005, which is the initial period.
 9.56 DIRECT TAX LAWS

(3) In case of a company incorporated after the initial period or a company incorporated before
the initial period but which becomes a qualifying company for the first time after the initial
period, an application can be made within three months of the date of its incorporation or the
date on which it became a qualifying company, as the case may be.
(4) The Joint Commissioner, on receipt of an application for option for tonnage tax scheme, may
call for such information or documents from the company as he thinks necessary in order to
satisfy himself about the eligibility of the company.
(5) After satisfying himself about the eligibility of the company to make such option for tonnage
tax scheme, he can either pass an order in writing approving the option for tonnage tax
scheme or, if he is not so satisfied, pass an order in writing refusing to approve the option for
tonnage tax scheme.

(6) A copy of such order should be sent to the applicant.

(7) An order refusing to approve the option for tonnage tax scheme can be passed only after
giving the applicant a reasonable opportunity of being heard.

(8) Every order granting or refusing the approval of the option for tonnage tax scheme should be
passed before the expiry of one month from the end of the month in which the application was
received. However, for an application received on or after 1.4.2025, order of granting or
refusing the approval of the option for tonnage tax scheme should be passed before the
expiry of three months from the end of the quarter in which the application was received.
(9) Where an order granting approval for tonnage tax scheme is passed, the provisions of this
Chapter will apply from the assessment year relevant to the previous year in which the option
for tonnage tax scheme is exercised.
Period for which the tonnage tax option will remain in force [Section 115VQ]
(1) An option for tonnage tax scheme (after it has been approved under section 115VP(3)) would
remain in force for a period of ten years from the date on which such option has been exercised.
(2) For this purpose, the option would be taken into account from the assessment year relevant
to the previous year in which such option is exercised.
(3) An option for tonnage tax scheme would cease to have effect from the assessment year
relevant to the previous year in which –

(i) the qualifying company ceases to be so or

 a
ASSESSMENT OF VARIOUS ENTITIES 9.57

(ii) a default is made in complying with the provisions contained in section 115VT or
section 115VU or section 115VV.
(4) The tonnage tax option will also cease to have effect in case –
(i) a company is excluded from the tonnage tax scheme under section 115VZC or
(ii) the qualifying company furnishes to the Assessing Officer, a declaration in writing to
the effect that the provisions of this Chapter may not be made applicable to it.
(5) In such a case, the profits of the company from the business of operating qualifying ships
shall be computed in accordance with the other provisions of the Act.

Renewal of tonnage tax scheme [Section 115VR]

(1) An option for tonnage tax scheme approved under section 115VP may be renewed within one
year from the end of the previous year in which the option ceases to have effect.

(2) The provisions of sections 115VP and 115VQ discussed above would apply in relation to a
renewal of the option for tonnage tax scheme in the same manner as they apply in relation to
the approval of option for tonnage tax scheme.

Bar from opting for tonnage tax scheme in certain cases [Section 115VS]
(1) A qualifying company is not eligible to opt for the tonnage tax scheme if –
(i) the company, on its own, opts out of the tonnage tax scheme or
(ii) it makes a default in complying with the provisions of section 115VT or section
115VU or section 115VV or
(iii) its option has been excluded from tonnage tax scheme in pursuance of an order
made under section 115VZC(1).
(2) In such cases, the qualifying company will not be eligible to opt for tonnage tax scheme for a
period of ten years from the date of such opting out or default or order, as the case may be.
(III) Conditions for Applicability of Tonnage Tax Scheme
Transfer of profits to Tonnage Tax Reserve Account [Section 115VT]
(1) A tonnage tax company is required to credit to a reserve account (called Tonnage Tax
Reserve Account) an amount not less than 20% of the book profits derived from its core and
incidental activities (referred to in section 115V-I(1)) in each previous year to be utilised in
the manner laid down below –
 9.58 DIRECT TAX LAWS

(i) The amount credited should be utilized for acquiring a new ship or new inland
vessel, as the case may be, before the expiry of 8 years for the purposes of the
business of the company; and
(ii) Until the acquisition of a new ship or new inland vessel, as the case may be, the
amount can be utilized for the purposes of the business of operating qualifying ships
other than for distribution by way of dividends or profits or for remittance outside
India as profits or for the creation of any asset outside India. [Sub -section (3)]
(2) A tonnage tax company may transfer a sum in excess of twenty per cent of the book profits.
Such excess sum transferred should also be utilised in above manner.
(3) “Book profit” will have the same meaning as in the Explanation to section 115JB(2) so far as
it relates to income derived from the core and incidental activities.
(4) Where the company has book profit from the business of operating qualifying ships and book
loss from any other source, and consequently, the company is not in a position to create the
full or any part of the reserves as required, then –
(a) the company should create the reserves to the extent possible in that previous year.
(b) The shortfall, if any, will be added to the amount of the reserves required to be
created for the following previous year.
(c) Such shortfall will be deemed to be part of the reserve requirement of that following
previous year.
(5) Consequences of mis-utilisation / non-utilisation [Sub-section (4)]
(i) Where any amount credited to the Tonnage Tax Reserve Account has –
(a) been utilized for any purpose other than that referred to in (1) above; or
(b) not been utilized for the purpose of acquiring a new ship for the purpose of the
business of the company within 8 years; or
(c) has been utilized for acquiring a new ship or new inland vessel, as the case
may be, within 8 years but such ship or inland vessel is sold or transferred,
otherwise than in any scheme of demerger, within 3 years from the end of the
previous year in which it was acquired
then, an amount which bears the same proportion to the total relevant shipping
income of the year in which such reserve was created, as the amount out of such
reserve so utilized or not utilized bears to the total reserve created during that year
shall be taxable under the other provisions of the Act i.e.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.59

Taxable amount =
Extent of reserves unutilized or misutilised
Relevant shipping income 
Total reserve created during the year

(ii) Such amount as calculated above would be taxable -

(a) in case (a) of (i) above, in the year in which the amount was so utilized; or
(b) in case (b) of (i) above, in the year immediately following the period of 8 years;
(c) in case (c) of (i) above, in the year in which the sale or transfer took place.
(iii) However, the income so taxable under the other provisions of the Act will be reduced
by the proportionate tonnage income charged to tax in the year of creation of such
reserves.
(6) Shortfall in credit to Tonnage Tax Reserve Account [Sub-section (5)]
If there is any shortfall in the amount credited to the Tonnage Tax Reserve Account, then the
amount which bears the same proportion to the total relevant shipping income as the shortfall
in credit to the reserves bears to the minimum reserve required to be credited, will be taxable
under the other provisions of the Act i.e.,
Shortfall in credit to reserves
Taxable amount = Relevant shipping income 
Minimum reserve to be credited
(7) Consequences of failure to create reserve for two consecutive previous years [Sub -
section (6)] -If the reserve required to be created is not created for any two consecutive
previous years, the option of the company for tonnage tax scheme will cease to have effect
from the beginning of the previous year following the second consecutive previous year i n
which the failure to create the reserve had occurred.
(8) Meaning of “new ship or inland vessel”: A new ship or inland vessel, as the case may be,
includes a ‘qualifying ship’, which before the date of its acquisition by the qualifying company
was used by any other person. However, it should not have been owned by any person
resident in India before the date of such acquisition.
ILLUSTRATION 5
Dolphy Ltd., a tonnage tax company provides following information for the P.Y. 2025 -26:
(i) Relevant Shipping Income - ` 350 lakhs

(ii) Tonnage Income - ` 180 lakhs

(iii) Book profits derived from core and incidental activities - ` 400 lakhs
 9.60 DIRECT TAX LAWS

Provide answers to following questions, considering each of the questions given below
independently:
(a) Calculate the minimum reserve requirement of the company as per section 115VT.
(b) Calculate the taxable amount under the other provisions of the Act, if Dolphy Ltd. transferred
only ` 66 lakhs to tonnage tax reserve account during the P.Y. 2026-27.
(c) Calculate the taxable amount under the other provisions of the Act, if Dolphy Ltd. mis-utilised
amount of ` 12 lakhs during P.Y. 2026-27 out of ` 92 lakhs transferred to tonnage tax reserve
account during P.Y. 2025-26.

SOLUTION
(a) The minimum reserve requirement of the company as per section 115VT = 20% of the
book profits derived from core and incidental activities = ` 400 lakhs × 20% = ` 80 lakhs
(b) Taxable amount under the other provisions of the Act = Relevant shipping income × Shortfall
in the credit to the reserves/ Minimum reserve requirement = ` 350 lakhs × [(` 80 lakhs – 66
lakhs) / ` 80 lakhs)] = ` 350 lakhs × ` 14 lakhs / ` 80 lakhs = ` 61.25 lakhs
(c) Taxable amount under the other provisions of the Act for P.Y. 2026-27 = Relevant shipping
income during P.Y. 2025-26 × Extent of reserves misutilised/Total reserve created during
P.Y. 2025-26 = ` 350 lakhs × ` 12 lakhs / ` 92 lakhs = ` 45.65 lakhs
Minimum training requirement for a tonnage tax company [Section 115VU]
(1) A tonnage tax company, after its option has been approved under section 115VP(3) is
required to comply with the minimum training requirement in respect of trainee officers in
accordance with the guidelines framed by the Director-General of Shipping and notified in the
Official Gazette by the Central Government. [Sub-section (1)]
(2) A copy of the certificate issued by the Director-General of Shipping to the effect that such
company has complied with the minimum training requirement in accordance with the
guidelines referred to in sub-section (1) for the previous year is required to be furnished along
with the return of income.
(3) If the minimum training requirement is not complied with for any five consecutive previous
years, the option of the company for tonnage tax scheme shall cease to have effect from the
start of the previous year following the fifth consecutive year in which the failure to comply
with the minimum training requirement occurred.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.61

Limit for charter in of tonnage [Section 115VV]

(1) Every company which has opted for tonnage tax scheme should charter in not more than 49%
of the net tonnage of the qualifying ships operated by it during any previous year. The term
“chartered in” does not include a ship or inland vessel, as the case may be, chartered in by
the company on bareboat charter-cum-demise terms.
(2) Such proportion of net tonnage in respect of a previous year is to be calculated based on the
average of net tonnage during that previous year.
(3) The average of net tonnage is to be computed in such manner as may be prescribed in
consultation with the Director-General of Shipping.
(4) Where the net tonnage of ships or inland vessel, as the case may be, chartered in exceeds
the limit of 49% during any previous year, the total income of such company in relation to that
previous year is to be computed as if the option for tonnage tax scheme does not have effect
for that previous year.
(5) Where the said limit of 49% is exceeded in any two consecutive previous years, the option
for tonnage tax scheme shall cease to have effect from the beginning of the previous year
following the second consecutive previous year in which the limit had exceeded.
Maintenance and audit of accounts [Section 115VW]
An option for tonnage tax scheme by a tonnage tax company will not have effect in relation to a
previous year unless such company –
(i) maintains separate books of account in respect of the business of operating qualifying ships
and
(ii) furnishes, the report of an accountant, in the prescribed form duly signed and verified by such
accountant on or before the specified date referred to in section 44AB i.e., one month prior
to the due date for filing return of income.
Determination of tonnage [Section 115VX]
(1) The tonnage of the ship or inland vessel, as the case may be, shall be determined in
accordance with the valid certificate indicating its net tonnage.
(2) “Valid certificate” means –
(i) in case of ships registered in India—
(a) having a length of less than twenty-four meters, a certificate issued under the
Merchant Shipping (Tonnage Measurement of Ship) Rules, 1987 made under
the Merchant Shipping Act, 1958;
 9.62 DIRECT TAX LAWS

(b) having a length of twenty-four meters or more, an international tonnage

certificate issued under the provisions of the Convention on Tonnage
Measurement of Ships, 1969 as specified in the Merchant Shipping (Tonnage
Measurement of Ship) Rules, 1987 made under the Merchant Shipping Act,
1958;
(ii) in case of ships registered outside India,
(a) a license issued by the Director-General of Shipping under section 406 or
section 407 of the Merchant Shipping Act, 1958 specifying the net tonnage on
the basis of Tonnage Certificate issued by the Flag State Administration where
the ship is registered or
(b) any other evidence acceptable to the Director-General of Shipping produced by
the ship owner while seeking permission for chartering in the ship.
(iii) in case of inland vessel registered in India, a certificate issued under the Inland
Vessels Act, 2021.
(IV) Amalgamation and Demerger of Shipping Companies
Amalgamation [Section 115VY]

(1) In case of amalgamation, the provisions relating to the tonnage tax scheme would apply to
the amalgamated company if it is a qualifying company.
(2) However, where the amalgamated company is not a tonnage tax company, it should exercise
an option for tonnage tax scheme under section 115VP(1) within three months from the date
of the approval of the scheme of amalgamation.
(3) Where the amalgamating companies are tonnage tax companies, the provisions of this
Chapter would apply to the amalgamated company for such period as the option for tonnage
tax scheme which has the longest unexpired period continues to be in force.
Example: If two tonnage tax companies X Ltd. and Y Ltd. are amalgamated to form a new
company Z Ltd., and the option for tonnage tax scheme of X Ltd. has an unexpired period of
8 years and Y Ltd. has an unexpired period of 6 years, then the provisions of this Chap ter
would apply to the new company Z Ltd. for a period of 8 years.

(4) Where one of the amalgamating companies is a qualifying company on 1st October 2004 and
has not exercised option for tonnage tax scheme within the initial period, then –
(i) the provisions of this Chapter will not apply to the amalgamated company and
 a
ASSESSMENT OF VARIOUS ENTITIES 9.63

(ii) the income of the amalgamated company from the business of operating qualifying
ships has to be computed in accordance with the other provisions of the Act.
Demerger [Section 115VZ]
(1) Where in a scheme of demerger, the demerged company transfers its business to the
resulting company before the expiry of the option for tonnage tax scheme, then the scheme
would apply to the resulting company for the unexpired period if it is a qualify ing company.
(2) The option for tonnage tax scheme in respect of the demerged company will remain in force
for the unexpired period of the tonnage tax scheme if it continues to be a qualifying company.

(V) Other Provisions

Effect of temporarily ceasing to operate qualifying ships [Section 115VZA]
(1) A temporary cessation (as against permanent cessation) of operating any qualifying ship by
a company would not be considered as a cessation of operating of such qualifying ship. The
company would still be deemed to be operating such qualifying ship for the purposes of this
Chapter.

(2) Where a qualifying company continues to operate a ship or inland vessel, as the case may
be, which temporarily ceases to be a qualifying ship, then such ship or inland vessel, as the
case may be, will not be considered as a qualifying ship for the purposes of this Chapter.

(VI) Cases where provisions of this Chapter do not apply

Avoidance of tax [Section 115VZB]
(1) The tonnage tax scheme will not apply where a tonnage tax company is a party to any
transaction or arrangement which amounts to an abuse of the tonnage tax scheme.
(2) A transaction or arrangement will be considered as an abuse if the entering into or the
application of such transaction or arrangement results, or would, but for this section have
resulted, in a tax advantage being obtained by –
(a) a person other than a tonnage tax company; or

(b) a tonnage tax company in respect of its non-tonnage tax activities.

(3) “Tax advantage” includes—

(i) (a) the determination of the allowance for any expense or interest, or

(b) the determination of any cost or expense allocated or apportioned,

 9.64 DIRECT TAX LAWS

which has the effect of reducing the income or increasing the loss, as the case may
be, from activities other than tonnage tax activities chargeable to tax.

Such computation should be on the basis of entries made in the books of account in
respect of the previous year in which the transaction was entered into; or

(ii) a transaction or arrangement which produces to the tonnage tax company more than
ordinary profits which might be expected to arise from tonnage tax activities.

Exclusion from tonnage tax scheme [Section 115VZC]

(1) Where a tonnage tax company is a party to any transaction or arrangement which amounts
to an abuse of the tonnage tax scheme, the Assessing Officer has the power to exclude such
company from the tonnage tax scheme, by an order in writing, after giving an opportunity of
being heard to such company.

(2) However, no order to this effect can be passed without the previous approval of the Principal
Chief Commissioner or Chief Commissioner.

(3) This section does not apply where the company shows to the satisfaction of the Assessing
Officer that the transaction or arrangement was a bona fide commercial transaction and has
not been entered into for the purpose of obtaining tax advantage under t his Chapter.

Where an order has been passed by the assessing officer excluding the tonnage tax company from
the tonnage tax scheme, then the option for tonnage tax scheme shall cease to be in force from the
first day of the previous year in which the transaction or arrangement was entered into.

(6) Companies under Liquidation [Sections 178]

(i) Notice to Assessing Officer: Every person

(a) who is the liquidator of any company which is being wound up, whether under the
orders of a Court or otherwise, or
(b) who has been appointed as the receiver of any assets of a company

is bound under a statutory obligation to give notice of his appointment as liquidator or receiver,
as the case may be. This notice may be given within thirty days of his appointment to the
Assessing Officer having jurisdiction to assess the income of the company.

(ii) Information of tax due by the Assessing Officer: The Assessing Officer, in his turn is bound
after making such enquiries or calling for such information as he may deem fit, to notify to the
 a
ASSESSMENT OF VARIOUS ENTITIES 9.65

liquidator, within three months from the date of receipt of the notice of appointment, of the
amount which in his opinion would be sufficient to provide for any tax which is then or likely
thereafter to become payable by the company.
(iii) Restriction on liquidator to part with assets: The liquidator is debarred from parting with
the assets of company and its properties in his hands until he is notified by the Assessing
Officer of the amount which will be sufficient to provide for any tax which is then, or is likely
thereafter, to become payable by the company except with the prior approval of
- the Principal Chief Commissioner or

- Chief Commissioner or
- Principal Commissioner or
- Commissioner
and on being so notified, shall set aside an amount equal to the amount notified.
However, the above restriction of debarring the liquidator from parting with assets or
properties shall not be applicable on
- payment of the tax payable by the company,
- payment to secured creditors whose debts are entitled under law to priority of
payments over the debts due to the Government on the date of liquidation and
- meeting such costs and expenses of the winding up of the company
as are, in the opinion of the Principal Chief Commissioner or Chief Commissioner or Principal
Commissioner or the Commissioner, reasonable.
(iv) Consequences of failure to give notice or set aside the tax due by the liquidator: If the
liquidator fails to notify the Assessing Officer of his appointment within the time specified or
fails to set aside the amount intimated by the Assessing Officer as being sufficient to provide
for the tax liability of the company or parts with any of the assets or property of the company
in his hands in contravention of the above provisions, he shall be personally liable for payment
of the tax which the company would be liable to pay.

However, if the amount of any tax payable by the company is notified by the Assessing
Officer, the personal liability of the liquidator under this sub-section shall be to the extent of
such amount.
Failure to comply with the above requirement would be an offence punishable under section
276A.
 9.66 DIRECT TAX LAWS

Where there are more liquidators than one, their obligations and liabilities under this section
are joint and several.
(v) Overrides other laws except IBC, 2016: The provisions of this section have the effect of
over-riding anything to the contrary contained under the Companies Act or any other law for
the time being in force and apply to all companies, public or private except the provisions of
Insolvency and Bankruptcy Code, 2016.

(7) Liability of directors of private company [Section 179]

(i) Liability of directors: Where any tax due from a private company in respect of any income
of any previous year or from any other company in respect of any income of any previous
year during which such other company was a private company cannot be recovered, then,
every person who was director of a private company at any time during the relevant previous
year shall be jointly and severally liable for the payment of the 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 company.
The personal liability imposed by this section on the directors of a private company shall have
the effect of over-riding any provision under the Companies Act, 2013 by which the liability of
the directors is reduced or curtailed. Thus, personal liability can be imposed by the Assessing
Officer on a direction even without any adjudication by a Court.
(ii) Meaning of Tax Due: For the purposes of this section, “tax due” includes penalty, interest,
fees or any other sum payable under the Income-tax Act, 1961.

9.2 TAXATION OF OTHER ENTITIES

ALTERNATE MINIMUM TAX (AMT) [CHAPTER XII-BA–SECTIONS 115JC TO 115JF]

(i) Applicability: Any person other than a company, who has claimed deduction under any
section (other than section 80P) included in Chapter VI-A under the heading “C – Deductions
in respect of certain incomes” or under section 10AA or under section 35AD would be subject
to AMT [Section 115JEE(1)].
The provisions of AMT would, however, not be applicable to an individual, HUF, AOPs, BOIs,
whether incorporated or not, or artificial juridical person, if the adjusted total income of such
person does not exceed ` 20 lakh [Section 115JEE(2)].
(ii) Levy of AMT@18.5% on Adjusted Total Income: Accordingly, where the regular income-
tax payable by a person, other than a company, for a previous year computed as per the
provisions of the Income-tax Act, 1961 (other than Chapter XII-BA) is less than the AMT
 a
ASSESSMENT OF VARIOUS ENTITIES 9.67

payable for such previous year, the adjusted total income shall be deemed to be the total
income of the person. Such person shall be liable to pay income-tax on the adjusted total
income @ 18.5% [Section 115JC(1)].
(iii) Meaning of Adjusted Total Income: “Adjusted total income” would mean the total income
before giving effect to Chapter XII-BA i.e., AMT provisions as increased by the deductions
claimed, if any, under –
(1) any section (other than section 80P) included in Chapter VI-A under the heading “C –
Deductions in respect of certain incomes” (Section 80-IA to 80RRB);

(2) section 10AA (SEZ); and

(3) section 35AD, as reduced by the depreciation allowable under section 32, as if no
deduction under section 35AD was allowed in respect of the asset for which such
deduction is claimed.
(iv) Furnishing Report by Chartered Accountant: Such persons to whom this section applies
should obtain a report in prescribed Form 29C from a Chartered Accountant certifying that the
adjusted total income and the AMT have been computed in accordance with the provisions of
this Chapter. The report has to be furnished on or before the specified date referred to in section
44AB (i.e., one month prior to the due date for filing return of income), in such form as may be
prescribed, from an accountant referred to in the Explanation below section 288(2), certifying
that the adjusted total income and the alternate minimum tax have been computed in
accordance with the provisions of this Chapter and furnish such report by that date.
(v) Levy of AMT @9%/15% of Adjusted Total Income in case of a unit located in IFSC or
co-operative society:
Where the person subject to AMT Rate of AMT on
adjusted total income
- is a unit located in an International Financial Services Centre 9%
(IFSC) deriving its income solely in convertible foreign
exchange or
- a co-operative society 15%

(vi) Applicability of Interest and Penal provisions: Section 115JE specifically provides that
“save as otherwise provided in this Chapter, all other provisions of this Act shall apply to a
person referred to in this Chapter”. Hence, all other provisions relating to self -assessment
under section 140A, advance tax, interest under sections 234A, 234B and 234C, penalty etc.
would also apply to a person who is subject to AMT.
 9.68 DIRECT TAX LAWS

(vii) Non-applicability of AMT provisions: The provisions of this section shall not apply to a
person
- a resident co-operative society who has opted for section 115BAD or 115BAE or
- where income tax payable in respect of total income of such person is computed as
per section 115BAC(1A) [Section 115JC(5)].
AMT provisions are also not applicable to Specified fund referred to in section 10(4D).
(Section 115BAC, 115BAD and 115BAE are discussed later on in this chapter)
Tax credit for AMT [Section 115JD]
(i) AMT paid in excess of the regular income-tax payable under the provisions of the Income-tax
Act, 1961 for the year would be eligible for credit to be carried forward and set -off against
income-tax payable in the later year to the extent of excess of regular income-tax payable
under the provisions of the Act over the AMT payable in that year. The balance tax credit, if
any, shall be carried forward to the next year for set-off in that year in a similar manner.
Where the amount of tax credit in respect of any income-tax paid in any country or specified
territory outside India under section 90 or section 90A or section 91, allowed against the
alternate minimum tax payable, exceeds the amount of the tax credit admissible against the
regular income-tax payable by the assessee, then, while computing the amount of credit
under this sub-section, such excess amount shall be ignored.
In other words, the amount of tax credit in respect of AMT shall not be allowed to be carried
forward to subsequent year to the extent such credit relates to the difference between the
amount of foreign tax credit (FTC) allowed against AMT and FTC allowable against the
regular tax payable by the assessee.
(ii) AMT credit can be carried forward for set-off upto a maximum period of 15 assessment years
succeeding the assessment year in which the credit becomes allowable.
(iii) No interest shall, however, be payable on such tax credit.
(iv) If the amount of regular income-tax or AMT is reduced or increased as a result of any order
passed under the Income-tax Act, 1961, the amount of tax credit allowed under section 115JD
would also vary accordingly.
(v) The provisions of AMT credit shall not apply to a person
- a resident co-operative society who has opted for section 115BAD or 115BAE or
- where income tax payable in respect of total income of such person is computed as
per section 115BAC(1A) [Section 115JD(7)].
 a
ASSESSMENT OF VARIOUS ENTITIES 9.69

Tax Credit allowable even if Adjusted Total Income does not exceed ` 20 lakh in the year of
set-off [Section 115JEE(3)]
The credit for tax paid under section 115JC shall be allowed in accordance with the provisions of
section 115JD, notwithstanding the conditions mentioned in sub-section (1) or (2) of section 115JEE.
Hence, even if the assessee has not claimed any deduction under section 10AA or section 35AD or
Chapter VI-A under the heading “C- Deductions in respect of certain incomes” in any previous year
and the adjusted total income of that year does not exceed ` 20 lakh, it would still be entitled to set-
off his brought forward AMT credit in that year.
Related Provisions
(i) Correspondingly, under section 140A, for determination of self-assessment tax payable, tax
credit claimed to be set-off in accordance with section 115JD has also to be reduced.
(ii) Such tax credit allowed to be set-off in accordance with the provisions of section 115JD has
to be reduced from the amount of tax on total income determined under section 143(1) or on
regular assessment, on which interest under section 234A is leviable for default in furnishing
return of income.
(iii) Similarly, section 234B levies interest for default in payment of advance tax, to enable
reduction of tax credit under section 115JD while computing “assessed tax”.
(iv) Likewise, in section 234C levying interest for deferment of advance tax, such tax credit under
section 115JD has to be reduced for computing “tax due on the returned income”.
ILLUSTRATION 6
Mr. Rajesh has income of ` 45 lakhs under the head “Profits and gains of business or profession”. One
of his businesses is eligible for deduction @100% of profits under section 80-IB for A.Y. 2026-27. The
profit from such business included in the business income is ` 20 lakhs. Compute the tax payable by Mr.
Rajesh, assuming that he has no other income during the P.Y. 2025-26 and he has exercised the option
to shift out of default regime under section 115BAC.
SOLUTION
Computation of regular income-tax payable under the provisions of the Act
Particulars `
Profits and gains of business or profession 45,00,000
Gross total Income 45,00,000
Less: Deduction under section 80-IB 20,00,000
Total Income 25,00,000
 9.70 DIRECT TAX LAWS

Tax payable
Up to ` 2,50,000 Nil
5% on next ` 2,50,000 12,500
20% on next ` 5,00,000 1,00,000
30% on balance ` 15,00,000 4,50,000
5,62,500
Add: Health and education cess@ 4% 22,500
Tax liability 5,85,000

Computation of Alternate Minimum Tax (AMT)

Particulars `
Total Income as per the regular provisions of the Income-tax Act, 1961 25,00,000
Add: Deduction under section 80-IB 20,00,000
Adjusted Total Income 45,00,000
AMT @ 18.5% of ` 45,00,000 8,32,500
Add: Health and Education Cess @ 4% 33,300
AMT liability 8,65,800

Since the regular income-tax payable as per the provisions of the Act is less than the AMT, the
adjusted total income of ` 45 lakhs would be deemed to be the total income of Mr. Rajesh and he
would be liable to pay tax @18.5% thereof. The tax payable by Mr. Rajesh for the A.Y. 2026-27
would, therefore, be ` 8,65,800.
Mr. Rajesh would be eligible for credit to the extent of ` 2,80,800 [` 8,65,800 – ` 5,85,000] to be
set-off in the year in which tax on total income computed under the regular provisions of the Act
exceeds the AMT. Such credit can be carried forward for succeeding 15 assessment years.

TAXATION OF FIRMS/LLPs AND THEIR PARTNERS

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.

(i) Meaning of Firm/LLP

Under section 2(23) of the Income-tax Act, 1961, 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 any other pe rson who being
 a
ASSESSMENT OF VARIOUS ENTITIES 9.71

a minor, has been admitted to the benefits of an existing partnership. In addition, the
definitions also include the terms limited liability partnership, a partner of limited liability
partnership as they have been defined in the Limited Liability Partnership Act, 2008.
A partnership is the relation between persons who have agreed to share the profits of
business carried on by all or any of them acting for all. The persons who have entered into
partnership with one another are called individually ‘partners’ and collectively a ‘firm’.

Firm

As defined under the Partnership As defined under the Limited

Act, 1932 Liability Partnership Act, 2008

A firm though not a legal person or juridical entity, is chargeable to tax as a 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.
(ii) Residential Status of Firm/LLP
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 India.
(iii) Tax Rate of Firm/LLP
Every firm is liable to pay tax flat rate of 30% on its total income of the previous year computed
in accordance with the provisions of the Act, plus surcharge @12% if its total income exceeds
` 1 crore plus health and education cess @4%.

Salient features of assessment of partnership firms

The following are the salient features of assessment of partnership firms:
(a) The firm will be taxed as a separate entity. There will be no distinction between
registered and unregistered firm.
 9.72 DIRECT TAX LAWS

(b) 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).
(c) 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.
(d) Where a firm pays interest to any partner, the firm can claim deduction of such
interest from its total income subject to certain conditions. However, the maximum
rate at which interest can be allowed to a partner will be 12% per annum.
(e) The income of the firm will be taxed at a flat rate of 30% plus surcharge @12% if
its total income exceeds `1 crore plus health and education cess @4%.

(iv) Assessment as firm [Section 184]

 Conditions to be fulfilled:

To get the status of PFAS, the firm should be evidenced by an “instrument”. The word
“instrument” means a document of legal nature by which any right or liability is created,
limited, extended, or extinguished.

Instrument does not necessarily mean a regular partnership deed, but it may constitute
any other relevant document. If the terms of a partnership are contained in a number
of documents or in the correspondence between the parties, the documents or letters
would constitute “instrument” for the purposes of section 184(1)(i).

The next condition is that the individual shares of partners must be specified in the
instrument. A firm cannot get the status of PFAS unless the instrument of partnership
specifies the individual shares of partners in the profits of the partnership. Evidence
regarding the shares of partners should be available within the framework of the
instrument. It should not involve searching of a number of documents.

The next condition is that a certified copy of the instrument should accompany the first
return of income of a firm. As already noted, “instrument” in this sense refers not only
to the partnership deed but also other documents from which the existence of
partnership can be proved. Accordingly, certified copies of all documents will have to
be submitted. Section 184 requires that the copy of the instrument shall be certified in
writing by all partners other than minors. If, however, the return is made after the
dissolution of the firm, it should be certified by all partners other than minors who were
partners in the firm immediately before dissolution and by the legal representative of
 a
ASSESSMENT OF VARIOUS ENTITIES 9.73

any such partner who is deceased. The certified copy of the instrument of partnership
shall accompany the return of income of the firm of the previous year relevant to the
assessment year.

If there is any change in the constitution of the firm or profit-sharing ratio during any
previous year, a certified copy of the revised instrument of partnership should be filed
along with the return of income of the relevant assessment year. Even if there is a
change in remuneration/payment of interest to partners but there is no change in profit
sharing ratio, a copy of the revised instrument of partnership should be submitted
along with return to comply with the provisions of section 40(b).

Section 184(5) provides that where the firm commits any default as mentioned in
section 144 (Best Judgment assessment - Refer Chapter 15: Assessment Procedure
for detailed discussion), the firm shall be so assessed that no deduction for payment
of interest, salary, bonus, commission or remuneration, by whatever name called,
made by the firm to any partner shall be allowed in computing the income chargeable
under the head “Profits and gains of business or profession”. However, the interest,
salary, bonus, commission or remuneration so disallowed shall not be charged to tax
in the hands of the partners under section 28(v).

Partnership Firm assessed as Firm [PFAS] – If

a certified copy
of the revised
a certified copy
instrument of
individual of the
the firm is partnership
shares of instrument
evidenced by filed along with
partners are accompany the
an the return of
specified in the first return of
“instrument”. income of the
instrument income of a
relevant
firm
assessment
year

 Computation of income of partnership firm: While computing the income of a firm

assessed as such, we have to keep in mind the following points:
(a) Remuneration is to be allowed
(b) Interest is to be allowed
 9.74 DIRECT TAX LAWS

(c) Unabsorbed depreciation and other losses should be provided for.

 Remuneration paid to partners: First let us discuss the question of deduction of
remuneration to the partners. In this context we have to remember the conditions
prescribed by section 37 as regards the allowability of residuary expenses.
Accordingly, no capital expenditure or personal expenses will be allowed. Further the
remuneration paid must be only and exclusively for the purposes of the business of
the firm. Apart from the general conditions prescribed in section 37 there are certain
specific conditions prescribed by section 40(b).
They are as follows: -
(1) Such remuneration should be paid only to the working partner.
(2) It should be authorised by the partnership deed.

(3) It should not pertain to a period prior to partnership deed.

(4) It should not exceed the permissible limit.
(1) Payment should be to a working partner:

Explanation 4 to section 40(b) defines working partner as one who is actively engaged
in conducting the affairs of the business or profession of the firm of which he is a
partner. This definition is very general. It seems that a partner can be a working partner
in more than one firm. If a partner is employed somewhere else too, he can still be a
working partner in the firm. However, in all such situations the partner must in fact be
a working partner in the firm. In other words, merely because a person is working
somewhere else too, such a fact does not by itself debar him from being a working
partner in a firm in which he is a partner. As stated before, to be a working partner,
the partner has to be actively engaged in conducting the affairs of the business or
profession of the firm. Now in order to be actively engaged in conducting the affairs of
the business or profession does not require either expressly or by implication that the
concerned partner should be so actively engaged in conducting the business affairs
on a full-time basis. A partner can be said to be actively engaged in conducting the
affairs of the firm even if he devotes a part and not the whole of his working hours.
Further, in order to be actively engaged in the affairs, a partner is not expected to be
engaged in the whole of the affairs of the business of the firm, nor is he expected to
know everything about the affairs of the business of the firm. For example, in a firm
with many partners, one partner may be looking after purchases, another after sales
 a
ASSESSMENT OF VARIOUS ENTITIES 9.75

and another after production and still another after administration, finance and
accounts. It cannot be contended that just because they are not overall in charge, they
cannot be considered as working partner.
Another significant point to be noted here is that the definition of “working partner” in
Explanation 4 contemplates an individual. Therefore, a partner other than an individual
(example a company) cannot be working partner. An interesting situation may be
considered here. When a company is a partner in a firm, a director or shareholder of
the company can very well be an employee of the firm in which the company is a
partner. Any salary/remuneration paid by the firm to such an employee would be totally
outside the ambit of disallowance under section 40(b). This would be so because the
individual who is an employee of the firm is not a partner in the firm. It is the company
in which he is the director, which is the partner and, section 40(b) contemplates
allowance of remuneration paid by a firm to its partners and not to other employees.
(2) It should be authorised by the Partnership Deed:

Any payment of salary, bonus, commission or remuneration by whatever name called

to a working partner is not allowed as a deduction if the payment is not authorised by
partnership deed or it is not in accordance with the terms of partnership deed. As a
result, a mere general authority in the partnership deed that such and such working
partners would be paid remuneration as may be agreed upon between the partners
from time to lime will not be sufficient. The partnership deed will have to contain clear
direction as to the quantum of remuneration to be paid to the working partners. The
CBDT had, vide Circular No. 739 dated 25-3-1996, clarified that no deduction under
section 40(b)(v) will be admissible unless the partnership deed either specifies
the amount of remuneration payable to each individual working partner or lays
down the manner of quantifying such remuneration. For example, such
remuneration may be specified by way of annual fixed payment or as a certain
specified percentage of the firm’s book profit at the year end. It may be noted that such
remuneration need not be paid on a monthly basis. An item like commissi on can be
paid even as a percentage of sales. Remuneration also can be yearly payment.
Now, a question arises whether the names of individual working partners should be
specified in the partnership deed or whether it is sufficient if the total remuneration
payable to the working partners as a whole is indicated. One opinion is that it is no t
necessary that individual partners should be identified or designated. It will be
sufficient to lay down an authorisation in the deed to the effect that remuneration will
 9.76 DIRECT TAX LAWS

be payable to the class of working partners up to so and so percentage of the book

profit. And further that, within such limits, the working partners shall share such
remuneration in any ratio as may be agreed upon. In other words, this concept gives
recognition to the working partners as a class and authorising remuneration for the
class rather than identifying or designating individual working partners and authorising
remuneration for each individual working partner. There is nothing in section 40(b)
which prohibits this type of interpretation. However, in order to avoid litigation, it is
better that the deed identifies and designates the working partners as well as the
remuneration payable to them.
As a result of this stipulation, every firm constituted on or after April 1, 1992 will have
to provide for an appropriate clause in its partnership deed satisfying this requirement.
However, so far as the existing firms are concerned, they will have to ex ecute a
supplementary deed or a deed of change in the constitution so as to incorporate a
clause within the deed of partnership relating to payment of remuneration to its working
partners.
(3) It should not pertain to period prior to partnership deed:
By virtue of a further restriction contained in 40(b)(iii), such remuneration paid to the
working partners will be allowed as deduction to the firm from the date of such
partnership deed and not from any period prior thereto. Consequently, if for instance a
firm incorporates the clause relating to payment of remuneration to the working partners
by executing an appropriate deed as on July 1st, but effective from April 1st, the firm
would get deduction for the remuneration paid to its working partners from July 1st
onwards but not for the period from April 1st to June 30th. In other words, it will not be
possible to give retrospective effect to oral agreements entered into vis-a-vis such
remuneration prior to putting the same in a written partnership deed.
ILLUSTRATION 7
A and B entered into partnership agreement on April 1, 2025. As per the deed, each
of them will be entitled to salary of ` 2,000 per month apart from profit. On August 1,
2025, they executed a supplementary deed by which they increased the remuneration
to ` 3,000 each effective from 1st April 2025. Discuss the validity of the supplementary
deed.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.77

SOLUTION

Remuneration will be payable effectively from the date of the deed which provides for
the payment of such remuneration. In the given case, the original deed provides for
remuneration at the rate of ` 2,000 for each partner from April 1, 2025 onwards. The
supplementary deed is executed on August 1, 2025 increasing the limit of
remuneration. Such an increase in the limit of remuneration will be allowable only from
1st August 2025, being the date of supplementary deed. Hence, for the period from
1st April 2025 to 31st July 2025, the partners will be allowed remuneration only at the
rate of ` 2,000 per month.
(4) It should not exceed the permissible limit:
As we have seen earlier, salary, bonus, commission or other remuneration may be
paid to any working partner in accordance with and as authorised by the terms of
the partnership deed and in relation to any period falling after the partnership deed.
However, the maximum amount of such payment to all the partners during the
previous year should not exceed the limits given below:-
Book Profit Quantum of Deduction
On the first ` 6 lakh of book profit or in ` 3,00,000 or 90% of book profit,
case of loss whichever is higher
on the balance of book profit 60% of book profit

Book Profit:
The permissible remuneration is to be computed as a percentage of book profit. For
this purpose, we have to draw up the profit and loss account and find the net profit.
This profit and loss account is to be prepared in the manner laid down in Chapter
IV-D. It may be noted that Chapter IV-D contains the provisions relating to
computation of income under the head ‘Profits and gains of business or profession’.
Further, Explanation 3 also lays down that if while arriving at the above net profit,
the remuneration paid/payable by a firm to its partners is debited to such a profit and
loss account, the aggregate of such remuneration paid/payable to the partners
shall be added to the net profit in order to arrive at the book profit.
When the Act says that the profit and loss account should be prepared in the manner
laid down in Chapter IV-D, it means that only those items which are chargeable under
section 28 as income will be taken into account and only deductions permissible
thereunder will be allowed.
 9.78 DIRECT TAX LAWS

For example, rent from house property, dividend, interest on bank deposit or
government securities are not chargeable as income from business or profession
under section 28. Therefore, if the profit and loss account of a firm contains these
receipts, they have to be excluded while calculating the net profit.
In the same way, items which are to be disallowed under the various provisions from
sections 28 to 44D will have to be eliminated. It naturally follows, therefore, that
brought forward business losses will not be deducted while calculating book profit.
In simple terms, ‘book profit’ means income computed under the head “Profits and
gains of business or profession” before deduction of partners remuneration.
Accordingly, unabsorbed depreciation can be set-off under section 32(2) against
such income to arrive at the book profit, but not unabsorbed business loss under
section 72.

The above table shows the upper limits up to which deduction is allowed to firm in
respect of the remuneration paid to its working partners. It does not mean that a firm
is prohibited from paying remuneration beyond these limits. A firm can pay
remuneration to working partners beyond these limits, but it will suffer disallowance in
respect of such excess under section 40(b) and consequently pay tax on it @30%. If
a firm pays remuneration to non-working partners, the same will be the result.
However, the above limits apply to the remuneration paid to the group of all working
partners in a firm taken together and not to each individual partner. Finally, it may be
noted that section 40(b) does not compel a firm to pay remuneration to its working
partners. It is purely at the discretion of the firm. However, once a firm pays
remuneration to its working partners it will be subject to the restrictive provisions of
section 40(b). It is also open to a firm to pay salary only to a few working partners a nd
not all the working partners.
 Interest payable to partners: So far as allowability of interest paid by a firm to its
partners under section 40(b) is concerned, the following conditions have been
prescribed by section 40(b):
(1) The interest payable by a firm to its partners should be authorised by and in
accordance with the partnership deed.
(2) The interest payable by a firm to its partners should not be for a period falling
prior to the date of such partnership deed authorizing the payment of such
interest.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.79

(3) The rate of interest payable to the partners shall not exceed 12% simple
interest per annum.

An important question could be regarding the amount with reference to which this
interest @12% will have to be calculated. For example, a partner may have contributed
capital to the firm and in addition may also advance loan to the firm. The question
would be whether the interest paid by the firm on capital would be allowable or that on
the loan would be allowable. Moreover, some firms have an accounting system of
maintaining current accounts of partners in addition to the capital accounts. When
some balance is standing to the credit of a partner in such current account as well the
question arises whether the interest paid on the balance in the current account will be
allowable within the meaning of section 40(b).
In this regard, it may be noted that section 40(b) does not refer to nor does it make
any distinction between the capital contributed by a partner to the firm, the loan
advanced by a partner to the firm or the balance in the current account of a partner.
Therefore, the interest paid by a firm to its partners on the credit balance standing
in all the accounts/whether in capital account, loan account or current account,
shall be allowed as deduction to the firm under section 40(b). The idea seems to
be to allow interest on the funds employed in the firm by a partner.
As it happens, many a time, a partner may have debit balance in his current account
and credit balance in his capital account or loan account. The question which would
arise in such a situation could be whether the interest payable to such a partner at the
rate of interest authorised by and in accordance with partnership deed will be reckoned
with reference to the aggregate of the credit balance in the capital account and the
loan account including the debit balance in the current account or whether it should be
calculated on the net balance that is the aggregate of the credit balance in the capital
account and in the loan account as reduced by the debit balance in the current
account. It appears that in such a situation the equitable principle would be to allow
interest reckoned with reference to the net balance. Alternatively, if interest is
recovered from a partner on the debit balance in his account and interest is paid to the
same partner on the credit balance in his account, the net amount paid to that partner
would be subjected to the provisions of section 40(b). However, interest received from
one partner cannot be set-off against interest paid to another partner.
The next issue which is to be considered here is the point of time at which interest
should be credited to the partners’ accounts. For example, a firm may adopt a policy
of crediting interest quarterly to the credit of the partners’ accounts. In such a ca se,
 9.80 DIRECT TAX LAWS

the firm would be paying in effect interest on interest at the year end. This would
amount to compounding interest quarterly. This is not permitted under section 40(b)
because what that section contemplates is simple interest and simple interest here
would mean interest which is calculated yearly or annually. Paying the interest on
interest credited periodically during a year would be contrary to the concept of simple
interest per annum.
 Partner in a representative capacity: If an individual is a partner in a firm in a
representative capacity (that is on behalf and for the benefit of another person) and
not in his personal capacity then, interest paid by the firm to such individual in his
personal capacity and not as a representative capacity will not be subject to the
conditions and ceiling as prescribed for disallowance. But interest paid by the firm to
such individual as representative partner or person represented shall be subject to the
conditions and ceiling as prescribed [Explanation 1 to section 40(b)].

Example: X is a partner in a firm in a representative capacity for and on behalf of his

HUF. Supposing the firm pays interest of ` 6,000 to X in his personal capacity and not
in his capacity as the representative of HUF, it will be allowed as deduction and the
prescribed ceiling will not apply. However, if such payment is made to X as a
representative partner or if the firm has paid the interest directly to HUF, then the
payment will be subject to the conditions and ceiling as prescribed.

 Interest received by a non-representative partner: If interest is paid to an individual

partner who is not the representative partner and the interest received by him is on
behalf of or for the benefit of another person, then such interest payment shall be
allowed without applying the ceiling limits [Explanation 2 to section 40(b)].

Example: X is a partner of a firm in his individual capacity and is not a representative

partner. Interest is paid by the firm to him in respect of a deposit made by his wife.
This will be allowed as a deduction because such interest is received by him purely on
behalf of another person.

 TDS on salary, remuneration, commission, bonus or interest to partner: Firm is

responsible to deduct tax @10% on any sum in the nature of salary, remuneration,
commission, bonus or interest paying to its partner.
The deduction of tax has to be made at the time of crediting such sum to the account
of the partner (including the capital account) or at the time of its payment, whichever
is earlier.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.81

No deduction of tax shall be made where such sum or the aggregate of such sums
credited or paid or likely to be credited or paid to the partner of the firm does not
exceed ` 20,000 during the financial year.
ILLUSTRATION 8
M/s. HIG, a firm, consisting of three partners namely, H, I and G, carried on the
business of purchase and sale of television sets in wholesale and manufacture and
sale of pens under a deed of partnership executed on 1.4.2014. H, I and G were
partners in their individual capacity.
The deed of partnership provided for payment of salary amounting to ` 1,25,000 each
to H and G, who were the working partners. A new deed of partnership was executed
on 1.10.2025 which, apart from providing for payment of salary to the two working
partners as mentioned in the deed of partnership executed on 1.4.201 4, for the first
time provided for payment of simple interest @12% per annum on the balances
standing to the credit of the Capital accounts of partners from 1.4.202 5.
The firm was dissolved on 31.3.2026 and the capital assets of the firm were distributed
among the partners on 20.4.2026. The net profit of the firm for the year ended
31.3.2026 after payment of salary to the working partners and debit/credit of the
following items to the Profit and Loss Account was ` 3,50,000:
(i) Interest amounting to ` 1,00,000 paid to the partners on the balances standing
to the credit of their Capital accounts from 1.4.2025 to 31.3.2026.
(ii) Interest amounting to ` 50,000 paid to the partners on the balances standing
to the credit of their Current accounts from 1.4.2025 to 31.3.2026.
(iii) Interest amounting to ` 20,000 paid to the Hindu undivided family of partner H
@ 18% per annum.
(iv) Payment of ` 25,000 towards purchase of television sets (stock in trade) made
by crossed cheque on 1.11.2025.
(v) ` 30,000 being the value of gold jewellery received as gift from a manufacturer
for achieving sales target.
(vi) Depreciation amounting to ` 15,000 (as per Income-tax Rules) on motor car
bought and used exclusively for business purposes but registered in the name
of partner ‘H’.
 9.82 DIRECT TAX LAWS

(vii) Depreciation under section 32(1)(ii) amounting to ` 37,500 of new machinery

bought and installed for manufacture of pens on 1.11.2025 at a cost of
` 5,00,000.
(viii) Interest amounting to ` 25,000 received from bank on fixed deposits made out
of surplus funds.
The firm furnishes the following information relating to it:
(a) Closing stock-in-trade was valued at ` 60,000 as per the method of lower of
cost or net realizable value consistently followed by it. The net realizable value
of the closing stock-in-trade was ` 65,000.
(b) Brought forward business loss relating to the assessment year 2025-26 was
` 50,000.
(c) The fair market value of the capital assets as on 20.4.2026 was ` 20,00,000
and the cost of their acquisition was ` 15,00,000.
Compute the total income of M/s. HIG for the Assessment Year 2026-27.
You are required to furnish explanations for the treatment of the various items given
above.
SOLUTION
Computation of total income of M/s. HIG for the A.Y. 2026-27
Particulars ` `
Net profit as per profit & loss account 3,50,000
Add: Interest to partners on capital accounts for the 50,000
period from 1.4.2025 to 30.9.2025 disallowed (total
interest ` 1,00,000 but deduction limited to 6 months
only hence 50% thereof is deductible and the
balance is added) [Note (i)]
Interest to partners on current accounts from 50,000
1.4.2025 to 31.3.2026 – not authorized by the deed,
hence disallowed [Note (ii)].
100% of ` 25,000 paid towards purchase of 25,000
television sets otherwise than by an account payee
cheque drawn on a bank or an account payee bank
draft or use of electronic clearing system through a
bank account or through such other electronic mode
as may be prescribed (being stock in trade, hence
disallowed) [Note (iv)].
 a
ASSESSMENT OF VARIOUS ENTITIES 9.83

Difference on account of valuation of closing stock- 5,000

in-trade at net realisable value (` 65,000 less
` 60,000) [Note (ix)]
Salary paid to working partners considered 2,50,000 3,80,000
separately.
7,30,000
Less: Additional depreciation on new machinery
(` 5,00,000 x 20%) = ` 1,00,000. Only 50% is
allowable as deduction. [Note (vii)] 50,000
6,80,000
Less: Interest received from bank on fixed deposits
considered separately 25,000
6,55,000
Less: Salary to working partners -
(i) As per limit in section 40(b)
On first ` 6,00,000 @ 90% 5,40,000
On the balance of `55,000 @ 60% 33,000
5,73,000
(ii) Salary actually paid 2,50,000
Deduction allowed being (i) or (ii), whichever 2,50,000
is less
4,05,000
Less: Business loss relating to A.Y. 2025-26 set off 50,000
Income from business 3,55,000
Income from other sources
Interest received from bank on fixed deposits [Note (viii)]. 25,000
Total Income 3,80,000

Notes:

(i) Interest to partners authorised by the partnership deed will be allowed as

deduction only for the period beginning with the date of the partnership deed
and not for any earlier period as per section 40(b)(iv). Therefore, interest paid
to the partners on the balances standing to the credit of their capital accounts
from 1.10.2025 alone is eligible for deduction, since the partnership deed was
executed only on 1.10.2025. Interest for the period prior to 1.10.2025 is not
allowed.
 9.84 DIRECT TAX LAWS

(ii) The partnership deed of 1.10.2025 provides for payment of interest on balances
in capital accounts of partners only. As such, the interest paid on the balances
standing to the credit of the current accounts of partners is not allowable under
section 40(b). The Kerala High Court has, in Novel Distributing Enterprises v.
DCIT (2001) 251 ITR 704 (Ker), on identical facts, held that interest paid to the
partners on their current account balances is not allowable.
(iii) Since H is a partner in his individual capacity, interest paid to the Hindu
Undivided Family of partner H does not attract disallowance under section
40(b)(iv). Also, assuming that the provisions of section 40A(2) do not get
attracted in this case, such interest shall be allowed as deduction in full even
though the interest rate is more than 12% p.a.

(iv) Section 40A(3) provides for disallowances @100% of the expenditure incurred
for an amount exceeding ` 10,000 otherwise than by an account payee cheque
drawn on a bank or an account payee bank draft or use of electronic clearing
system through a bank account or through such other electronic mode as may
be prescribed. Since the firm has made payment of ` 25,000 towards purchase
of television sets by a crossed cheque and not by an account payee cheque,
100% of such expenditure would be disallowed.
(v) Gold jewellery valued at ` 30,000 received as gift from a manufacturer for
achieving sales target is taxable under section 28(iv), being a benefit arising
from business. Since it has already been credited to profit and loss account, no
further adjustment is required.
(vi) Depreciation on motor car bought and used exclusively for the purposes of
business is allowable though not registered in the name of the firm in view of
the ratio of the decision of the Supreme Court in Mysore Minerals Ltd. v. CIT
(1999) 239 ITR 775.
(vii) The firm is entitled to additional depreciation @ 20% under section 32(1)(iia) in
respect of the new machinery installed for manufacture of pens. Since the new
machinery is put to use for less than 180 days during the relevant previous
year, the additional depreciation is restricted to 50% of the prescribed rate of
20% i.e., it is restricted to 10%. The balance additional depreciation can be
claimed in the immediately succeeding financial year.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.85

(viii) Interest received from bank on fixed deposits made out of surplus funds is
assessable under the head ‘Income from other sources’. Hence, it is not taken
into account for the purpose of computing book-profit.
(ix) As per para 24 of ICDS II: Valuation of Inventories, closing stock has to be
valued at net realizable value in the case of a dissolved firm. As such, the
closing stock-in-trade of the firm has to be valued at the net realizable value of
` 65,000. Since it has been valued at ` 60,000, being the cost, the balance
` 5,000 has to be added.
(x) Net profit shown in the profit and loss account computed in the manner laid
down in Chapter IV-D as increased by the aggregate amount of the
remuneration paid or payable to all the partners constitutes book profit as per
Explanation 3 to section 40(b). Carry forward and set off of business loss is
covered under Chapter VI. Hence, brought forward business loss relating to the
assessment year 2025-26 is not considered for calculation of book-profit.

(xi) Section 9B would be attracted in the hands of M/s HIG in the A.Y. 2027-28, since
capital assets are received by the partners on 20.4.2026, i.e., P.Y. 2026-27.
 Computation of income of partner of a firm (PFAS): While computing the income
of a partner including a minor partner of a firm, the following points have to be taken
into consideration.
Share income exempt under section 10(2A): The partner’s share in the total income
of firm (PFAS) will be exempt in his hands and will not be included in his total income.
His share in the total income of the firm will be calculated as follows: -
Partner's share in profits of firm as per partnership deed
Total income of firm 
Total profit of the firm

By virtue of this exemption, a partner of PFAS will not be taxed in respect of his share
in the firm’s income since the firm itself will be taxed as a separate entity @30%. There
will be no allocation of income among the partners. On account of this exemption, he
will not be entitled to set-off his share in the firm’s loss against his other personal
income.
Chargeability of remuneration and interest: Remuneration and interest received by
a partner of a PFAS in accordance with the conditions prescribed under section 40(b)
will be taxable in his hands as income from profits and gains of business or profession.
 9.86 DIRECT TAX LAWS

If remuneration or interest paid to a partner is disallowed in the assessment of the firm

due to the fact that they are not in accordance with the conditions prescribed under
section 40(b) then the partner will not be taxed in respect of the amount disallo wed
because in such a case the firm itself will be liable to pay tax on the amount which has
been disallowed in its assessment. In other words, if the firm is given the benefit of
deduction of remuneration and interest paid to a partner then the liability to tax in
respect of such amount will be that of a partner. If the firm is not given the benefit of
deduction because of the non-compliance with the provisions of section 40(b) then the
firm itself will be liable in respect of the amount and the partner will not be taxed in
respect of it in his personal assessment. It is obvious that such remuneration or
interest which has been disallowed in the hands of the firm but actually received by a
partner will be assumed to be his share in the income of such firm and exemption
under section 10(2A) will operate.
Suppose a portion of the remuneration and interest in the assessment of the firm is
disallowed since they exceed the overall ceiling limit prescribed under section 40(b),
the question arises as to how to allocate such disallowance in the hands of the partner.
One reasonable basis is to assume that the remuneration and interest paid to the
partners concerned has been disallowed in proportion to the gross remuneration and
interest paid to them and the exemption of the disallowed sum should be available to
the partners in the same proportion.
 Assessment of firms – Some of the important issues to be considered by the
Assessing Officer while framing assessment [Circular 12/2019, dated 19.6.2019]:
(i) While computing remuneration which is allowable to a working partner under
section 40(b)(v), the term 'in accordance with the terms of the partnership deed'
in clauses (ii) and (v) of section 40(b) implies that remuneration should not be
undetermined or undecided. Hence, in all situations, partnership deed should
form the basis for determination of remuneration payable to the working
partners. Furthermore, in situations where the remuneration either so specified
in the partnership deed or computed as per the method indicated therein falls
short of the amount allowable under section 40(b)(v), it would be restricted to
the figure computed on the basis of the partnership deed.
(ii) While computing remuneration payable to the working partners under section
40(b)(v) of the Act, the remuneration should not exceed a particular aggregate
amount which is based upon the figure of 'book profit'. Explanation 3 to section
40(b) contains definition of 'book profit' for the purposes of determination of
 a
ASSESSMENT OF VARIOUS ENTITIES 9.87

remuneration of the partners and provides that 'book profit' shall mean the net
profit, as shown in the profit & loss account for the relevant previous year,
computed in the manner laid down in Chapter IV-D as increased by the
aggregate amount of the remuneration paid or payable to all the partners of the
firm if such amount has been deducted while calculating the net profit.
Therefore, while computing 'book profit' for purposes of section 40(b)(v), all
incomes such as capital gain, interest, rental income, income from other
sources etc. which do not fall under the head 'Profits and gains of business or
profession', should be excluded.
(iii) Under section 185, any non-compliance by the firm or its partners with
provisions of section 184 may result in denial of expenses such as
remuneration, interest etc. payable to the partners which are otherwise
allowable under the provisions of the Act.
(iv) Where firms try to inflate the profits eligible for deduction under section 80 -IA
by not claiming expenditure towards remuneration, salary, interest etc. which
are payable to the partners, the Assessing Officers may examine these
transactions in light of provisions of section 80-IA(10) which empower
Assessing Officer to re-compute profit of the eligible business after excluding
the profits of the related activity/business which produced the excessive profit.
 Treatment of losses: If PFAS incurs any loss, the firm alone can set off and forward
such losses to be set off against income of the subsequent years. The firm will not be
allowed to apportion its unabsorbed losses among its partners.
 Set off of carry forward loss in case of change in the constitution of the firm
[Section 78]: If there is a change in the constitution of the firm, the loss of a
retired/deceased partner can be carried forward by the firm only to the extent that it
does not exceed such partner’s share in the profits of the firm of the relevant previous
year.

However, it is to be carefully noted that section 78 is applicable only in case there is a

change in the constitution of the firm as result of retirement or death of a partner in the
previous year. In other words, it does not apply when there is a change in the profit -
sharing ratio or change in the constitution because of induction of a new partner.
Similarly, section 78 will not apply to set off and carry forward of unabsorbed
depreciation etc.
 9.88 DIRECT TAX LAWS

Example: ABC & Co. is a firm with 3 partners – A, B & C having equal profit-sharing
ratio. For the P.Y. 2025-26, the loss from business is ` 3,00,000 and unabsorbed
depreciation is ` 1,50,000. Business loss and unabsorbed depreciation represents the
amount after inter-source and inter-head set-off. C retires on 31.03.2026 from the firm.
Firm can carry forward business loss of ` 2,00,000 (3,00,000 – 1,00,000) and
unabsorbed depreciation of ` 1,50,000 for set-off against income of subsequent
assessment years.

 Liability of partner of LLP in liquidation [Section 167C]: This section provides for
the liability of partners of LLP in liquidation. In case of liquidation of an LLP, where tax
due from the LLP cannot be recovered, every person who was a partner of the LLP at
any time during the relevant previous year will be jointly and severally liable for
payment of such tax unless he proves that non-recovery cannot be attributed to any
gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the
LLP. This provision would also apply where tax is due from any other person in respect
of any income of any previous year during which such other person was a LLP. “Tax
due”, for the purpose of this section includes penalty, interest or any other sum payable
under the Income-tax Act, 1961.
 Assessment in case of change in constitution, succession and dissolution of a
firm [Section 187 to 189A]
Change in constitution of a firm: Where at the time of making an assessment under
section 143 or 144 it is found that a change has occurred in the constitution of a firm,
assessment shall be made on the firm as constituted at the time of making the
assessment.
Meaning of change in constitution of the firm: It means
(a) If one or more of the partners cease to be partners (other than a case where
ceases to be a partner by way of demise of the partner) or one or more new
partners are admitted, in such circumstances that one or more of the persons
who were partners of the firm before the change continue as partner or partners
after the change.
(b) All the partners of firm continue to be the partner of the firm but there is a
change in their profit-sharing ratio or change in shares of some of them.
Succession of one firm by another: In a case where a firm carrying on a business
or profession is succeeded by another firm; separate assessment will be made on the
 a
ASSESSMENT OF VARIOUS ENTITIES 9.89

predecessor firm and the successor firm in accordance with the provisions of section
170 [Section 188].
Liability of partners: Where any tax, penalty or other sum payable by the firm for the
relevant previous year is due, then every person being a partner of a firm and the legal
representative of deceased partner during the previous year shall be jointly and
severally liable along with the firm in respect of such sum [Section 188A].
Dissolution of firm or discontinuance of business: Where a firm is dissolved or
business or profession is discontinued by the firm, the Assessing Officer shall make
an assessment of the total income of the firm as if no discontinuance or dissolution
has taken place and all the provisions of the Act relating to levy of a penalty or any
other sum chargeable under this Act, shall be applicable accordingly [Section 189].
Every person who was at the time of dissolution or discontinuance a partner of a firm
and the legal representative of deceased partner shall be jointly and severally liable
for the amount of tax, penalty or other sum payable by the firm and all the provis ions
of the Act shall apply accordingly. If any proceedings have commenced in respect of
any assessment year before dissolution or discontinuance, the proceeding may be
continued against such persons (i.e., partner and legal representative) from that stage .
The liability of legal representative is limited to the extent to which the estate is capable
of meeting the liability.

Tax consequences on transfer of capital asset to a partner on dissolution or

reconstitution of a firm - Section 9B deals with taxability on receipt of capital asset
or stock in trade or both by a partner from a firm on dissolution or reconstitution of
firm. The taxability of receipt of money or capital asset or both by a partner on
reconstitution of a firm is dealt with in section 45(4). Thus, in a case of reconstitution
of firm, where a partner receives capital asset from the firm, the provisions of both
section 9B and 45(4) are attracted in the hands of the firm. The taxation under these
two provisions has to be worked out independently.
Tax treatment on dissolution of firm is dealt with in section 9B and is not covered under
section 45(4). For details, please refer Chapter 4: Capital Gains in Module 1

ILLUSTRATION 9
Vijay Agencies, a partnership firm constituted by three partners with equal shares was
dissolved on 1-03-2025 after a search. The tax liability of the firm outstanding to be
paid was determined at ` 15 lakhs. Out of three partners, one was declared insolvent
on 18-03-2026 by the Court. The Assessing Officer, for recovering the demand,
 9.90 DIRECT TAX LAWS

attached the Bank Accounts of other two partners and could recover an amount of ` 6
lakhs from the Account of one such partner. You are asked the following questions by
the partners of the dissolved firm:
(i) About the liability of each of them to pay outstanding demand.
(ii) Whether the action of Assessing Officer to attach the Bank Account of partners
to recover the tax demand of the dissolved firm is justified?
SOLUTION
As per section 189(3), every person who was at the time of dissolution, a partner of
the firm, shall be jointly and severally liable for the amount of tax, penalty or other sum
payable and all the provisions of the Act relating to assessment of such tax or
imposition of such penalty or other sum, shall apply. Therefore,
(i) the three partners (till one was declared as insolvent by the Court) are jointly
and severally liable for making the payment of outstanding dues of ` 15 lakhs.
After insolvency of one partner, the other two partners are jointly and severally
liable to pay such demand.
(ii) Accordingly, the action of the Assessing Officer to attach the bank accounts of
the partners for recovery of outstanding demand is correct and the amount of
` 6 lakhs recovered by attachment of the bank account of one of the partners
is also in order.
 Conversion of company into an LLP
(i) 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 had incorporated the taxation scheme of
LLPs in the Income-tax Act, 1961 on the same lines 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.
(ii) Under section 56 and section 57 of the Limited Liability Partnership Act, 2008,
conversion of a private company or an unlisted public company into an LLP is
permitted. Consequently, section 47(xiiib) has been inserted under the Income-
tax Act, to provide that -
(1) any transfer of a capital asset or intangible asset by a private company
or unlisted public company to an LLP; or
 a
ASSESSMENT OF VARIOUS ENTITIES 9.91

(2) any transfer of a share or shares held in a company by a shareholder

on conversion of a company into an LLP in accordance with section 56 and
section 57 of the Limited Liability Partnership Act, 2008, shall not be regarded
as a transfer for the purposes of levy of capital gains tax under section 45,
subject to fulfillment of certain conditions. This clause has been introduced to
facilitate conversion of small private and unlisted public companies into LLPs.
These conditions are as follows:
(1) the total sales, turnover or gross receipts in business of the company
should not exceed ` 60 lakhs in any of the three preceding previous
years;
(2) all the shareholders of the company immediately before conversion
become partners of the LLP in the same proportion as their shareholding
in the company;
(3) no consideration other than share in profit and capital contribution in the
LLP arises to the shareholders;
(4) the erstwhile shareholders of the company continue to be entitled to
receive at least 50% of the profits of the LLP for a period of 5 years from
the date of conversion;
(5) The total value of assets as appearing in the books of account of the
company in any of the three previous years preceding the previous year
in which the conversion takes place, should not exceed ` 5 crores;
(6) all assets and liabilities of the company become the assets and liabilities
of the LLP; and
(7) no amount is paid, either directly or indirectly, to any partner out of the
accumulated profit of the company for a period of 3 years from the date
of conversion.
(iii) However, if subsequent to the transfer, any of the above conditions are not
complied with, the capital gains not charged under section 45 would be deemed
to be chargeable to tax in the previous year in which the conditions are not
complied with, in the hands of the LLP or the shareholder of the predecessor
company, as the case may be [section 47A(4)].
(iv) Further, the successor LLP would be allowed to carry forward and set -off the
business loss and unabsorbed depreciation of the predecessor company
[section 72A(6A)].
 9.92 DIRECT TAX LAWS

However, by virtue of section 72A(6B), the successor LLP can carry

forward the loss of the predecessor company only to the extent of eight
assessment years from the immediate succeeding assessment years in
which such loss was first computed for the original predecessor
company.
(v) However, if the entity fails to fulfill any of the conditions mentioned in (ii) above,
the benefit of set-off of business loss/unabsorbed depreciation availed by the LLP
would be deemed to be the profits and gains of the LLP chargeable to tax in the
previous year in which the LLP fails to fulfill any of the conditions listed above.
(vi) The tax credit under section 115JAA for MAT paid by the company under
section 115JB would not be allowed to the successor LLP [Section 115JAA(7)].
(vii) The actual cost of the block of assets in the case of the successor LLP shall be
the written down value of the block of assets as in the case of the predecessor
company on the date of conversion [Explanation 2C to section 43(6)].
(viii) The aggregate depreciation allowable to the predecessor company and
successor LLP shall not exceed, in any previous year, the depreciation
calculated at the prescribed rates as if the conversion had not taken place.
Such depreciation shall be apportioned between the predecessor company and
the successor LLP in the ratio of the number of days for which the assets were
used by them [Section 32(1)(ii)].
(ix) The cost of acquisition of the capital asset for the successor LLP shall be
deemed to be the cost for which the predecessor company acquired it. It would
be further increased by the cost of improvement of the asset incurred by the
predecessor company or the successor LLP [Section 49(1)].
(x) If the capital asset became the property of the LLP as a result of conversion of
a company into an LLP, and deduction has been allowed or is allowable in
respect of such asset under section 35AD, the actual cost would be taken as
Nil [Explanation 13 to section 43(1)].

However, where an asset, in respect of which deduction is claimed and allowed

under section 35AD is deemed to be the income of the assessee in accordancel
with the provisions of section 35AD(7B) (on account of being used for a purpose
other than specified business under section 35AD), the actual cost of the asset
to the assessee shall be actual cost to assessee as reduced by the amount of
depreciation allowable had the asset been used for the purpose of business,
 a
ASSESSMENT OF VARIOUS ENTITIES 9.93

calculated at the rate in force, since the date of its acquisition [Proviso to
Explanation 13 to section 43(1)]
(xi) If a company eligible for deduction under section 35DDA in respect of
expenditure incurred under Voluntary Retirement Scheme (one-fifth of such
expenditure allowable over a period of five years) is converted into an LLP and
such conversion satisfies the conditions laid down in section 47(xiiib), then, the
LLP would be eligible for such deduction from the year in which the transfer
took place.
(xii) If a shareholder of a company receives rights in a partnership firm as
consideration for transfer of shares on conversion of a company into a LLP,
then the cost of acquisition of the capital asset being rights of a partner referred
to in section 42 of the LLP Act, 2008 shall be deemed to be the cost of
acquisition to him of the shares in the predecessor company, immediately
before its conversion [Section 49(2AAA)].

TAXATION OF CO-OPERATIVE SOCIETIES

(i) 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 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 the Act. Apart from this, the comput ation 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 ITR 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.
 9.94 DIRECT TAX LAWS

(ii) Deduction under section 80P: 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. (Students may refer to the detailed discussion of this provision in Chapter 8
“Deductions from Gross Total Income”.)
(iii) Option to exercise concessional rates of tax under section 115BAD or 115BAE: Section
115BAA provides an option to an existing domestic company to pay tax at concessional rate
of 22%, if it does not claim incentive/exemption and deduction as provided in said section.
Section 115BAB provides that manufacturing domestic companies set up on or after
01.10.2019, which commence manufacturing or production by 31.03.2024 and do not avail of
any specified incentive or deductions, may opt to pay tax at a concessional rate of 15%.
On similar lines, section 115BAD was inserted w.e.f. A.Y. 2021-22 to provide that a co-operative
society resident in India has the option to pay tax at 22%, subject to fulfilment of certain
conditions. Further, w.e.f. A.Y. 2024-25, section 115BAE has been inserted to provide an option
to a manufacturing co-operative society set up on or after 01.04.2023, which commences
manufacturing or production on or before 31.03.2024 and does not avail of any specified
incentive or deductions, may opt to pay tax at a concessional rate of 15%. In both cases,
surcharge would be levied @10% on such tax. However, it may be noted that deduction u/s
80P will not be available under the concessional tax regimes.
Sections 115BAE and 115BAD provides for concessional rates of tax and exemption from
Alternate Minimum Tax (AMT) in respect of certain resident co-operative societies. The
provisions of these two sections are tabulated hereunder -
(1) (2) (3) (4)
Particulars Section 115BAE Section 115BAD
1. Applicability Co-operative society resident Co-operative society
in India engaged in resident in India
manufacturing/generation of
electricity
2. Rate of tax 15% 22%
3. Rate of surcharge 10% 10%
4. Effective rate of tax 17.16% 25.168%
(including surcharge [Tax@15% (+) [Tax@22% (+)
& HEC) Surcharge@10% (+) Surcharge@10% (+)
HEC@4%] HEC@4%]
5. Applicability of AMT Not applicable Not applicable
 a
ASSESSMENT OF VARIOUS ENTITIES 9.95

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
6. Manner of computation of tax liability
Income on which The rate of tax (i.e., 17.16%) is The rate of tax (i.e.,
concessional rate of applicable in respect of income 25.168%) is
tax is applicable derived from or incidental to notwithstanding
manufacturing or production of anything contained in
an article or thing or generation the Income-tax Act,
of electricity. 1961, but subject to
[Read with point no.11 the provisions of
below, wherein the rate of Chapter XII, other than
34.32% (i.e., Tax@30% + section 115BAE
surcharge@10% + HEC@4%)
would be applicable in
specified circumstance]
Rate of tax on Such income would be subject Such income would be
income covered to tax at the rates mentioned in subject to tax at the
under Chapter XII [for the said sections in Chapter rates mentioned in the
example, long-term XII. Surcharge@10% would said sections in
capital gains be levied on tax computed on Chapter XII.
chargeable to tax u/s such income. HEC@4% would Surcharge@10% is
112 and 112A, short- be levied on the income-tax leviable on tax
term capital gains plus surcharge. computed on such
chargeable to tax u/s income. HEC@4%
111A] would be levied on the
income-tax plus
surcharge.
Rate of tax on other The applicable tax rate is The applicable tax rate
income in respect of 25.168% (i.e., tax@22%, plus is 25.168% (i.e.,
which no specific surcharge @10% plus tax@22% plus
rate of tax is HEC@4%), if such income has surcharge@10% plus
provided in Chapter neither been derived from nor HEC@4%).
XII is incidental to manufacturing There is, however, no
or production of an article or restriction regarding
thing or generating electricity claim of any
(For example, income from deduction or
house property and income allowance permissible
from other sources). under the relevant
In respect of such income, no provisions of the Act.
deduction or allowance in
respect of any expenditure
or allowance shall be allowed
in computing such income.
 9.96 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
Rate of tax on STCG The applicable rate of tax is The applicable rate of
derived from transfer 25.168% (i.e., tax@22%, plus tax is 25.168% i.e., tax
of a capital asset on surcharge@10% plus @22%, plus
which no HEC@4%). surcharge @10%
depreciation is There is, however, no plus cess@4%.
allowable under the restriction regarding claiming There is no restriction
Act of deduction or allowance in regarding claiming of
this regard. deduction or allowance
in this regard.
7. Conditions to be fulfilled for availing concessional rate of tax and exemption
from AMT
Conditions to be (i) The co-operative No time limit specified.
fulfilled for availing society should be set- Both existing co-
concessional rate of up and registered on operative society and
tax and exemption or after 1.4.2023. new co-operative
from AMT society can avail
benefit.
(ii) It should commence Need not be engaged
manufacturing or in a manufacturing or a
production of an production
article or thing or
business of
generating electricity
on or before 31.3.2024
(iii) It should not be formed No similar condition
by splitting up or the has been prescribed
reconstruction of a
business already in
existence
(iv) It does not use any No similar condition
machinery or plant has been prescribed
previously used for any
purpose [Refer Note at
the end]
(v) It should not be engaged No similar condition
in any business other has been prescribed
than the business of
manufacture or
production of any article
or thing and research in
 a
ASSESSMENT OF VARIOUS ENTITIES 9.97

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
relation to, or distribution
of, such article or thing
manufactured or
produced by it.
Note – Business of
manufacture or
production of any article
or thing shall include
generation of electricity
does not include
business of –
(1) Development of
computer
software in any
form or in any
media
(2) Mining
(3) Conversion of
marble blocks or
similar items into
slabs
(4) Bottling of gas
into cylinder
(5) Printing of books
or production of
cinematograph
films
(6) Any other
business as may
be notified by the
Central Govt. in
this behalf.
8. Common conditions In case of a co-operative society opting for either section
for both sections for 115BAE or 115BAD, the total income should be computed-
availing the (i) without providing for deduction under any of the
concessional rate of following sections:
tax and exemption
from AMT Section Provision
10AA Exemption of profits and gains derived
from export of articles or things or from
 9.98 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
services by an assessee from unit in
SEZ.
32(1)(iia) Additional depreciation @20%, as the
case may be, of actual cost of new plant
and machinery acquired and installed by
manufacturing undertakings.
33AB Deduction@40% of profits and gains
of business of growing and
manufacturing tea, coffee or rubber in
India, to the extent deposited with
NABARD in accordance with scheme
approved by the Tea/Coffee/ Rubber
Board.
33ABA Deduction@20% of the profits of a
business of prospecting for, or
extraction or production of, petroleum
or natural gas or both in India, to the
extent deposited with SBI in an
approved scheme or deposited in Site
Restoration Account.
35(1)(ii)/ Deduction for payment to any
(iia)/(iii) research association, company,
university etc. for undertaking
scientific research or social science or
statistical research.
35(2AA) Deduction of payment to a National
Laboratory or University or IIT or
approved specified person for
scientific research
35AD Investment-linked tax deduction for
specified businesses.
35CCC Deduction of expenditure incurred on
notified agricultural extension project
80C to Deductions from gross total income
80U under Chapter VI-A other than the
provisions of section 80JJAA.
(ii) without set-off of any loss carried forward or
depreciation from any earlier assessment year, if
such loss or depreciation is attributable to any of the
 a
ASSESSMENT OF VARIOUS ENTITIES 9.99

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
deductions listed in (i) above [Such loss and
depreciation would be deemed to have been already
given effect to and no further deduction for such loss
shall be allowed for any subsequent year]
(iii) by claiming depreciation u/s 32 determined in the
prescribed manner (i.e., in respect of depreciation
of any block of assets entitled to more than 40%
shall be restricted to 40% on the written down
value of such block of assets). However, additional
depreciation u/s 32(1)(iia) cannot be claimed.
Note – Additional points relevant in the context of
section 115BAD:
(1) In the case of a person having a Unit in the IFSC,
referred to in section 80LA(1A), which has exercised
option for section 115BAD, deduction u/s 80LA
would be allowed subject to fulfilment of the
conditions specified in that section.
(2) Since there is no time line within which option under
section 115BAD can be exercised, a co-operative
society having brought forward losses and
depreciation on account of deductions listed in (i)
above may, if it so desires, postpone exercise the
option under section 115BAD to a later assessment
year, after set off of the losses and depreciation so
accumulated.
9. Failure to satisfy On failure to satisfy the On failure to satisfy the
conditions conditions mentioned in point conditions mentioned in
no. 7 and 8 above in any P.Y., point no. 8 above in any
the option exercised would be P.Y., the option
invalid in respect of the exercised would be
assessment year relevant to that invalid in respect of the
previous year and subsequent assessment year
assessment years; relevant to that previous
Consequently, the other year and subsequent
provisions of the Act would apply assessment years;
to the person as if the option had Consequently, the other
not been exercised for the provisions of the Act
assessment year relevant to that would apply to the
previous year and subsequent person as if the option
assessment years. had not been exercised
 9.100 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
for the assessment year
relevant to that previous
year and subsequent
assessment years.
10. Availability of set-off No brought forward AMT credit Brought forward AMT
of AMT credit credit cannot be set-off
brought forward against income u/s
from earlier years 115BAD.
Note - If a co-operative
society has b/f AMT
credit, it can first
exhaust the AMT
credit, and thereafter
opt for section 115BAD
in a subsequent
previous year.
11. Adjustments for If the Assessing Officer opines No such requirement
transactions with that the course of business to make any
persons having between the co-operative adjustment
close connection society and any other person
having close connection
therewith is so arranged that
the business transacted
between them produces more
than the ordinary profits to the
co-operative society, he is
empowered to take into
account the amount of profits
as may be reasonably deemed
to have been derived
therefrom, while computing
profits and gains of such co-
operative society.
In case the arrangement
referred above involves a
specified domestic transaction
referred to in section 92BA,
then, the amount of profits from
such transaction would be
determined by considering the
arm’s length price (ALP).
 a
ASSESSMENT OF VARIOUS ENTITIES 9.101

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
The amount, being profits in
excess of the amount of the
profits determined by the
Assessing Officer, shall be
deemed to be the income of
the person.
The income-tax on the
income so deemed shall be
subject to tax @ 34.32% (i.e.,
tax @ 30% + surcharge
@10% +HEC @ 4%).
Note – The scope of “specified
domestic transaction” referred
to in section 92BA has been
expanded to include within its
ambit, any business transacted
between such persons with
close connection, where one
such person is a co-operative
society claiming benefit under
section 115BAE.
12. Exercise of option by The beneficial provisions of The beneficial
the co-operative this section would apply only if provisions of this
society within the option is exercised in the section would apply if
prescribed time prescribed manner on or option is exercised in
before the due date u/s 139(1) the prescribed manner
for furnishing the first of the on or before the due
returns of income for any date u/s 139(1) for
previous year relevant to furnishing the return of
assessment year or any income for any
subsequent assessment year. previous year relevant
Such option, once exercised, to assessment year or
would apply to subsequent any subsequent A.Y.
assessment years. Such option, once
Further, once the option has exercised, would apply
been exercised for any previous to subsequent
year, it cannot be assessment years.
subsequently withdrawn for
the same or any other previous Further, once the
year. option has been
exercised for any
 9.102 DIRECT TAX LAWS

(1) (2) (3) (4)

Particulars Section 115BAE Section 115BAD
Note – The option has to be previous year, it
exercised at the time of cannot be
furnishing the first of the subsequently
returns of income for any withdrawn for the
previous year. If a person fails same or any other
to so exercise such option, it previous year.
cannot be exercised thereafter Note – The option can
for any subsequent previous be exercised even in a
year. Accordingly, co- later year, but once
operative societies who have exercised, cannot be
already opted for withdrawn
concessional tax under subsequently.
section 115BAE will be
governed by the provisions
of section 115BAE and a
fresh option cannot be
exercised under section
115BAE from A.Y. 2025-26
onwards.

Note - For the purpose of point no.7(iv) in column (3) of the above table in relation to a co -
operative society exercising option under section 115BAE, any machinery or plant which was
used outside India by any other person shall not be regarded as machinery or plant previously
used for any purpose, if all the following conditions are fulfilled, namely: —
(a) such machinery or plant was not, at any time previous to the date of the installation,
used in India;
(b) such machinery or plant is imported into India from any country outside India;
(c) no deduction on account of depreciation in respect of such machinery or plant has
been allowed or is allowable under the provisions of the Income-tax Act, 1961 in
computing the total income of any person for any period prior to the date of installation
of the machinery or plant by the person.
Further, where in the case of a person, any machinery or plant or any part thereof previously
used for any purpose is put to use by the co-operative society and the total value of the
machinery or plant or part so transferred does not exceed 20% of the total value of the
machinery or plant used by the co-operative society, then, the condition specified that the co-
operative society does not use any machinery or plant previously used for any purpose would
be deemed to have been complied with.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.103

ILLUSTRATION 10
Transfer fees are received by a cooperative housing society from its incoming and outgoing
members. Are such transfer fees liable to tax in the hands of the cooperative society?
SOLUTION
The issue under consideration is whether the transfer fees received by a co -operative housing
society from its incoming and outgoing members is taxable or exempt on the principle of mutuality.
On this issue, the High Court, in Sind Co-operative Housing Society v. ITO (2009) 317 ITR 47, observed
that under the byelaws 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 account of the 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 income,
can have no application since the co-operative housing society is not a trade or professional
association.

Applying the rationale of the above ruling, transfer fees received by a co-operative housing society from
its incoming and outgoing members would not be liable to tax in the hands of the co-operative society.
TAXATION OF INDIVIDUALS/HUF/AOPs OR BOIs
(1) Default Tax Regime [Section 115BAC]
Individuals/ Hindu Undivided Family (HUF)/ Association of Persons (AoPs) other than a co-operative
society / Body of Individuals (BoIs) and Artificial Juridical Persons have to pay tax at concessional
rates of tax provided under section 115BAC. The tax rates given under section 115BAC are the
default tax rates unless the assessee exercises an option to shift out of the said regime. However,
such persons have to forego certain exemptions and deductions under this regime. Alternatively,
they can exercise the option to shift out of the default tax regime and pay tax under the optional tax
regime as per the regular provisions of the Act at the tax rates prescribed by the Annual Finance Act
of that year.
 9.104 DIRECT TAX LAWS

I. Concessional tax rates under section 115BAC

Individuals/ HUF/ AoPs other than a co-operative society/ BoIs or artificial judicial persons
(Assessment of Individuals/ AoPs/ HUFs are discussed later on under this chapter) other than
those who exercise the option to opt out this regime under section 115BAC(6), have to pay tax in
respect of their total income (other than income chargeable to tax at special rates under Chapter XII
such as section 111A, 112, 112A, 115BB, 115BBJ etc.) at the following concessional rates, subject
to certain conditions specified under section 115BAC(2) –

(i) Upto ` 4,00,000 NIL

(ii) From ` 4,00,001 to ` 8,00,000 5%
(iii) From ` 8,00,001 to ` 12,00,000 10%
(iv) From ` 12,00,001 to ` 16,00,000 15%
(v) From ` 16,00,001 to ` 20,00,000 20%
(vi) From ` 20,00,001 to ` 24,00,000 25%
(vii) Above ` 24,00,000 30%

II. Conditions to be satisfied for availing concessional rates of tax: The following are the
conditions to be satisfied for availing concessional rates of tax:
S. No. Particulars
(1) Certain deductions/exemptions not allowable: Section 115BAC(2) provides that while
computing total income, the following deductions/exemptions would not be allowed:
Section Exemption/Deduction
10(5) Leave travel concession
10(13A) House rent allowance
10(14) Exemption in respect of special allowances or benefit to meet
expenses relating to duties or personal expenses (other than
those as may be prescribed for this purpose).
10(17) Daily allowance or constituency allowance of MPs and MLAs
10(32) Exemption in respect of income of minor child included in the
income of parent
10AA Tax holiday for units established in SEZ
16 (i) Entertainment allowance
(ii) Professional tax
24(b) Interest on loan in respect of self-occupied property
32(1)(iia) Additional depreciation
33AB Tea/Coffee/Rubber development account
33ABA Site Restoration Fund
 a
ASSESSMENT OF VARIOUS ENTITIES 9.105

35(1)(ii),(iia), Deduction in respect of contribution to

(iii) or - notified approved research association/ university/college/
35(2AA) other institutions for scientific research [Section 35(1)(ii)]
- approved Indian company for scientific research [Section
35(1)(iia)]
- notified approved research association/
university/college/other institutions for research in social
science or statistical research [Section 35(1)(iii)]
- An approved National laboratory/ university/IIT/ specified
person for scientific research undertaken under an
approved programme [Section 35(2AA)]
35AD Investment linked tax incentives for specified businesses
35CCC Deduction in respect of expenditure incurred on notified
agricultural project
80C to 80U Deductions under Chapter VI-A (other than employers
contribution towards NPS under section 80CCD(2), Central
Government contribution towards Agnipath Scheme under
section 80CCH(2) and deduction in respect of employment of
new employees under section 80JJAA).
(2) Certain losses not allowed to be set-off: While computing total income, set-off of
any loss -
(i) carried forward or depreciation from any earlier assessment year, if such loss or
depreciation is attributable to any of the deductions referred to in (1) above; or
(ii) under the head house property with any other head of income;
would not be allowed.
(3) Depreciation or additional depreciation: Depreciation u/s 32 is to be determined in
the prescribed manner. Depreciation in respect of any block of assets entitled to more
than 40%, would be restricted to 40% on the written down value of such block of
assets. Additional depreciation u/s 32(1)(iia), however, cannot be claimed.
(4) Exemption or deduction for allowances or perquisite: While computing total income,
any exemption or deduction for allowances or perquisite, by whatever name called,
provided under any other law for the time being force in India would not be allowed.
(5) In case of a person having a unit in IFSC referred to in section 80LA(1A), whose
income is chargeable to tax under section 115BAC(1A), deduction under section
80LA would be allowed subject to fulfilment of the conditions specified in that section.
Additional points:
(i) An employee whose income is chargeable to tax under section 115BAC(1A) would be
entitled for -
- In case of salary income: Standard deduction under section 16(1)(ia) upto
` 75,000;
 9.106 DIRECT TAX LAWS

- In case of income in the nature of family pension: A deduction of a sum equal to

33-1/3 per cent of such income or ` 25,000, whichever is lower;
- Deduction under section 80CCD(2) in respect of contribution made by any other
employer: Upto 14% of salary;
- travelling allowance (i.e., allowance granted to meet the cost of travel on tour or
transfer);
- daily allowance (i.e., allowance granted on tour or for the period of journey in
connection with transfer, to meet the ordinary daily charges incurred by an
employee on account of absence from his normal place of duty);
- conveyance allowance (i.e., allowance granted to meet the expenditure incurred
on conveyance in performance of duties of an office or employment of profit,
where free conveyance is not provided by the employer); and
- exemption in respect of transport allowance granted to an employee who is blind
or deaf and dumb or orthopedically handicapped with disability of the lower
extremities of the body to the extent of ` 3,200 p.m.
(ii) An individual, being an employee paying tax as per section 115BAC, would not be
entitled for exemption of perquisite of free food and non-alcoholic beverages provided
by an employer through paid vouchers.
(iii) Loss or depreciation referred to in (2) above would be deemed to have been already
given effect to and no further deduction for such loss or depreciation shall be allowed
for any subsequent year.
Where income-tax on total income of the assessee is computed under this section and there is
a depreciation allowance in respect of a block of asset from an earlier assessment year
attributable to additional depreciation u/s 32(1)(iia), which has not been given full effect to prior
to A.Y. 2024-25 and which is not allowed to be set-off in the A.Y.2024-25 due to section
115BAC, corresponding adjustment shall be made to the WDV of such block of assets as on
1.4.2023 in the prescribed manner i.e., the WDV as on 1.4.2023 will be increased by the
unabsorbed additional depreciation not allowed to be set-off.

III. Time limit for exercising the option to shift out of the default tax regime
(i) In case of an assessee having no income from business or profession: Where such
individual/HUF/AoP (other than a co-operative society)/BoI or Artificial Juridical person is not
having income from business or profession, he/it can exercise an option to shift out/opt out of
the default tax regime under this section and such option has to be exercised along with the
return of income to be furnished under section 139(1) for a previous year relevant to the
 a
ASSESSMENT OF VARIOUS ENTITIES 9.107

assessment year. In effect, such individual/HUF/AoP/BoI or Artificial Juridical person can

choose whether or not to exercise the option of shifting out of the default tax regime in each
previous year. He may choose to pay tax under default tax regime under section 115BAC in
one year and exercise the option to shift out of default tax regime in another year.
(ii) In case of an assessee having income from business or profession: Such
individual/HUF/AoP/BoI or Artificial Juridical person having income from business or
profession has an option to shift out/ opt out of the default tax regime under this section and
the option has to be exercised on or before the due date specified under section 139(1) for
furnishing the return of income for such previous year and once such option is exercised, it
would apply to subsequent assessment years.
Such person who has exercised the above option of shifting out of the default tax regime for
any previous year shall be able to withdraw such option only once and pay tax under the
default tax regime under section 115BAC for a previous year other than the year in which it
was exercised.

Thereafter, such person shall never be eligible to exercise option under this section, except
where such person ceases to have any business income in which case, option under (i) above
would be available.

AMT liability not attracted: Individual/HUF/AoP/BoI or Artificial Juridical person paying tax under
default tax regime under section 115BAC is not liable to alternate minimum tax u/s 115JC. Such
person would not be eligible to claim AMT credit also.
Note: It may be noted that in case of Individual/HUF/AoP/BoI or Artificial Juridical person not having
income from business or profession, the total income and tax liability (including provisions relating
to AMT, if applicable under normal provisions) may be computed every year both in accordance with
the regular provisions of the Income-tax Act, 1961 and in accordance with the provisions of section
115BAC, in order to determine which is more beneficial and accordingly such person may decide
whether to pay tax under default tax regime under section 115BAC or exercise the option to shift out
and pay tax under normal provisions of the Act for that year.
(2) Taxation of Individuals
The term “individual” as such has nowhere been defined in the Income-tax Act, 1961. Section 2(31),
however, states that “person” inter alia, includes an individual. In the commonly understood sense
of the term, an individual means a human being or a single person. The person may be major, minor,
married or unmarried, possessing sound or unsound mind. All the same, he is assessable as an
‘individual’ and is liable to pay tax, if the total income earned by him during any previous year
 9.108 DIRECT TAX LAWS

exceeds the prescribed limit exempted from tax. If an individual who is liable to pay tax for any year
dies before he is assessed to tax, his executor, administrator or legal representative is treated as
the individual assessee for purposes of assessment of the income of the deceased person.
(i) Tax rates
Individual assessee can pay tax at concessional rates under the default tax regime under
section 115BAC (discussed above). However, he has to forego certain exemptions and
deductions under this regime. Alternatively, he can exercise the option to shift out of the
default tax regime and pay tax under the optional tax regime as per the regular provisions of
the Act at the tax rates prescribed by the Annual Finance Act of that year.
[The slab rates for A.Y. 2026-27 applicable to an Individual/HUF/AOP/BOI/ Artificial Juridical
Person exercising the option of shifting out of the default tax regime are discussed in Chapter
1 in Module 1]
(ii) Assessment of a non-resident individual
The scope of deemed income taxable in the hands of a non-resident as laid down in section
5 is explained in section 9(1) which extends the liability to tax of a non-resident individual in
respect of income which although not actually accruing or arising in India deemed to be so
accruing or arising, assumes significance in the assessment of non-resident individual. For
better understanding of the provisions of section 9, students are advised to refer to Chapter
21 - “Non-resident Taxation in Module 4 of the Study material.
(iii) 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 non-citizens
of India, and there is no difference in the general principles for computing the total income
under the Income-tax Act, 1961, 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 under section 10(6). These have been discussed in detail in Chapter 21 –“Non-
resident Taxation in Module 4 of the Study material.
(iv) Exemptions, reliefs and concessional rates of tax available to individuals
The tax exemptions and reliefs available under the Act to individuals in respect of income
chargeable to tax fall under the following categories:

(a) Income altogether excluded from the total income, and on which in consequence, no
income-tax is payable [Section 10].
 a
ASSESSMENT OF VARIOUS ENTITIES 9.109

(b) Deductions from gross total income both in respect of income, a part of which is not
chargeable to income-tax and payments made by the assessee, a part or the whole of
which is deductible from the gross total income [Chapter VI-A]
However, certain exemptions and deductions are not available where an individual is paying
tax as per the default regime under section 115BAC(1A).
(v) Rebate of tax and relief in certain cases
 Income from association of persons or bodies of individuals: If the assessee is a
member of an association of persons or a body of individuals (other than a company,
co-operative society or society) income-tax shall not be payable by him in respect of
any portion of the amount receivable by him from the association or body on which tax
has already been paid by the association or body at the maximum marginal rate or any
higher rate [Section 86].
Further, if the total income of AOP or BOI is not chargeable to income -tax, then the
share of member shall be chargeable to tax as part of his total income. Thus, in such
case, the share of member shall form part of his total income.
For the purposes of this provision in the case of an association of persons which is
assessable under section 67A, the members of the AOP whose shares in the income
are indeterminate or unknown, will be entitled to receive equal shares in the income
of the AOP and the individual share of such member will be determined accordingly.
 Rebate of income-tax to an individual resident in India: In order to provide tax relief
to the individual tax payers, section 87A provides a rebate from the tax payable by an
assessee, being an individual resident in India.
Rebate to resident individual paying tax under default tax regime u/s 115BAC
(i) If the total income of the resident individual is chargeable to tax under section
115BAC and the total income of such individual does not exceed ` 12,00,000,
the rebate shall be equal to the amount of income-tax payable on his total income
for any assessment year or an amount of ` 60,000, whichever is less.
The amount of rebate under section 87A shall not exceed the amount of
income-tax (as computed before allowing such rebate) on the total income of
the assessee with which he is chargeable for any assessment year.
It is further provided that the rebate shall not exceed the amount of income-tax
computed as per the rates provided in section 115BAC.
 9.110 DIRECT TAX LAWS

ILLUSTRATION 11
Mr. X aged 34 years and a resident in India, has a total income of ` 11,70,000,
comprising his salary income and interest on bank fixed deposit. Compute his tax
liability for A.Y.2026-27 under default tax regime under section 115BAC.
SOLUTION
Computation of tax liability of Mr. X for A.Y. 2026-27
Particulars `
Tax on total income of ` 11,70,000
5% of ` 4,00,000 i.e., from ` 4,00,000 to ` 8,00,000] 20,000
10% of ` 3,70,000 i.e., from ` 8,00,001 to ` 11,70,000 37,000
57,000
Less: Rebate u/s 87A (Lower of tax payable or ` 60,000) 57,000
Tax Liability Nil

(ii) If the total income of the resident individual is chargeable to tax under section
115BAC and the total income of such individual exceeds ` 12,00,000 and
income-tax payable on such total income exceeds the amount by which the total
income is in excess of ` 12,00,000, the rebate would be as follows.
Step 1 – Total income (-) ` 12 lakhs (A)
Step 2 - Compute income-tax liability on total income (B)
Step 3 - If B > A, rebate under section 87A would be a B – A.
The amount of rebate under section 87A shall not exceed the amount of
income-tax (as computed before allowing such rebate) on the total income of
the assessee.

It is further provided that the rebate shall not exceed the amount of income-tax
computed as per the rates provided in section 115BAC.
ILLUSTRATION 12
Ms. Pallavi aged 32 years and a resident in India, has a total income of
` 12,18,000, comprising his salary income and interest on bank fixed deposit.
Compute her tax liability for A.Y.2026-27 under default tax regime under section
115BAC.
 a
ASSESSMENT OF VARIOUS ENTITIES 9.111

SOLUTION
Computation of tax liability of Ms. Pallavi for A.Y. 2026-27
Particulars `
Step 1: Total Income of ` 12,18,000 - ` 12,00,000 18,000 (A)
Step 2: Tax on total income of ` 12,18,000
Tax@15% of ` 18,000 + ` 60,000 62,700 (B)
Step 3: Since B > A, rebate u/s 87A would be B - A
[` 62,700 - ` 18,000] 44,700
18,000
Add: HEC@4% 720
Tax Liability 18,720

Rebate to a resident individual paying tax under optional tax regime (normal
provisions of the Act)
If total income of such individual does not exceed ` 5,00,000, the rebate shall be
equal to the amount of income-tax payable on his total income for any assessment
year or an amount of ` 12,500, whichever is less.
The amount of rebate under section 87A shall not exceed the amount of income -tax
(as computed before allowing such rebate) on the total income of the assessee with
which he is chargeable for any assessment year.
Rebate is, however, not available in respect of tax payable on long-term capital gains
taxable u/s 112A.
 Relief from taxation in respect of income from retirement benefit account
maintained in a notified country [Section 89A]: Where a specified person has
income accrued in a specified account, such income shall be taxed in such manner
and in such year as may be prescribed.
Meaning of certain terms:
Terms Meaning
Specified account An account maintained in a notified country by the specified
person in respect of his retirement benefits and the income
from such account is not taxable on accrual basis but is taxed
by such country at the time of withdrawal or redemption.
Notified country A country as notified by the Central Government. So far vide
Notification No. 25/2022, dated 4.4.2022, Canada, USA and
UK have been notified by the Central Government.
 9.112 DIRECT TAX LAWS

Specified person A person resident in India who opened a specified account in

a notified country while being non-resident in India and
resident in that country.

Accordingly, the CBDT has, vide Notification No.24/2022 dated 4.4.2022 inserted Rule
21AAA providing for taxation of income from retirement benefit account maintained in
a notified country.

Option to be exercised by specified person - Where a specified person has income

accrued in a specified account(s) during P.Y.2021-22 or thereafter, then, at the option
of the specified person, such income would be included in the total income of the
previous year relevant to the assessment year in which income from the said specified
account(s) is taxed at the time of withdrawal or redemption, as the case may be, in
the notified country. The option has to be exercised for all the specified accounts
maintained by the specified person.

Exclusions from total income of specified person - Where the option has been
exercised by a specified person, the total income of the specified person for the
previous year in which income is taxable would not include the income which:

- has already been included in the total income of such specified person in any
of the earlier previous years during which such income accrued and tax thereon
has been paid under the Act; or

- was not taxable in India, in the previous year during which such income
accrued, on account of,

• such specified person being a non-resident, or resident but not ordinarily

resident, during that previous year; or

• application of the DTAA, if any.

Foreign tax, if any, paid on such income would be ignored for the purposes of
computation of the foreign tax credit under Rule 128.

Option once exercised cannot be withdrawn - The option has to be exercised in the
prescribed form, which has to be furnished electronically under digital signature or
electronic verification code on or before the due date u/s 139(1). The option once
exercised for a specified account(s) in respect of a previous year in the prescribed
form would apply to all subsequent previous years and cannot be subsequently
 a
ASSESSMENT OF VARIOUS ENTITIES 9.113

withdrawn for the previous year for which the option was exercised or any previous
year subsequent to that previous year (except in case where the specified person
becomes a non-resident in any subsequent previous year).

Consequences when specified person becomes non-resident in a subsequent

previous year - In case the specified person, after exercising option in the prescribed
form for any previous year, say, P.Y.2025-26, becomes a non-resident during any
subsequent previous year, say, P.Y.2028-29, (referred to as the relevant previous
year) then, the option exercised above would be deemed to have never been exercised
with effect from the relevant previous year, i.e., from P.Y.2028-29. The income which
has accrued in the specified account(s) during the previous year, beginning with the
previous year in which option was exercised (P.Y.2025-26) till the previous year
immediately preceding the relevant previous year (i.e., upto P.Y.2027-28) would be
taxable during the previous year immediately preceding the relevant previous year
(i.e., in the P.Y.2027-28). The tax on such income has to be paid on or before the due
date for furnishing the return of income for the relevant previous year (due date for
P.Y. 2028-29).

(vi) Rates of Surcharge Applicable to Individuals

Higher surcharge of 25% and 37% is leviable, where the total income of individuals/
HUF/AOPs/BoIs/artificial juridical persons exceeds ` 2 crores and ` 5 crores, respectively,
and the individual has exercised the option to shift out of the default regime under section
115BAC. However, the higher surcharge rates would not be applicable on tax payable on
dividend income or tax payable at special rates under section 111A, 112 and 112A. Further,
where an individual is paying tax as per the default regime under section 115BAC(1A),
the maximum rate of surcharge is 25% for total income exceeding ` 2 crores.

[Refer to Chapter 1: Basic Concepts in Module 1 of the Study Material, containing rates of
surcharge for understanding the manner of computation of surcharge on capital gains,
dividend and other income components of total income]
 avv
9.114 DIRECT TAX LAWS
avv
(3) Taxation of Hindu Undivided Families
(i) Concept of HUF
A Hindu undivided family (HUF) is treated as a separate entity for the purpose of
assessment under the Income-tax Act, 1961. 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 daughters.
Some members of the HUF are called co-parceners. They are related to each other and to
the head of the family. 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 an interest in joint family property by birth. Earlier, only
male descendants were considered as coparceners. With effect from 6th September, 2005,
daughters have also been accorded coparcenary status. It may be noted that only the
coparceners have a right to demand partition.
A daughter of coparcener by birth shall become a coparcener in her own right in the same
manner as the son. Being a coparcener, she can claim partition of assets of the family. The
rights of a daughter in coparcenary property are equal to that of a son. However, other
female members of the family, for example, wife or daughter-in-law of a coparcener are
mere members of the HUF and are not eligible for such coparcenary rights.
The existence of a HUF does not arise from a contract but arises from status. There need
not be more than one male member or one female coparcener w.e.f. 6 th September, 2005 to
form a HUF. The Income-tax Act, 1961 also does not indicate that a HUF as an assessable
entity must consist of at least two male members or two coparceners.
Under the Income-tax Act, 1961, Jain undivided families and Sikh undivided families would
also be assessed as a HUF.

Schools of Hindu Law

Mitakshara school Dayabaga school

Rest of India except West West Bengal and Assam

Bengal and Assam
 ASSESSMENT OF VARIOUS ENTITIES 9.115

The basic difference between the two schools of Hindu law with regard to succession is as
follows: v
Dayabaga school of law Mithakshara school of law
Prevalent in West Bengal and Assam. Prevalent in rest of India.
Nobody acquires the right, share in the property by One acquires the right to the
birth as long as the head of family is living. family property by his birth and
not by succession irrespective
of the fact that his elders are
living.
Thus, the children do not acquire any right, share in Thus, every child born in the
the family property, as long as his father is alive and family acquires a right/ share in
only on death of the father, the children will acquire the family property.
right/share in the property.
Hence, the father and his brothers would be the
coparceners of the HUF.

(ii) 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.
(iii) Assessment of HUF after partition of HUF [Section 171]
There are two types of partition. They are –
(a) 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.
(b) 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 31 st December 1978: Partial partitions after
31st December 1978 are not recognized for tax purposes. If any partial partition has
been effected after 31.12.1978, then no claim of such partial partition shall be
recorded by the Assessing Officer. Such family will continue to be assessed as if no
 avv DIRECT TAX LAWS
9.116
avv
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
tax, penalty, interest, fine or other sum payable under the Act. The several liability of
a member would be proportionate to the share of joint family property allotted to him
on such partial 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 effected in 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, in addition to any tax for which he is separately liable, 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.
If partition has been effected after expiry of previous year, the total income of the HUF
for the previous year 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.
If partition has already taken place: If the Assessing Officer finds after completion of the
assessment of a HUF that the partition has already taken place, the Assessing Officer shall
proceed to recover the tax from every person who was a member of the family before the
partition.
Every such member of the HUF is jointly and severally liable for payment of tax on such
assessed income of the HUF.
(iv) Computation of total income of HUF
The following points should be taken into consideration while determining the total income
of HUF -
(a) 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)].
 ASSESSMENT OF VARIOUS ENTITIES 9.117

(b) Section 10(2) exempts any receipt by an individual as a member of a HUF out of the
family income. v

(c) If a member of the HUF receives any fee or remuneration as a director or a partner
in a 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.
(v) Tax rates
HUF can pay tax at concessional rates under the default tax regime under section 115BAC
(discussed earlier). However, it has to forego certain exemptions and deductions under this
regime. Alternatively, it can exercise the option to shift out of the default tax regime and pay
tax under the optional tax regime as per the regular provisions of the Act at the tax rates
prescribed by the Annual Finance Act of that year.
[The slab rates for A.Y. 2026-27 applicable to an Individual/HUF/AOP/BOI/ Artificial
Juridical Person, exercising the option of shifting out of the default tax regime are discussed
in Chapter 1 in Module 1].
(vi) Rates of surcharge applicable to HUF
Higher surcharge of 25% and 37% is leviable, where the total income of individuals/ HUF/
AOPs/BOIs/artificial juridical persons exceeds ` 2 crores and ` 5 crores, respectively and
the HUF has exercised the option to shift out of the default tax regime. However, the higher
surcharge would not be applicable on tax payable on dividend income and tax payable at
special rates under section 111A, 112 and 112A. Further, where an HUF is paying tax as
per the default regime under section 115BAC(1A), the maximum rate of surcharge is 25%
for total income exceeding ` 2 crores. [Refer to Chapter 1: Basic Concepts containing rates
of surcharge for understanding the manner of computation of surcharge on capital gains,
dividends and other income components of total income].
(vii) Conversion of separate property into property of HUF
Generally, income 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 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.
 avv DIRECT TAX LAWS
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avv
It naturally follows that once the assets belonging to the individual are impressed with the
character of joint family property, the income arising therefrom, 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 if he transfers his separate property to his family for less than
its fair market value, nothing would be taxable in the hands of HUF u/s 56(2)(x) and the
provisions 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.
(viii) 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
capacity, 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 are identical in nature
and size. 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.

Example: A HUF consists of the Karta, his wife, two sons and daughter. The HUF runs a
departmental store. One of the two sons is qualified in business administration and the
other one is an automobile engineer. Together they start a garage for repairing all types of
motor cars. The technical aspects are looked after by the engineer while the general
administration is taken care of by the son qualified in business administration. For starting
the business, the HUF has advanced an interest-free loan of ` 50,000. The business is
yielding good profits. Now the question arises whether the income from the business should
be assessed in the hands of the Hindu undivided family.
It is obvious that the family, in providing the interest-free loan to the business of the brothers
has suffered a detriment. However, the Delhi High Court has laid down the following
proposition in this connection in the case of CIT vs. Charandass Khanna & Sons (1980) 123
ITR 194 (Delhi). If investment plays a minor role and it is primarily the personal efforts,
specialised skill and enterprise of the individual coparceners which resulted in the new
business being set up and the profits accruing, it may not essentially be said that the income
belongs to the HUF. In the present case, the good profits are more due to the specialised
skills acquired by the two sons in their respective fields. Of course, the capital, got from the
 ASSESSMENT OF VARIOUS ENTITIES 9.119

family as interest free loan, has its role to play but it is nevertheless a minor one. Therefore,
we can say that the income from the business set up by the brothers is assessable invtheir
hands as individuals according to the agreed rate of sharing and not as the income of the
family.

The Supreme Court has also upheld this principle in K.S. Subbiah Pillai vs. CIT (237 ITR
11). It was held that remuneration received on account of personal qualification and
exercise of individual exertion was assessable as individual income and not as income of
HUF. The following principles have been
broadly applied by the Supreme Court for Remuneration received on
determining the character of the receipt by account of personal qualification
way of remuneration paid to a coparcener: and exercise of individual
exertion is assessable as
(i) when the remuneration received by the individual’s income and not as
coparcener though not in form but in income of HUF.
substance was one of the modes of
return made to the family because of
investment of the family funds, it has to be assessed as the income of Joint Hindu
Family.
(ii) when the remuneration is not paid to the detriment of the family funds, it is
assessable as the income of recipient Karta or coparcener as an individual.
(iii) when it is a compensation for the services, skill or labour of the coparcener, it has to
be assessed as the income of such a coparcener in his individual capacity.

Example: The Karta of a HUF receives salary in his capacity as a treasurer and secretary
of a bank. The HUF has furnished ` 1,00,000 as security deposit. Decide whether the
salary can be assessed as the income of the HUF.
The position of treasurer and secretary requires considerable personal skill and integrity on
the part of the incumbent. It is true that the security deposit might have been furnished by
the HUF, however, since the salary is paid to the Karta primarily for the exercise of his
personal skill and integrity, it is to be assessed as his individual income.

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,
 avv DIRECT TAX LAWS
9.120
avv
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:
(1) The income is earned by the detriment to the joint family funds.
(2) It is earned with the aid of joint family funds.
(3) There is real and sufficient connection between the investment of the joint
family funds and the income by way 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.
(ix) Members of HUF in 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
coparcenary has no place in the partnership.
When the Karta of Hindu undivided family enters into a partnership with strangers, the
member of the family does 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 utilise 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.
(x) 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
 ASSESSMENT OF VARIOUS ENTITIES 9.121

payment is genuine and not excessive, such remuneration would be an expenditure laid out
v
wholly and exclusively for the purpose of the business of the family and would be allowable
as an expenditure.
(xi) 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.
(xii) 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:
(a) 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).
(b) 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)(x) provides that any sum of money or value of property received by a
HUF without consideration would be chargeable to income-tax under the head
“Income from other sources”, if the aggregate value or in case of immovable property
stamp duty value of the property exceeds ` 50,000 during a year. However, a sum
received by a HUF from its relative, i.e., a member of the HUF, is exempt. For
details, refer Chapter 5 on “Income from other sources”.
ILLUSTRATION 13
Mr. Ram (aged 56) is Karta of his HUF. The HUF consists of himself, his wife and two sons viz.
Mr. C (aged 28) and Minor D (aged 16). The HUF is assessed to income tax and has business
income from the year 2015-16 onwards. The business income of HUF for the year ended
31.3.2026 is ` 5,00,000 (computed). Mr. Ram is employed in a private company and his salary
income for the same period is ` 6,10,000 (computed).
You are requested to answer the following treating each of them as independent situations:

(i) Mr. C gave cash gift of ` 1,00,000 to the HUF of Mr. Ram. What would be the total income of HUF?
 avv DIRECT TAX LAWS
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avv
(ii) The HUF has one house property fetching rent of ` 10,000 per month and some movable
assets. There is a proposal to make a partial partition of HUF by allotting the house
property to Mr. C. Is it advisable to do a partial partition?
(iii) Minor D earned ` 70,000 by use of his special skill and talent. How would his income be taxed?
(iv) A car owned personally by Mr. Ram was blended with HUF during the year. It was leased
out for a monthly rent of ` 10,000 from 1-10-2025. How would this income be taxed?
SOLUTION
(i) Cash gift of ` 1 lakh by Mr. C, Ram’s major son, to the HUF of Mr. Ram would not be
taxable in the hands of the HUF, since gifts from a relative of the HUF does not fall within
the scope of income taxable under section 56(2)(x). Since Mr. C, being Mr. Ram’s son, is a
member of Ram’s HUF, he is a relative of the HUF. Hence, the total income of HUF would
be ` 5 lakhs, being the business income computed.
Note - Salary income of Mr. Ram, the Karta of the HUF, who is employed in a private
company would be taxed in his individual hands, since the remuneration earned by the
Karta on account of the personal qualifications and exertions and not on account of the
investment of the family funds cannot be treated as income of the HUF.

(ii) Partial partition (after 31.12.1978) is not recognized and the HUF, which has been hitherto
assessed to tax, shall continue to be liable to be assessed as if no such partial partition has
taken place [Section 171(9)].
The rental income in this case would continue to be assessed in the hands of the HUF,
even after partial partition. Therefore, it is not advisable to do a partial partition.
(iii) Income of ` 70,000 earned by Minor D by use of his special skill and talent would be
taxable in his individual hands. It will not be included in the hands of his parent by virtue of
the exception to section 64(1A) contained in the proviso to section 64(1A) .
(iv) As per section 64(2), where a member of the HUF blends his self-acquired property for
inadequate consideration with the HUF, income derived therefrom is deemed to arise to the
transferor-member and not to the HUF. In this case, Mr. Ram has blended his personal
property (i.e., car) with the HUF.
Since there is no consideration in case of blending, the income from car computed in the
prescribed manner, [which can be as per the presumptive provisions or lease rental of ` 60,000
(` 10,000 × 6 months) less depreciation] would be deemed as the income of Mr. Ram.
 ASSESSMENT OF VARIOUS ENTITIES 9.123

(4) Taxation of AOP/ BOI and their members

v
Section 2(31) defines “person” as including “association of persons” or a “body of individuals”. The
expression association of persons is to be understood in its ordinary sense meaning there by a
group or congregation of persons. The expression association of persons is of a wider connotation
and scope than that of a body of individuals. An association of persons may have as its members
not only individuals (including minors) but also companies, firms, joint families and other
associations. When there is a group of persons formed for the promotion of an enterprise or when
co-adventures join together in a common action, they are assessable as an association of
persons. Ordinarily, there can be no association of persons in business unless the members of the
group join together out of their own volition or will.
In order to constitute an association of persons, the members thereof must join any common
purpose or common action and the object of the association must be to produce income. Mere
receipt of income by a group of members in common will not make it an association unless income
is earned by its own effort in common.
The co-owners, co-legatees and joint receivers joining for a common purpose or action would be
assessable as an association of persons. For example, if the funds of a number of beneficiaries
are put together and one business is carried on with the combined resources by the trustee,
guardian or administrator, the business must be regarded as a single business assessable in the
hands of an association of persons. However, section 26 specifically provides an exception to the
assessment of co-owners as an association of persons. According to that section, where the
shares of the co-owners in respect of income from house property are defined and ascertainable ,
the co-owners must be assessed not as an association of persons but individually even if the
property may be owned and managed and developed jointly by the co -owners.
For the purpose of assessment, it is not necessary that the association should be legally
constituted. In other words, it is not necessary that there must be mutual rights and obligations
amongst the members enforceable in law. The illegality, invalidity or incorrectness in the
constitution of an association does not in any way affect its liability to tax or its chargeability as a
unit of assessment. A partnership which is illegal or otherwise void will have to be assessed as an
association of persons. The question whether there is an association of persons or not depends
upon the facts and circumstances of each case.
(i) Tax Rates
An AOP/BOI can pay tax at concessional rates under the default tax regime under section 115BAC
(discussed earlier). However, it has to forego certain exemptions and deductions under this
 avv DIRECT TAX LAWS
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avv
regime. Alternatively, it can exercise the option to shift out of the default tax regime and pay tax
under the optional tax regime as per the regular provisions of the Act at the tax rates prescribed by
the Annual Finance Act of that year.
[The slab rates for A.Y. 2026-27 applicable to an Individual/HUF/AOP/BOI/ Artificial Juridical
Person, exercising the option of shifting out of the default tax regime are discussed in Chapter 1 in
Module 1].
(ii) Computation of total income of AOPs/BOIs
1. Computation of total income in the case of an association of persons or body of individuals
will be done in the same manner as in the case of any other assessee.
2. In computing the total income, interest, salary, bonus, commission, remuneration, by
whatever name called, paid to members will not be allowed [Section 40(ba)]
However, in the case of payment of interest the following provisions will apply:
Explanation 1 below section 40(ba): If interest is paid by an AOPs/BOIs to any member who has
also paid interest to the AOPs/BOIs then only that amount of interest paid by the AOPs/BOIs will
be disallowed in its assessment which is in excess of the interest paid by the member to the
AOPs/BOIs i.e., net interest shall be disallowed.
Explanation 2 below section 40(ba): If an individual is a member of an AOPs/BOIs in a
representative capacity, on behalf of or for the benefit of another person, then interest paid by the
AOPs/BOIs to such individual in his personal capacity will not be taken into account for the
purpose of disallowance. However, interest paid by the AOPs/BOIs to such individual or vice-versa
as representative member or interest paid by the AOPs/BOIs directly to the beneficiary will be
taken into account for the purpose of disallowance.
Explanation 3 below section 40(ba): If interest is paid to a member who is not a member in a
representative capacity, but such interest is received by him on behalf of or for the benefit of
another person the interest payment will be allowed.
 Computation of tax where shares of members in AOPs/BOIs are unknown [Section
167B]: Tax on the total income would be computed as follows:
Circumstances Taxability
1. If individual share of any member is not Tax will be levied at the maximum
known marginal rate.
However, if total income of any member
of AOPs/BOIs is taxable at a rate higher
 ASSESSMENT OF VARIOUS ENTITIES 9.125

than maximum marginal rate (for

example, a foreign company which is a
v
member), then total income of
AOPs/BOIs shall be chargeable to tax
at such higher rate of tax.
2. If individual share of a member is known
and
(a) total income of any member The AOPs/BOIs will pay tax at the
(excluding his share from maximum marginal rate.
AOPs/BOIs) exceeds the basic However, if total income of any member
exemption limit [` 4,00,000 as per of AOPs/BOIs is taxable at a rate higher
default regime under section than maximum marginal rate (for
115BAC or ` 2,50,000/` 3,00,000/ example, a foreign company which is a
` 5,00,000 as per optional regime member), then, total income of
under normal provisions] AOPs/BOIs shall be chargeable to tax
as follows:
• Portion of income attributable to
such member shall be taxable at
such higher rate as applicable to
that member.
• Balance income shall be taxable at
the maximum marginal rate of tax.
(b) no member has total income The AOPs/BOIs will pay tax as per the
(excluding his share from default regime under section 115BAC or
AOPs/BOIs) exceeding the basic optional regime as per normal
exemption limit [` 4,00,000 as per provisions of Income-tax law applicable
default regime under section to an individual.
115BAC or ` 2,50,000/` 3,00,000/
` 5,00,000 as per optional regime
under normal provisions]

 Rate of Surcharge applicable to AOP /BOI

Higher surcharge of 25% and 37% is leviable, where the total income of AOP/BOI exceed
`2 crores and ` 5 crores, respectively and they have exercised the option to shift out of the
default tax regime.
Where an AOP is paying tax as per the default regime under section 115BAC(1A), the
maximum rate of surcharge is 25% for total income exceeding ` 2 crores.
However, in respect of the following income, surcharge cannot exceed 15% both under the
default regime and under the optional regime as per the normal provisions of the Act:
 avv DIRECT TAX LAWS
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avv
- on tax payable at special rates under section 115AD on dividend income or short -
term capital gains or long-term capital gains arising from the transfer of securities
referred to in 115AD(1)(b);
- on tax payable on dividend income and tax payable at special rates under section
111A, 112 and 112A;

- where the AOP consists of only company as its member.

[Refer to Chapter 1: Basic Concepts in Module 1 containing rates of surcharge for
understanding the manner of computation of surcharge on capital gains, dividends and
other income components of total income and also refer Chapter 21: Non-resident Taxation
in Module 4 for the table containing the rates of surcharge applicable to AOPs/BOIs (having
any income under section 115AD)]

 Assessment of share in the hands of member [Section 86]:

A member’s share in the total income of an AOPs/BOIs will be treated as follows:
- If an AOPs/BOIs has paid tax at the maximum marginal rate, or a higher rate, the
member’s share in the total income of the AOPs/BOIs will not be included in his total
income.
- If the AOPs/BOIs has paid tax at regular rates applicable to an individual, the
member’s share in the income of the AOPs/BOIs computed under section 67A shall
form part of his total income. However, the member will be allowed rebate under
section 110 at the average rate in respect of such share.
- If the AOPs/BOIs has not paid tax on its total income, the member’s share in the total
income of the AOPs/BOIs will be included in his total income and taxed at regular rates.

paid tax at the

the member’s share will not be included in his/its total
maximum marginal
income
rate, or a higher rate
If an AOPs/BOIs has

the member’s share computed under section 67A shall

paid tax at regular form part of his total income
rates applicable either
as per default regime
or optional regime However, the member will be allowed rebate under
section 110 at the average rate in respect of such share.

not paid tax on its total the member’s share will be included in his total income
income and taxed at regular rates.
 ASSESSMENT OF VARIOUS ENTITIES 9.127

 Computation of member’s share in the total income of AOPs/BOIs [Section 67A] : A

member’s share in the income of an AOPs/BOIs (wherein the shares of membersv are
determinate and known) will be computed as follows:
(a) Any interest, salary, bonus, commission, remuneration, etc. paid to a member during
the previous year will be deducted from the total income of the association or body,
and the balance will be apportioned among the members in proportion to their
respective shares.
(b) If the amount apportioned to a member as per (a) is a profit, any interest, salary, etc. paid
to him by the association or body during the previous year will be added to that amount
and the aggregate sum will be such member’s share in the income of the AOPs/BOIs.
(c) If the amount apportioned to a member as per (a) is a loss, any interest, salary, etc.,
paid to him by the association or body will be deducted from the amount of loss and
the balance sum will be such member’s share in the income of the AOPs/BOIs.
The share of a member in the income/loss of the AOPs/BOIs will, for the purposes of
assessment, be apportioned under the various heads of income in the same manner in
which income/loss of the association has been determined under each head.
Any interest paid by a member on capital borrowed by him for the purpose of investment in
the AOPs/BOIs will be allowed as deduction while computing his share of income under the
head “Profits and gains of business or profession.”
 Determination of tax where total income includes income on which no tax is payable
[Section 110]:
If the total income of an assessee includes any income on which no income-tax is payable,
the assessee would be entitled to a deduction, from the amount of income-tax with which he
is chargeable on his total income, of an amount equal to the income-tax calculated at the
average rate of income-tax on the amount on which no income-tax is payable.
 Share of member of an AOPs/BOIs in the income of the AOPs/BOIs to be reduced
from net profit for computing book profit for levy of MAT [Section 115JB]
(i) Under section 115JB, in the case of a company, if the tax payable on the total
income computed as per the normal provisions of the Income-tax Act, 1961 is less
than 15% of its book profit, such book profit shall be deemed to be the total income
of the company and the tax payable for the relevant previous year shall be 15% of its
book profit.
 avv DIRECT TAX LAWS
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avv
(ii) Explanation 1 below section 115JB(2) provides that the expression “book profit”
means profit as shown in the statement of profit and loss account prepared in
accordance with the provisions of the Companies Act or in accordance with the
provisions of the relevant statute governing a company, as increased or reduced by
certain adjustments, as specified thereunder.
(iii) Under section 86, no income-tax is payable on the share of a member of an
AOPs/BOIs in the income of the AOPs/BOIs in certain circumstances. A company
which is a member of an AOPs is also not required to pay tax in respect of its share
in the income of the AOPs in such cases. However, prior to A.Y.2016 -17, under
section 115JB, a company which is a member of an AOPs was liable to MAT on such
share also, since such income was not then excluded from the book profit while
computing the MAT liability of the member. It may be noted that in a similar situation,
where a company is a partner in a firm, the share in the profits of the firm is exempt
in the hands of the partner as per section 10(2A) and no MAT is payable by the
partner on such profits, since income to which any provision of section 10 applies,
has to be reduced for computing book profit.
(iv) In order to ensure equity, clause (iic) in Explanation 1 below section 115JB(2) has
been inserted with effect from A.Y. 2016-17 to provide that the share of a member of
an AOPs or BOIs, in the income of the AOPs or BOIs, on which no income -tax is
payable in accordance with the provisions of section 86, should be reduced while
computing book profit for levy of MAT under 115JB, if any such amount is credited to
statement of profit and loss account. Consequently, clause (fa) has also been
inserted in Explanation 1 to add back the expenditures, if any, debited to the
statement to profit and loss, corresponding to such income, while computing book
profit for levy of MAT.
ILLUSTRATION 14
JK Associates is an Association of Persons (AOP) consisting of two members, J, aged 40 years
and K, aged 37 years. Shares of the members are: 60% (J) and 40% (K). Income of the AOPs for
the previous year 2025-26 is ` 11 lakhs.
J and K’s income, other than income from AOP, amount to ` 2.50 lakhs and ` 2.90 lakhs,
respectively.
 ASSESSMENT OF VARIOUS ENTITIES 9.129

Compute tax liability of the AOP assuming that J exercises the option to shift out of the default
regime and the AOP and its member K pays tax under default tax regime under section v
115BAC(1A).
SOLUTION
Computation of tax of AOP is governed by section 167B. Tax on total income of AOP is computed
as follows:

(i) If individual share of a member is known, and the total income of any member, excluding
his share from such AOP, exceeds the basic exemption limit, then, the AOP will pay tax at
the maximum marginal rate.

(ii) If individual share of a member is known and no member has total income (excluding his
share from AOP) exceeding the basic exemption limit, then, the AOP will pay tax at the
rates applicable to an individual.

Section 86 provides for assessment of share in the hands of members of AOP as follows:

A member’s share in the total income of AOP will be treated as follows: -

(i) If an AOP has paid tax at the maximum marginal rate or a higher rate, the member’s share
in the total income of AOP will not be included in his total income and will be exempt.

(ii) If the AOP has paid tax at regular rates applicable to an individual, the member’s share in
the income of AOP will be included in his total income and he will be allowed rebate at the
average rate of tax in respect of such share.
Tax Liability of J K Associates, AOP
Since none of the members have income, other than income from the AOP, exceeding the basic
exemption limit, the AOP would be taxed at the rates applicable to an individual. Therefore, the
AOP’s tax liability would be follows:
` 4,00,000 – ` 8,00,000 @5% ` 20,000
` 8,00,001 – ` 11,00,000 @10% ` 30,000
` 50,000
Add: Health & education cess @4% 2,000
Tax Liability 52,000
 avv DIRECT TAX LAWS
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Tax Liability of J and K
Particulars J K
` `
Share of profit from AOP 6,60,000 4,40,000
Income from other sources 2,50,000 2,90,000
Total Income (A) 9,10,000 7,30,000
Tax liability 94,500 16,500
Add: Health and Education cess @ 4% 3,780 660
Total tax (B) 98,280 17,160
Average rate of tax [B/A x 100] 10.8% 2.351%
Total tax liability 98,280 17,160
Less: Rebate under section 86 read with section 110 in respect
of share of profit from AOP (share in AOP x Average rate of tax) 71,280 10,344

Tax liability of members 27,000 6,816

Tax Liability (Rounded off) 27,000 6,820

TAXATION OF LOCAL AUTHORITY

(i) General meaning
The expression “local authority” has not been defined by the Income-tax Act, 1961. A local
authority is a person under section 2(31) of the Income-tax Act, 1961, 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’.
(ii) 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
 ASSESSMENT OF VARIOUS ENTITIES 9.131

its own jurisdiction area or from the supply of water or electricity within or outside its own
jurisdictional area are totally exempt from tax. v

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.
(iii) 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 at 30% on its total income of the
previous year computed in accordance with the provisions of the Act, plus surcharge @ 12% if
its total income exceeds ` 1 crore plus health and education cess @ 4%.

TAXATION OF MUTUAL CONCERNS

(i) General principles of mutuality –
(a) 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.
(b) 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.
(c) 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.
 avv DIRECT TAX LAWS
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(d) 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.
(e) 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.
(f) 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.
(g) 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.
From the above principles we can conclude that one cannot trade with oneself 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:
(1) Where the mutual concern is a mutual insurance society and the income is derived
from the carrying on of any business of insurance.
(2) 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.
(ii) Insurance business
Under section 2(24)(vii) any surplus accruing to life as well as general mutual insurance
concerns will fall within the definition of the word “income” and as such would be taxable as
income from business. Section 44 expressly provides the profits and gains of any business
of insurance including that carried on by a mutual insurance company or a cooperative
society shall be computed not according to the provisions of the Act for computation of
income under the various heads but according to the method prescribed in the Rules
contained in the First Schedule to the Act. It is also provided that any expenditure which is
not admissible under section 37 in computing the profits and gains of a business will be
included to the profits and gains of life insurance business.
(iii) Trade and professional associations

A trade, professional or similar association may be a mutual concern. Section 28(iii) enacts
that “income derived by a trade, professional or similar association from specific services
performed for its members” shall be taxable as business profits. Under section 2(24)(v) any
 ASSESSMENT OF VARIOUS ENTITIES 9.133

sum chargeable under section 28(iii) is deemed to be income. The object of these
v to
provisions seems to be to tax as profit the surplus arising from specific services rendered
members by a mutual trade, professional or similar association which otherwise may not be
liable to tax in view of the general principles applicable to mutual concerns.
It may carefully be noted that a trade association is not the same thing as a trading
association. A trade association means an association of tradesmen or businessmen for the
protection or advancement of their common interests. Again clause (iii) of section 28 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.
Since the surplus arising to trade, professional or similar association during the process of
advancement of the common interest of the members is not includible in the taxable income
it follows that the concerned expenditure will not also be allowed. Section 44A gives a
benefit in this regard. It provides that in the case of such trade associations which did not
distribute any parts of its income to its members, the amount of any deficit (deficiency)
(excess of expenditure incurred for the advancement of the common interest of the
members of the association over receipt from the members) would be deductible from the
assessable income of the association to the maximum extent of 50% of such income.
This deficiency is to be deducted in the first instance from the assessable income under the
head “Profits and gains of business or profession”. If the deficiency exceeds such income
the balance of deficiency can be set off against assessable income from any other head.
The maximum limit of 50%, however, still operates. It should be noted that any adjustment
of the deficiency is permissible only after effect has been given as provided in the Act to all
losses, allowances etc., for the year in question or brought forward from earlier years.
(iv) 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.
 avv DIRECT TAX LAWS
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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.

9.3 LIABILITY OF SUCCESSOR TO BUSINESS IN

RESPECT OF TAX CHARGEABLE FROM THE
PREDECESSOR [SECTION 170]
(1) Assessment of successor and predecessor: Where a person carrying on any business
or profession is succeeded by another person who continues to carry on that business or
profession, both the successor and the person who is succeeded to (hereinafter called the
predecessor) shall be assessed in the following manner:
- the predecessor in business would be assessable in respect of the income of the
previous year in which succession took place upto the date of succession;
- the successor would be assessable in respect of the income of that previous year
after the date of succession.
Accordingly, the income of the year in which the succession takes place is to be
apportioned between the predecessor and the successor with the share of each. The
income must be computed separately and each must be granted the deductions and
allowance applicable to him. The assessment on each of these persons must be separate
and distinct.
(2) Assessment when predecessor cannot be found: Where the predecessor cannot be
found, the assessment of
- the income of the previous year in which the succession took place up to the date of
succession and
- of the one year preceding the previous year of succession
should be made on the successor in like manner and to the same extent as it would have
been made on the predecessor, and all the provisions of the Act shall apply accordingly.
(3) Assessment or reassessment or other proceedings during the pendency of
succession: In case there is succession, the assessment or reassessment or any other
proceedings, made or initiated on the predecessor during the course of pendency of such
 ASSESSMENT OF VARIOUS ENTITIES 9.135

succession, shall be deemed to have been made or initiated on the successor and all the
provisions of this Act shall apply accordingly. v

Meaning of the term "pendency": “Pendency” means the period

- commencing from the date of filing of application for such succession of business
before the High Court or tribunal or the date of admission of an application for
corporate insolvency resolution by National Company Law Tribunal (NCLT) and
- ending with the date on which the order of such High Court or tribunal or NCLT
is received by the Principal Commissioner or the Commissioner.
(4) Recovery of sum payable by predecessor from the successor: If the assessment has
already been made on the predecessor for either or both of the years aforesaid, but the
sum payable in pursuance of each assessment cannot be recovered from the predecessor
or any person, the sum payable by the predecessor shall be payable and recoverable by
the successor. Successor shall be entitled to recover the full amount of sum paid by him
from the predecessor.
Under this section, the Assessing Officer is required to record a finding that the sum in
respect of the income of the year of succession or the preceding year cannot be recovered
from the predecessor, before seeking to recover such sum from the successor.
(5) Predecessor income includes capital gain by virtue of succession: The successor’s
liability to tax arises also in respect of any gain (e.g., capital gains) accruing to the
predecessor from the transfer of the business or profession as a result of the succession.
[Explanation to section 170].

9.4 TAX PLANNING CONSIDERATIONS IN RELATION TO

BUSINESS
The scope of income liable to tax under the head “Profits and gains of business or profession”
covered by sections 28 to 44D of the Income-tax Act, 1961 has been discussed earlier. The object of
this part of the study material is to discuss from the angle of tax planning the various areas in which
tax payer will have to take appropriate decisions to ensure that the incidence of tax in respect of his
income chargeable under this head is reduced to the extent possible, by taking advantage of the
various allowances, deductions and other tax concessions provided under the law.
For a new business, the spheres in which the question of tax planning is relevant are as follows:
(i) Form of the organization
 avv DIRECT TAX LAWS
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avv
(ii) Nature of the business
(iii) Financial Structure

(iv) Acquisition of plant and machinery and other fixed assets

(v) Setting up and commencement of business
Each of these aspects will be considered briefly in the following paragraphs. In addition, there is lot
of scope for planning with reference to the method of accounting to be employed and the various
deductions and special incentives provided under the Income-tax Act, 1961.
(1) Form of Business Organization: The choice of the appropriate form of business
organization will have to be thought of and decided by the person who intends to carry on business
or profession at the beginning itself, because a change in the form of business organization after
the commencement of the business, may attract liability to tax.
A new business can be organized under any of the following forms:
(i) Sole proprietorship
(ii) Hindu undivided family
(iii) Association of persons or Body of Individuals
(iv) Partnership firm/LLP
(v) Company

(vi) Co-operative society

The selection of a particular form of organization would depend not only on the tax aspect but on
other considerations also, e.g., financial requirements and resources, requirement of limited
liability and many other practical considerations.
However, depending upon the taxable status and level of tax liability of the owners, a selection can
be made from the various forms available for setting up a new unit.
 Sole Proprietorship: In the case of a sole proprietorship concern, one of the important tax
disadvantages would be that no allowance or relief would be available to the tax payer in
computing his income from business in respect of even a reasonable amount of
remuneration attributable to the services rendered by him for carrying on the business. As a
result, the taxable income arrived at would be a larger amount than what it would have been
if it had been the case of, say, a firm paying remuneration to partners, such remuneration is
allowable subject to the limits specified in section 40(b)(v). The taxable income from
 ASSESSMENT OF VARIOUS ENTITIES 9.137

business would get reduced and correspondingly, the incidence of tax would also be
reduced. v

Under sole proprietorship, the entire income of a business unit gets assessed in the hands
of the same person along with other income, while the entire loss and other allowances
shall be available for set off in his hands against other income. This may have some
advantage in the initial years, after which the possibility of converting it into company/firm
may be considered; on such conversion, the questions of possible capital gains tax, etc.,
will have to be considered.
 Hindu Undivided Family: The Hindu undivided family as a unit of taxation continues to
exist for the purpose of carrying on business as well and there is a large number of cases
where business is carried on by the members of the family on behalf on the family. Since
the law does not specifically provide for the disallowance of such expenses, it is
advantageous to carry on a business through the HUF wherever possible. The income of
the family is computed and first taxed in the hands of the family at the rates applicable to it.
The income of the family may, thereafter, be divided amongst the members of the family
and the members, in such cases, do not attract any liability to tax in view of the specific
exemption granted under section 10(2) of the Income-tax Act, 1961. Thus, if a business is
carried on by a Hindu undivided family, the advantages which are available in the case of a
company could be fully availed of and in addition, the members of the family would not
become liable to tax when they receive any portion of the family’s income.

Individual or HUF having income from business or profession has an option to shift out/ opt
out of the default tax regime under this section and the option has to be exercised on or
before the due date specified under section 139(1) for furnishing the return of income for
such previous year and once such option is exercised, it would apply to subsequent
assessment years.
Such person who has exercised the above option of shifting out of the default tax regime for
any previous year shall be able to withdraw such option only once and pay tax under the
default tax regime under section 115BAC for a previous year other than the year in which it
was exercised.
Thereafter, such person shall never be eligible to exercise option under this section, except
where such person ceases to have any business income in which case, option under (i)
above would be available. (Please refer to the detailed discussion on section 115BAC
given in earlier paras of this Chapter)
 avv DIRECT TAX LAWS
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avv
 Partnership Firm/LLP: All firms and LLPs will be taxed at a flat rate of 30%. If the total
income exceeds ` 1 crore, surcharge @12% would be attracted. Further, health and
education cess @4% would be applicable. There will be no basic exemption and the entire
income will be taxed. In computing the taxable income of a firm, certain prescribed
deductions in respect of interest and remuneration have to be allowed. The share income of
a firm in the hands of the partners of the firm which is separately assessed as such is fully
exempt under section 10(2A).
TDS Liability on Partnership Firm: As per section 194T, partnership firm is required to
deduct tax at source @10% on any sum paid to partners, such as salary, remuneration,
commission, bonus, or interest. No deduction is required if the sum or aggregate of
such sum does not exceed ` 20,000 during the financial year.

Note: An Individual, HUF or a partnership firm (but not an LLP), who is a resident carrying
on eligible business can declare income on presumptive basis as per the provisions of
section 44AD @8% of gross receipts or 6% in case gross receipts are received by an
account payee cheque/bank draft/use of ECS through bank account /through any other
electronic mode as may be prescribed on or before the due date of filing return of income ].
The prescribed electronic modes are credit card, debit card, net banking, IMPS (Immediate
payment Service), UPI (Unified Payment Interface), RTGS (Real Time Gross Settlement),
NEFT (National Electronic Funds Transfer), and BHIM (Bharat Interface for Money) Aadhar
Pay [CBDT Notification No. 8/2020 dated 29.01.2020].
An assessee, being a resident in India, carrying on notified profession can declare income
on presumptive basis@50% of gross receipts as per the provisions of section 44ADA. In
such a case, they need not get their books of account audited as per section 44AB.
ILLUSTRATION 15
Mr. Gavaskar sought voluntary retirement from a Government of India Undertaking and received
compensation of ` 40 lakhs on 28th February, 2025. He is planning to use the money as capital for
a business dealership in electronic goods. The manufacturer of the product requires a security
deposit of ` 15 lakhs, which would carry interest at 8% p.a. Gavaskar’s wife is a graduate and has
worked as marketing manager in a multinational company for 15 years. She now looks for a
change in employment. She is willing to join her husband in running the business. She expects an
annual income of ` 5 lakhs. Mr. Gavaskar would like to draw a monthly remuneration of ` 40,000
and also interest @ 10% p.a. on his capital in the business. Mr. Gavaskar has approached you for
a tax efficient structure of the business.
 ASSESSMENT OF VARIOUS ENTITIES 9.139

Discuss the various issues, which are required to be considered for formulating your advice.
Computation of income or tax liability is not required. v
SOLUTION
The selection of the form of organisation to carry on any business activity is essential in view of
the differential tax rates prescribed under the Income-tax Act, 1961 and specific concessions and
deductions available under the Act in respect of different entities. For the purpose of formulating
advice as to the tax efficient structure of the business, it is necessary for the tax consultant to
consider the following issues:
(i) In the case of sole proprietary concern, interest on capital and remuneration paid to the
proprietor is not allowable as deduction under section 37(1) as the expenditure is of
personal nature. On the other hand, in the case of partnership firm, both interest on capital
and remuneration payable to partners are allowable under section 37(1) subject to the
conditions and limits laid down in section 40(b). The partnership should be evidenced by an
instrument and the individual share of partners should be specified in the instrument.
Remuneration and interest should however, be authorised by the instrument of partnership
and paid in accordance with such instrument. Such interest and salary shall be taxable in
the hands of partners to the extent the same is allowed as deduction in the hands of the
firm under section 40(b). Interest to partners can be allowed upto 12% on simple interest
basis, while the limit for allowability for partners' remuneration is based on book profit under
section 40(b). As per section 40(b)(v), partners’ remuneration shall be allowed to the extent
of aggregate of -
(a) On the first ` 6,00,000 of book profit or in case of loss – ` 3,00,000 or @90% of
book profits, whichever is more
(b) On the balance of book profit – at the rate of 60%
Note
However, if the firm is eligible to declare presumptive taxation under section 44AD, 8% of
gross receipts or 6% of gross receipts, as the case may be, would be deemed as its income.
All deductions under section 30 to 37 are deemed to be allowed. No deduction is allowable,
including deduction for partner’s remuneration and interest on capital.
(ii) Partner's share in the profits of firm is not taxed in the hands of the partners by virtue of
section 10(2A).
(iii) If a proprietary concern is formed, the salary of Mrs. Gavaskar shall be allowed as
deduction under section 37(1).
 avv DIRECT TAX LAWS
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avv
(iv) The possibility of invoking section 40A(2) cannot be ruled out as salary is payable to a
relative, who is an interested person within the meaning of section 40A(2). However, it can
be argued successfully that salary of ` 5 lakhs is justified in view of her long experience as
marketing manager of a multinational company and the fair market value of services to be
rendered by her to the concern.
(v) An issue arises as to whether remuneration of Mrs. Gavaskar would be includible in the
total income of Mr. Gavaskar. Under section 64(1)(ii), remuneration of the spouse of an
individual working in a concern in which the individual is having a substantial interest shall
be included in the total income of the individual. However, the clubbing provision does not
apply if the spouse possesses technical or professional qualification and the income is
solely attributable to the application of his or her technical or professional knowledge and
experience. Further, technical or professional qualification would not necessarily mean the
qualifications obtained by degree or diploma of any recognized body [Batta Kalyani vs. CIT
(1985) 154 ITR 0059 (AP)]. The experience of Mrs. Gavaskar as a marketing manager in a
multinational company for 15 years may reasonably be considered as a professional
qualification for this purpose.
(vi) If Mrs. Gavaskar joins the proprietary concern or partnership concern of her husband as
employee, remuneration of ` 5 lakhs shall be taxed in her hands under the head "salary".
Standard deduction u/s 16(ia) of ` 50,000 (under optional tax regime) and ` 75,000 (under
default tax regime) would be allowed.
(vii) lf she joins as partner in the business, remuneration shall be taxed in her hand as business
income under section 28 to the extent such remuneration is allowed in the hands of the firm
under section 40(b).
(viii) For individuals, tax can be computed as per slab rates provided under the default regime
under section 115BAC(1A). Alternatively, he can exercise the option to shift out of the
default tax regime and pay tax under the optional tax regime as per the regular provisions of
the Act at the tax rates prescribed by the Annual Finance Act of that year. However, where
he exercises the option of shifting out of the default regime for any previous year, he would
be able to withdraw such option only once.
The surcharge rate is also depended on the total income and the highest surcharge would
be 37% where total income exceeds ` 5 crores and the assessee has opted to shift out of
the default tax regime whereas under default regime highest rate of surcharge would be
25%. Health and Education cess @ 4% on income-tax plus surcharge, if applicable, is
attracted in all the cases. Whereas for partnership firms’ tax is levied at a flat rate of 30%.
Surcharge @12% would be attracted only if total income exceeds ` 1 crore.
 ASSESSMENT OF VARIOUS ENTITIES 9.141

If a sole proprietary concern is formed, Mr. Gavaskar has an option to pay income-tax in
v
respect of his total income (other than income chargeable to tax at special rates under
Chapter XII) as per the default regime under section 115BAC or as per the optional regime
under the normal provisions of Income-tax Act.
 Company: For any large venture requiring substantial investment and recourse to borrowed
funds from banks and institutions, ordinarily the form of a limited company will have to be
adopted. Within the company form of organisation, however, several alternatives exist. On
the basis of the ownership and control, a company can either be organised as a widely held
company, i.e. a company in which the public are substantially interested within the meaning
of section 2(18) of the Income-tax Act, 1961. Alternatively, it can be organised as a closely
held company. Depending upon the choice of the form of organisation of the company, the
following important tax consequences would have to be considered from the view point of
tax planning:
(i) The provisions of section 79 regarding restrictions on carry forward of losses in the
event of substantial change in the shareholding of the company also become
applicable if the company is one in which the public are not substantially interested.
This aspect would assume particular significance in the case of closely held
companies where losses are made and shareholdings are transferred before such
losses are fully absorbed.
(ii) Also, MAT provisions are applicable to companies. It so happens that in case of
companies enjoying tax holiday benefits still have to pay tax under MAT provisions,
credit of which also cumulated for number of years without being used causing
significant outflow of funds in the initial years.
Thus, it can be seen that the concept of deemed dividend under section 2(22)(e) and the
provisions of section 79 do not apply to a widely held company.
Place of Effective Management (PoEM) framework is introduced to determine the tax
payable by a foreign company that for all purposes is managed from India and yet does not
pay tax domestically. Many Indian companies that have traditionally used holding
companies and subsidiaries overseas for various reasons are assessing how they may be
affected and are racing to put new structures in place before they come under scrutiny.
These provisions provide for a foreign company to be a resident of India, if the company’s
place of effective management is in India. If a company’s POEM is situated in India; it will
be treated as Indian resident. Its global income will be taxable in India.
 avv DIRECT TAX LAWS
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avv
Rate of tax: The income-tax rate on foreign companies is higher at 35% plus surcharge
@2% (if total income exceeds ` 1 crore but does not exceed ` 10 crore) and @ 5%, if the
total income exceeds ` 10 crore as against 30%/25%, as the case may be (plus surcharge
@7%, if total income exceeds ` 1 crore but does not exceed ` 10 crore and @12%, if total
income exceeds ` 10 crore) on domestic companies.

Concessional Tax Regimes under section 115BAA and section 115BAB: Section
115BAA provides for concessional rate of tax @22% (plus surcharge@10% and HEC@4%)
for domestic companies, subject to certain conditions, like non-availability of profit-linked
deductions and investment-linked tax deduction under the Act, non-availability of deduction
for contribution to research and development, additional depreciation etc. Domestic
Companies have to exercise the option to be governed by section 115BAA. Once the
company exercises such an option under section 115BAA in a year, it would continue to be
governed by the special provision u/s 115BAA thereafter and cannot opt for regular
provisions in any subsequent year.

Section 115BAB provides for concessional rate of tax @15% (plus surcharge@10% plus
HEC@4%) to manufacturing or electricity generating domestic companies set up and
registered on or after 1.10.2019, and commences manufacturing or generating electricity on
or before 31.3.2024, subject to certain conditions, like non-availability of profit-linked
deductions and investment-linked tax deduction under the Act, non-availability of deduction
for contribution to research and development, additional depreciation etc. The option for
section 115BAB could be exercised by the domestic companies in the very first year in
which the eligible company is set up, failing which it cannot exercise such an option in the
future years. Accordingly, companies who have already opted for concessional tax under
section 115BAB will be governed by the provisions of section 115BAB and a fresh option
cannot be exercised under section 115BAB from A.Y. 2025-26 onwards. The company who
has exercised such an option under section 115BAB, it would continue to be governed by
the special provisions u/s 115BAB thereafter and cannot opt for regular provisions in any
subsequent year.

It may be noted that companies exercising option under section 115BAA or section 115BAB
are not liable to minimum alternate tax under section 115JB.

These two sections, namely sections 115BAA and 115BAB have already discussed earlier
in detail in this chapter.
 ASSESSMENT OF VARIOUS ENTITIES 9.143

ILLUSTRATION 16
ABC Ltd., a pharmaceutical company incorporated in the year 2016-17, purchased a new plantv and
machinery for ` 10 lakhs on 01-04-2025. The total income of the company for Assessment Year
2026-27 before allowing additional depreciation in respect of new plant and machinery is ` 20
lakhs. ABC Ltd. has not opted for the concessional tax regime under section 115BAA or 115BA A
so far. Compute the tax liability of ABC Ltd. for A.Y. 2026-27 assuming its turnover for the previous
year 2023-24 was ` 350 crores. Ignore the provisions of MAT.
SOLUTION
Computation of tax liability of ABC Ltd. for A.Y. 2026-27 under regular provisions of the Act

Particulars `
Total Income before allowing additional depreciation 20,00,000
Less: Additional Depreciation u/s section 32(1)(iia)[ `10 lakh x 20%] 2,00,000
Total Income 18,00,000
Applicable Tax Rate (since turnover of P.Y. 2023-24 ≤ ` 400 crores) 25%
4,50,000
Add: Health & Education cess@4% 18,000
Tax Liability 4,68,000

Computation of tax liability of ABC Ltd. for A.Y. 2026-27 under section 115BAA
Particulars `
Total Income before allowing additional depreciation 20,00,000
Less: Additional Depreciation u/s section 32(1)(iia) [Not allowable as -
deduction while computing income u/s 115BAA]
Total Income 20,00,000
Applicable Tax Rate 22%
Tax payable 4,40,000
Add: Surcharge@10% 44,000
4,84,000
Add: Health & Education cess@4% 19,360
Tax Liability 5,03,360

Since tax liability under the regular provisions of the Act is lower than the tax liability under the
provisions of section 115BAA, it would be beneficial for ABC Ltd. not to opt for section 115BAA.
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 Co-operatives: The co-operative form of business organisation, i.e., a co-operative society
would also be advantageous from the tax angle and, in addition to the general benefits
flowing from the co-operative form the society, can claim deduction in respect of the
reasonable amount of remuneration payable to the members of the society for their services
rendered, including the amount of commission, if any, payable to them and the interest on
the deposits or loans given by them. The co-operative society is entitled to a further tax
benefit arising from section 80P under which the income of a co-operative society is
exempted from tax under different circumstances depending upon the nature of the income
and/or the amount thereof. In addition to the various tax concessions which are available to
all assessees, the co-operative society stands to gain substantially by virtue of the special
benefits available to it under section 80P. The profits of the society remaining after payment
of tax would be distributed by it amongst its members in the form of dividends subject to the
relevant legislation.
However, it may be noted that benefit under section 80P has been withdrawn in respect of
all co-operative banks, other than primary agricultural credit societies (i.e. as defined in Part
V of the Banking Regulation Act, 1949) and primary co-operative agricultural and rural
development banks (i.e. societies having its area of operation confined to a taluk and the
principal object of which is to provide for long-term credit for agricultural and rural
development activities). This is for the purpose of treating co-operative banks at par with
other commercial banks, which do not enjoy similar tax benefits.
Concessional tax regimes under section 115BAD and section 115BAE: Section
115BAD provide that a co-operative society resident in India has the option to pay tax at
22%, subject to fulfilment of certain conditions. Section 115BAE provides an option to a
manufacturing co-operative society set up on or after 01.04.2023, which commences
manufacturing or production on or before 31.03.2024 and does not avail of any specified
incentive or deductions, to opt to pay tax at a concessional rate of 15%. Co-operative
societies who have already opted for concessional tax under section 115BAE will be
governed by the provisions of section 115BAE and a fresh option cannot be exercised
under section 115BAB from A.Y. 2025-26 onwards. In both cases, surcharge would be
levied @10% on such tax.
Sections 115BAE and 115BAD provide for concessional rates of tax and exemption from
Alternate Minimum Tax (AMT) in respect of certain resident co-operative societies.
From the above analysis of various forms of the organisation and their treatment for income -tax
purposes, it may be appreciated that the provisions of the taxation laws have a considerable
 ASSESSMENT OF VARIOUS ENTITIES 9.145

influence on the entrepreneurs in their choice of particular form of the organisation that they
should establish. v
(2) Nature of the business : Besides the form of organisation, the choice of the nature of the
business also calls for appropriate planning with reference to the various special benefits available
under the taxation laws to the particular kinds of industries which are not available to other kinds.
Some of these benefits are of such a substantial nature that they constitute one of the major
factors in the determination of the nature of the business.
Broadly, business for this purpose may be divided into two categories - trading and manufacturing
business. There could be a third category involving a combination of both. Deduction is available
under section 10AA to units established in SEZ. Deduction is available to units established in
Special Economic Zones during P.Y. 2020-21 where letter of approval, required to be issued in
accordance with the provisions of the SEZ Act, 2005, has been issued on or before 31 st March,
2020 and the manufacture or production of articles or things or providing services has begun on or
before 31 st March, 2021 or such other date after 31 st March, 2021, as notified by the Central
Government. In such case, the SEZ has deemed to have commenced manufacture or production
in the P.Y.2019-20 and would be eligible for benefit of deduction under section 10AA.
A taxpayer carrying on manufacturing or industrial activities would be in a position to avail of the
various concessions such as depreciation allowance, benefit of amortisation under sections 32,
35ABA, 35ABB, 35D and 35E.
Tax holiday benefit under section 80-IAC would be available in case of eligible start-up, under
section 80-IBA in case of developing and building housing projects and under section 80LA in case
of offshore banking unit and IFSC located in Special Economic Zone.
Section 35AD of the Act also extends investment linked tax deduction to taxpayers with respect to
the capital expenditure incurred for setting up and operation of specified businesses.
While deciding the nature of the business, the benefit of tax exemption or concessional treatment
available in respect of certain types of income such as agricultural income, new industrial
undertakings, ships, business of repairs to ocean going vessels, business of exploration, etc. of
mineral oils, etc. should also be taken into account.
(3) Sources of Funds or Financial Structure : Broadly speaking, the choice in the matter of
financing a new unit or business would be between capital and borrowings. New units being set up
by existing units or companies would have the possibility of using retained profits. In the case of a
company, the means of finance are as follows:

(i) Share capital.

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(ii) Debentures.
(iii) Other borrowed moneys.

(iv) Generation of funds through profits.

While the return on share capital is a charge on the profits after tax, the return on loans to the
lenders is a charge on the profits before tax. Thus, recourse to borrowings would offer a tax
advantage which will be reflected in a higher rate of return on the owner’s capital.
(4) Acquisition of ‘Fixed Assets’ : Apart from other considerations relevant in the context, the
consequences may require a careful choice between buying or leasing some or more of the fixed
assets. Assets can be bought or hired. If these are bought and are depreciable, e.g. , building,
plant and machinery and furniture, the assessee can claim depreciation on the cost over the years.
The entire cost can be claimed as deduction against the profit. If hired, however, the charge for
hire becomes an admissible deduction. Having regard to the fact that the acquisition of an asset
requires a larger immediate outlay than what is necessary in the case of hiring, the company may
opt for hiring in some cases rather than for straight acquisition. For example, taking the business
premises on rent rather than purchasing the same may be a better proposition.
But in the case of plant and machinery, two additional considerations may arise. New plant and
machinery in certain industries may enable a company to claim deduction on account of
depreciation and additional depreciation which may outweigh other considerations. Similarly, if
there can be a new industrial undertaking, substantial tax benefits may be available by way of tax
holiday benefit, etc. but that would require employment of new plant and machinery to a large
extent. These considerations may prompt an assessee to make two choices —(i) not to hire plant
and machinery but to purchase them and (ii) not to purchase second hand plant and machinery but
to purchase them new.
In appropriate cases, the assessee may go in for second hand imported plant and machinery,
satisfying the conditions laid down. In cases where an assessee opts to go for old plant and
machinery, the limit regarding the use of old plant and machinery, as laid down in Section 80 -IAC
should be taken into consideration. Difficulties may arise in applying the 20% limit for the value of
old plant or machinery for the purpose of section 80-IA etc. since the concept of value to be
adopted for this purpose has not been spelt out in the law and it is not clear whether such value
should refer to the cost or market value or the written down value as per books or as per income -
tax records. Particular care will have to be taken while planning for such a situation.
The assessee engaged in the specified business mentioned in section 35AD can avail the benefit
of deduction of capital expenditure incurred wholly and exclusively of the purpose of such specified
business. Capital expenditure incurred prior to commencement of business shall be allowed as
 ASSESSMENT OF VARIOUS ENTITIES 9.147

deduction during the previous year in which the assessee commences operation of the specified
business if, such expenditure incurred is capitalized in the books of accounts of the assessee v on
the date of commencement of its operation. However, such deduction is not available in respect of
capital expenditure incurred on acquisition of any land, goodwill or financial instrument. In case the
deduction under this section is claimed, no deduction shall be allowed under Chapter VI -A under
“Deduction in respect of certain incomes” in relation to the specified business for the same or any
other assessment year.
Interest on borrowed capital
Under clause (iii) of section 36(1), deduction of interest is allowed in respect of capital borrowed
for the purposes of business or profession in the computation of income under the head "Profits
and gains of business or profession". As per the proviso to section 36(1)(iii), any amount of
interest paid, in respect of capital borrowed for acquisition of an asset for any period beginning
from the date on which the capital was borrowed for acquisition of the asset till the date on which
such asset was first put to use, shall not be allowed as deduction.
ICDS IX on Borrowing Costs deals with the treatment of borrowing costs. It requires borrowing
costs which are directly attributable to the acquisition, construction or production of a qualifying
asset to be capitalized as part of the cost of that asset.
Qualifying asset has been defined to mean –
 land, building, machinery, plant or furniture, being tangible assets;
 know‐how, patents, copyrights, trademarks, licences, franchises or any other business or
commercial rights of similar nature, being intangible assets;
 inventories that require a period of twelve months or more to bring them to a saleable
condition.
This ICDS requires capitalization of specific borrowing costs (in respect of funds borrowed
specifically for the purpose of acquisition, construction or production of a qualifying asset) and
general borrowing costs. In case of qualifying assets being tangible and intangible assets, the
capitalization shall commence from the date on which funds were borrowed and cease when such
asset is first put to use.
This ICDS also provides the formula for capitalization of borrowing costs when funds are borrowed
generally and used for the purpose of acquisition, construction or production of a qualifying asset.
For this restricted purpose, a qualifying asset shall be such asset that necessarily require a period
of 12 months or more for its acquisition, construction or production. In this case, the capitalization
of borrowing costs shall commence from the date on which funds were utilized.
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(5) Setting up and commencement of production : Setting up of business in the context of
the Income-tax Act, 1961 is a concept entirely confined to that Act. It is not the same as the
commencement of the business and these two concepts have been clearly distinguished for
income-tax purpose. Between the date of the setting up and date of commencement, there may be
an interregnum during which the assessee may be incurring expenses of a revenue nature.
Under the taxation laws, the expenditure incurred prior to the date of setting up is not normally
admissible for income-tax purposes. But if those are incurred on and from the date of setting up,
but before commencement of the business, they may be allowed as deduction for tax purposes
provided of course they are revenue in nature and are incurred wholly and exclusively for the
purposes of business.
It is now practically well settled by various judicial rulings that a business is set up as soon as it is
ready to commence production and it is not necessary that actual production should be so
commenced. Thus, in the case of a company established for manufacturing cement, the business
is set up as soon as acquiring of limestone is commenced even if at that time the plant and
machinery may not have been installed so that actual manufacturing operations may commence.
A tax planner should accordingly fix the setting up date in such a manner that the company gets
the maximum scope for allowability of expenses incurred contemporaneously to the date of setting
up remembering that if those are incurred prior to the setting up date those are inadmissible as
direct deductions while, if such expenses are of a revenue nature and they are wholly and
exclusively incurred for business purpose, and are incurred subsequent to the date of setting up,
they will be admissible as normal deductions. The following examples may be noted:
(a) Such expenditure may be allowed as revenue expenditure. Expenditure by way of
brokerage, legal charges, etc. for arranging long term loans, interest on borrowing — India
Cement Ltd. vs. CIT 60 ITR 52 (SC).
(b) Such expenditure may form part of the cost of assets on which depreciation may be
available – Challapalli Sugars Ltd. vs. CIT 98 ITR 167 (SC).
In this context, the provisions of Explanation 8 to Section 43(1) to the effect that any
interest paid or payable in connection with the acquisition of an asset, which is relatable to
any period after such asset is first put to use cannot be capitalised, are relevant.
(c) Such expenditure may constitute preliminary expenditure and may be eligible for
amortisation over a five year period under section 35D.
 ASSESSMENT OF VARIOUS ENTITIES 9.149

(d) Such expenditure, if being of a capital nature and if not falling under any of the three
v of
categories noted above may be disallowed and there may not be relief either on account
depreciation or amortisation.
(6) Tax planning for business deductions — Some general considerations : There are
several matters which affect the assessee’s ability to deduct various expenses for income -tax
purposes. Some of the principal considerations to be borne in mind planning for business
deductions, are given below:
Successful tax planning for business deductions pre-supposes a clear and thorough understanding
of the various statutory provisions governing the deductions and an awareness of the statutory
rights as well as various restrictions and conditions governing such rights. The general
considerations applicable to tax planning in the field of business deductions, revolve round their -
(a) allowability.
(b) year of allowability
(c) extent of allowability (disallowing provisions if any), and
(d) carry-forward to future years.
Often, the question of expenditure being capital or revenue and the consequences attaching to the
likely treatment eventually may also be an important part of the tax planning exercise. This aspect
has been discussed at a later stage.
One of the important aspects of tax planning would be to see that the maximum deduction or
allowance is obtained in the earliest possible time for the purpose of determination of taxable
income. Therefore, while deciding about incurring of capital and revenue expenditure, the
assessee should consider the tax treatment of such expenditures and the period within which the
benefit of deduction or amortisation would be obtained so that he can estimate and work out cash
flow position over a period of time. While tax considerations play a major role in investment
decisions, the general principles of financial management and their effect on investment decisions
should not be ignored.
The tax planner should keep in mind the advantage arising out of minimising the expenditure,
especially in the initial years of a business, so that the profits may be maximised and the assessee
may be in a position to avail of the various tax incentives like depreciation as also the tax holiday
provisions.
Normally, deduction for expenditure is allowable in the year in which it is incurred or paid
depending on the method of accounting followed, viz, mercantile or cash. In other words, the
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expenditure to be claimed as deduction should be claimed in the relevant year. Where the
assessee follows the cash system of accounting, the allowance in respect of expenses would be
available only when the moneys in respect of them are actually paid by the assessee. Whereas in
the case of mercantile system of accounting, if a business liability has definitely arisen in the
accounting year, a deduction should be allowed. Where accounts are kept on a mercantile basis, if
an expenditure is claimed on the ground that it is legally deductible, it can be claimed in the year in
which the liability for the expenditure is incurred even though the payment itself is made in a
subsequent year. If an assessee following mercantile system fails to claim an expense in the year
in which it accrues he loses the right to claim it as a deduction altogether. He cannot claim or
make any attempt to reopen the accounts of the earlier year to which the expense relates.
The Supreme Court’s decision in C.I.T. vs. Gemini Cashew Sales Corporation (1967) 65 ITR 643
emphasizes the principle that if the liability to make the payment has arisen during the previous
year, it must be appropriately regarded as the expenditure of that year and merely because the
payment in respect of the expenditure is made in the subsequent year, the assessee would not be
entitled to claim deduction in respect thereof in the subsequent year. As pointed out earlier, this is
subject to the provisions of section 43B.
Normally, deduction can be claimed by the assessee only in respect of those expenses and losses
which have been actually incurred by the assessee during the previous year, i.e. after the business
is set up. However, there are some exceptions to this rule and a tax planner should be aware of
the exceptions and make use of them in appropriate cases. For example, expenditure incurred on
scientific research before the commencement of the business — capital or revenue during the
three years immediately preceding the commencement of the business and coming within the
scope of the Explanation to sections 35(1)(i) and 35(1)(ii), capital expenditure incurred prior to
commencement of specified business allowed as deduction in the year of commencement of
business, in case capitalized under section 35AD, preliminary expenses incurred before
commencement of the business and coming within the scope of section 35D, expenditure on
prospecting for minerals coming within the scope of section 35E, are cases where the assessee
could claim deduction in respect of the expenditure even though the expenditure was not incurred
during the previous year.
Similarly, the expenditure in respect of which deduction is claimed by the assessee should not be
in the nature of capital expenditure. This is again subject to the statutory exceptions contained in
provisions like section 35 and 35AD. Again, subject to the statutory exceptions, the expenditure
should be incurred wholly and exclusively for the purpose of the business.
 ASSESSMENT OF VARIOUS ENTITIES 9.151

Various other expenses incurred prior to the commencement of commercial operations may, in
v
appropriate cases, be accumulated and capitalised by being spread over the cost of various assets
constructed or acquired during the pre-production period. If this is done on a proper basis, the cost
of the various assets including the indirect expenses capitalised can be depreciated for tax
purposes to the extent that the cost relates to assets which are themselves depreciable for
income-tax purposes. This is a matter which the tax planner should bear in mind in order to ensure
that expenses incurred during the construction period are properly accounted and allocated.
Specific deductions under the Income-tax Act, 1961
The Income-tax Act, 1961 lists several specific deductions. A deduction falling under each
category is allowable subject to the conditions and limitations, if any which may be specified. At
times the restrictive conditions apply to expenditure which is prima facie suspect as, for example,
transactions with relatives or associates or within the same group coming within the scope of
section 40A(2). While planning for business deductions, due regard must be had to these
limitations.
In addition to the specific provisions the omnibus provision in section 37 also enables an assessee
to claim deduction in respect of expenditure laid out ‘wholly and exclusively for the purpose of the
business’ the tax planner has to take into consideration the principles emerging from the
innumerable relevant judicial rulings while availing of the facility of deduction under this provision.
Any expenditure incidental to business, may be deducted except those prohibited by any provision
of the Act.
Ordinarily, an expenditure which is specifically provided for should be claimed under the relevant
section rather under the omnibus provision. To justify the deduction under the residual clause, all
that is required is that the expenditure must have been incurred wholly and exclusively and it is not
necessary to prove that the expenditure was also incurred ‘necessarily’ or ‘reasonably”. The
expenditure must have been incurred ‘for the purpose of business’. These words are wider than
the phrase “for the purpose of earning profits”. A specific quid pro quo is not essential. It is not
necessary to show that the expenditure resulted in commensurate benefit or advantage either
during the same year or subsequently.
An expenditure is liable to be disallowed if it is either of a personal nature or of a capital nature.
The question whether a particular expenditure is of a personal nature must be judged by reference
to the assessee himself and not any other person.
Capital or Revenue: Generally speaking, an expenditure is regarded as being of a capital nature,
if it results in the acquisition of an asset or of an advantage or benefit of an enduring nature.
 avv DIRECT TAX LAWS
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 The test with regard to the nature of the expenditure-capital or revenue - is to be applied
with reference to its purpose rather than its effect. The test must be applied by reference to
the assessee himself and not any other person. For instance, a company must be obliged to
construct pipelines for the purpose of its business but under conditions whereby the
pipelines ultimately become the property of a municipal corporation rather than the
company itself. In such a case, although the pipelines undoubtedly constitute tangible
assets the expenditure may not be regarded as of a capital nature, since the assets do not
belong to the company but to some other person. There are many judicial rulings to support
this view. A leading case that maybe referred to in this context is Lakshmiji Sugar Mills Co.
P. Ltd. vs. CIT (1971) 82 ITR 376 (SC)].
 If the purpose of the expenditure is to secure a commercial advantage, rather than
acquisition of a capital asset, it is likely to be allowed as revenue expenditure even though
the advantage may endure for an indefinite period. However, this rule is by no means
inflexible or capable of universal application. Conversely, if the purpose of the expenditure
is the acquisition of an advantage or benefit of an enduring nature the expenditure is liable
to be treated as capital expenditure even if the period or durability of the asset acquired as
the result of the expenditure is very short. For example, if a company making shoes
acquires knives and lasts, whose life is only three years, the expenditure may nevertheless
be regarded as capital expenditure.
 In applying the various case laws on the subject of distinction between capital and revenue,
it should be recognised that circumstances do change and the law normally keeps pace
with such changing circumstances. The expenditure that was regarded as capital
expenditure resulting in long-term benefit during the relatively laissez faire days of the 19th
century may not perhaps, be regarded as capital expenditure in the context of the rapid
technological changes which are the feature of industrial life today. The decision of the
Supreme Court in Shahzada Nund & Sons vs. CIT 108 ITR 358 also supports this view. A
tax planner would do well to keep track of the various cases reported from time to time so
as to keep himself informed of the trend of judicial thinking in this regard.
In this context, the requirements spelt out in the various income computation and disclosure
standards have also to be kept in mind while considering the point in time of deductibility of
expenditure.
 Expenditure specifically allowed: The Income-tax Act, 1961 specifically allows many types of
expenditure such as depreciation, expenditure on scientific research, expenditure on know-how,
preliminary expenses, bad debts etc. The Act prescribes several conditions and restrictions for
 ASSESSMENT OF VARIOUS ENTITIES 9.153

the allowance of such expenditure. The tax-planner should take care to see that all the
prescribed conditions are complied with so that deductions may not be denied. v

Note - A company who has opted for the special provisions under section 115BAA or
115BAB would, however, not be eligible to claim deduction on account of , inter alia,
additional depreciation and contribution for scientific research to companies/research
association/IITs.
 Other business expenses: As already explained earlier, section 37(1) deals with the
various items of expenses which are otherwise not covered by the provisions of Section 30
to 36 of the Income-tax Act, 1961 and specifically provides that all expenses which are
incurred wholly and exclusively (though not necessarily) for the purpose of the business or
profession carried on by the assessee would be deductible in computing the assessee’s
business income. In order to qualify for deduction under this provision, the following
important conditions will have to be fulfilled:
(i) The expenditure should have been incurred by the assessee in the ordinary course
of his business or profession;
(ii) The expenditure should be of a revenue nature and should not be of capital nature;
(iii) The expenditure should not be of a personal nature;
(iv) The expenditure should not be covered by any other provisions of sections 30 to 36
for purposes of allowance and it should not also be covered by any of the provisions
of disallowance contained in sections 40 to 44D; and
(v) The expenditure should not be one which is in the nature of an appropriation of
income or diversion of profits by an overriding title. It should not also be one in
respect of which deduction is permissible under Chapter VI-A of the Income-tax Act,
1961 from the gross total income of the assessee.
 Commercial expediency: The concept of ‘commercial expediency’ helps a tax payer in
insisting that a reasonable view is taken of his right to deduct normal expenditure. The trend
in judicial thinking has also recognised this concept. This concept reflects the fact that it is
virtually impossible for the legislation to list all possible deductions to which an assessee
would be entitled in computing his taxable income and therefore the fact that a business
has to be run by the assessee himself under normal commercial conditions must be
recognised in determining the allowability of certain expenditure. The test of commercial
expendiency should be applied from the point of view of a normal prudent businessman, by
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reference to modern concepts of business responsibility and not by reference to the
subjective standards of the revenue department.
A claim on the ground of commercial expediency is subject to the under-noted conditions
and limitations:
(a) If the expenditure is covered by one of the express provisions in the Act, it must
conform to the requirements stipulated therein.
(b) An expenditure which is expressly disallowed under the Act cannot be claimed on
grounds of commercial expediency.
(c) An expenditure cannot be claimed on grounds of commercial expediency if it is improper
or illegal. It may be commercially expedient to pay a bribe or incur a penalty but this does
not mean that the bribe or penalty would be normally deductible for tax purposes.
There is also a distinction between a payment made for a violation or breach of law and
payment made for a breach of contract. Courts have taken the view that where the
payments are not in the nature of penalties for infraction of any law but made in pursuance
of the exercise of an option given in a particular scheme and where the assessee opts for it
out of commercial expediency and business consideration, it could be allowed as deduction.
(7) Tax planning in case of losses : The provisions of sections 70, 71 and 72 of the Income-
tax Act, 1961 regulate the manner in which losses incurred in the business carried on by any tax
payer will have to be dealt with for tax purposes. The consideration to be given by tax payers in
the matter of taking the full benefit of set-off of losses permissible under the law is as important as
the considerations for tax planning which are taken into account in regard to business expenses or
claiming the maximum allowances and deductions particularly in view of the fact that the
provisions of set-off of losses offer valuable scope for planning.
Under section 73, losses incurred in speculation business are to be set off only against the income
from the business of speculation, if any, which the assessee may derive in the same year or in the
subsequent four years. In view of the prohibition in the matter of set -off of losses incurred in
speculation business, it would be in the interest of the assessee to avoid indulging in the business
of speculation if it is likely to result in losses and there is no possibility of setting it off against
future speculation profits within the specified period. Where the business of speculation carried on
by the assessee is not profitable, he could discontinue the business of speculation in the same line
so that the quantum of losses could be reduced and the assessee could resort to speculation in
any other profitable field thereby taking the benefit of exception provided under the law.
 ASSESSMENT OF VARIOUS ENTITIES 9.155

The Supreme Court, in CIT vs. Shantilal P. Ltd. (1983) 144 ITR 57, held that a transaction cannot
be described as a ‘speculative transaction’ within the meaning of section 43(5), where therev is a
breach of a contract and on a dispute between the parties, damages are awarded as
compensation by an arbitration award. However, where there is no dispute and damages on a pre -
determined basis are payable under the contract, without actual delivery of the goods contracted
for, the transaction would be a speculative one. If any loss arises out of such a speculative
transaction, such speculation loss would not be available for adjustment against other business
profits, if any.
Loss from specified business referred to in section 35AD can be carried forward indefinitely under
section 73A for set-off against income from the same or any other specified business. Such loss
cannot, however, be set-off against income from non-specified business or income under any other
head.
The assessee should exercise his right to set off of brought forward loss at the first available
opportunity. The Madras High Court, in Tyresoles (India) vs. CIT [1963] 49 ITR 515, held that where
losses sustained are not set off against the profits of the immediately succeeding year or years, they
cannot be set off against profits at a later date. This has been followed by the Punjab and Haryana
High Court in B.C.S. Kartar Chit Fund and Finance Co. (P.) Ltd. vs. CIT [1989] 79 CTR (P & H) 232.
Hence, as a matter of proper tax planning, the assessee should exercise the right under section 72 in
the immediately succeeding year/years when the profits allow such a set off.
It is also significant to note that, under section 79, a closely held company will be entitled to claim
the benefit of carry forward and set-off of losses, only if shares carrying at least 51% of the voting
power is held on the last day of the previous year by the same persons who held such shares on
the last day of the previous year in which the loss was incurred. In case of a closely held company,
being an eligible start up referred to in section 80-IAC, the loss incurred in any year prior to the
previous year (say, in P.Y.2021-22) can be carried forward for set-off against the income of the
relevant previous year (i.e., P.Y.2025-26), if shares carrying at least 51% of the voting power is
held on the last day of the previous year (i.e., as on 31.3.2026) by the same persons who held
such shares on the last day of the previous year in which the loss was incurred (i.e., as on
31.3.2022). In the alternative, all shareholders of such company holding shares carrying voting
power on the last day of the previous year in which the loss was incurred (i.e., as on 31.3. 2022),
should continue to hold those shares on the last day of the previous year in which the loss is to be
set-off (i.e., as on 31.3.2026) and such loss should have been incurred during the ten years
beginning from the date of incorporation of such company. This benefit will not be denied, if the
change has occurred on account of death of a shareholder or on account of transfer by a
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shareholder to his relative by way of a gift. This benefit will also not be denied if the change in
shareholding of an Indian company, which is a subsidiary of a foreign company, is the result of an
amalgamation or demerger. However, this is subject to the condition that 51% shareholders of the
amalgamating or demerged foreign company continue to be the shareholders of the amalgamated
or resulting foreign company. Further, the benefit of carry forward and set -off would not be denied
to accompany, where a change in the shareholding takes place in a previous year pursuant to a
resolution plan approved under the Insolvency and Bankruptcy Code, 2016, after affording a
reasonable opportunity of being heard to the jurisdictional Principal Commissioner or
Commissioner.
It should be kept in mind that section 79 applies to carry forward and set off of losses and not to
the benefit of deduction in respect of unabsorbed depreciation.
Loss Returns: In the context of discussion on losses it would be relevant to point out that the tax
planner would do well to keep in mind the implications of the provisions of section 139(3) read with
section 80.
If an assessee is to get the benefit of the determination of the loss and its carry forward under
section 72(1) or 73(2) or 73A(2) or 74(1) or 74A(3), he should file a return voluntarily within the
period specified in section 139(1).
However, filing of return within the period specified in section 139(1) is not necessary for carry
forward of loss from house property under section 71B and unabsorbed depreciation.
Section 80AC stipulates compulsory filing of return of income on or before the due date specified
under section 139(1) as a pre-condition for availing benefit of deductions under any provision of
Chapter VI-A under the heading "C.-Deductions in respect of certain incomes".

9.5 OTHER PROVISIONS RELATED TO VARIOUS

ENTITIES
(1) Tax on income from life insurance business

Section 115B provides for a concessional rate of tax for taxing the profits and gains derived from
the business of life insurance. Under these provisions, in the case of an assessee whose total
income includes any profits and gains derived from the business of life insurance computed in
accordance with the First Schedule to the Income-tax Act, 1961, the income-tax payable shall be
the aggregate of –
 ASSESSMENT OF VARIOUS ENTITIES 9.157

(i) the amount of income-tax calculated on the income from life insurance business included
in total income at the rate of 12½% and v

(ii) 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 profits and gains from the life
insurance business.
Income accruing or arising to a company from life insurance business referred to in section 115B
would not be subject to MAT. [Section 115JB(5A)].
Taxation of income/loss of non-life insurance business: Rule 5 of the First Schedule to the
Income-tax Act, 1961 provides that the profits and gains of non-life insurance business would be
the profit before tax and appropriations as disclosed in the profit and loss account prepared in
accordance with the provisions of the Insurance Act, 1938 or the IRDA Act, 1999, subject to
following adjustment -
- expenditure or allowances not allowable under sections 30 to 43B,
- any provision for diminution in the value of investment debited to profit and loss account
has to be added back,
- any gain or loss on realization of investments not credited or debited to profit and loss
account, shall be added or deducted, as the case may be, and

- reserve for unexpired risk as prescribed shall be allowed.

(2) Special Rates of tax in respect of certain specified income or assets

 Tax on income from GDRs purchased in foreign currency or capital gains arising
from transfer of such GDRs [Section 115ACA]
(i) Eligible assessee [Section 115ACA(1)(a)/(b)]-This section applies to resident
individuals who are employees of an Indian company engaged in specified
knowledge based industry or service, or employee of its subsidiary engaged in
specified knowledge based industry or service.
(ii) Eligible income and special rate of tax [Section 115ACA(1)(a)/(b)] - Where the
total income includes the following income namely –
(a) income by way of dividends in respect of Global Depository Receipts of an
Indian company engaged in specified knowledge based industry or service,
purchased by an eligible assessee in foreign currency issued in accordance
with such employees’ stock option scheme as the Central Government may
specify in this behalf,
 avv DIRECT TAX LAWS
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(b) income by way of long-term capital gains arising from the transfer of the
aforesaid Global Depository Receipts,
Then, the aforesaid income will be taxed at the following rates:
• at the rate of 10% in respect of income by way of interest or dividend
referred to in (a) above; and
• at the rate of 12.5% in respect of long-term capital gain from the transfer of
above bonds or GDRs.
(iii) No deduction is allowed [Section 115ACA(2)]- In the case of the aforesaid
resident employee, no deduction shall be allowed under any provisions of this Act,
where the gross total income consists only of income by way of dividend from Global
Depository Receipts.
However, where the gross total income includes dividend income or long term capital
gain from such Global Depository Receipts, the deduction under any provisions of
the Act shall be allowed only on that portion of gross total income which does not
include such income from the Global Depository Receipts.
(iv) No benefit of first and second proviso of section 48 [Section 115ACA(3)]- The
first and second provisos to section 48 relating to the computation of capital gains
shall not apply in case of transfer of Global Depository Receipts of an Indian
company purchased by the resident employee in foreign currency. In other words, no
indexation will be available even if the assets are long term capital assets.
(v) Meaning of certain terms:
S. Term Meaning
No.
1. Global Any instrument in the form of a depository receipt or
Depository certificate (by whatever name called) created by the
Receipts Overseas Depository Bank outside India or in an
International Financial Services Centre and issued to
investors against the issue of –
(i) ordinary shares of issuing company, being a
company listed on a recognized stock exchange in
India; or
(ii) foreign currency convertible bonds of issuing
company;
(iii) ordinary shares of issuing company, being a
company incorporated outside India, if such
depository receipt or certificate is listed and traded
on any International Financial Services Centre
 ASSESSMENT OF VARIOUS ENTITIES 9.159

2. Specified (i) information technology software;

knowledge- (ii) information technology service; v
based (iii)entertainment service;
industry or (iv) pharmaceutical industry;
service (v) bio-technology industry; and
(vi) any other industry or service, as may be notified by
the Central Government
3. Subsidiary The term includes subsidiary incorporated outside India
4. Information Any service which results from the use of any information
technology technology software over a system of information
service technology products for realising value addition
5. Overseas A bank authorised by the issuing company to re-issue
Depository Global Depository Receipts against issue of Foreign
Bank Currency Convertible Bonds or ordinary shares of the
issuing company.
 Concessional Taxation Regime for royalty income in respect of patent developed and
registered in India [Section 115BBF]
(i) The Finance Act, 2016 introduced a concessional taxation regime for royalty income
from patents for the purpose of promoting indigenous research and development and
making India a global hub for research and development.
(ii) The purpose of the concessional taxation regime is for encouraging entities to retain and
commercialise existing patents and for developing new innovative patented products.
(iii) Further, this beneficial taxation regime will incentivise entities to locate the high-value
jobs associated with the development, manufacture, and exploitation of patents in India.
(iv) The nexus approach has been recommended by the OECD under Action Plan 5 in
Base Erosion and Profit Shifting (BEPS) project. This approach requires attribution
and taxation of income arising from exploitation of Intellectual property (IP) in the
jurisdiction where substantial research and development (R & D) activities are
undertaken instead of the jurisdiction of legal ownership. The provisions of section
115BBF are accordingly in line with such approach.
(v) Concessional rate of tax - Section 115BBF provides that where the total income of
the eligible assessee includes any income by way of royalty in respect of a patent
developed and registered in India, then such royalty shall be taxable at the rate of
10% (plus applicable surcharge and cess). For this purpose, developed means at-
least 75% of the expenditure should be incurred in India by the eligible assessee for
any invention in respect of which patent is granted under the Patents Act, 1970.
 avv DIRECT TAX LAWS
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(vi) No expenditure is allowed - No deduction for any expenditure or allowance in
respect of such royalty income shall be allowed under the Act.
(vii) Option of concessional rate to be exercised before due date under section
139(1) - The eligible assessee has to exercise the option for taxation of income by
way of royalty in respect of a patent developed and registered in India in accordance
with the provisions of section 115BBF in the prescribed manner, on or before the due
date specified under section 139(1) for furnishing the return of income for the
relevant previous year.
(viii) Not eligible to opt for concessional taxation under this section for 5
assessment years - Where an eligible assessee opts for taxation of income by way
of royalty in respect of a patent developed and registered in India for any previous
year in accordance with section 115BBF, and the assessee offers the income for
taxation for any of the five assessment years relevant to the previous year
succeeding the previous year not in accordance with section 115BBF(1),then the
assessee shall not be eligible to claim the benefit of section 115BBF for five
assessment years subsequent to the assessment year relevant to the previous year
in which such income has not been offered to tax in accordance with section
115BBF(1).
(ix) Non-applicability of MAT provisions - Further, the amount of income by way of
royalty in respect of patent chargeable to tax under section 115BBF would not be
subject to MAT under section 115JB. The same would be reduced while arriving at
the book profit. Consequently, the related expenditure would be added back for
arriving at the book profit.
(x) Meaning of certain terms
S. Term Meaning
No.
1 Eligible Eligible assessee means:
assessee • A person resident in India,
• who is the true and first inventor of the invention and
• whose name is entered on the patent register as the
patentee in accordance with Patents Act, 1970 .
Eligible assessee includes:
every such person, being the true and the first inventor of the
invention, where more than one person is registered as
patentee under Patents Act, 1970 in respect of that patent.
2 Royalty “Royalty”, in respect of a patent, means consideration
(including any lump sum consideration but excluding any
consideration which would be the income of the recipient
 ASSESSMENT OF VARIOUS ENTITIES 9.161

chargeable under the head “Capital gains” or consideration for

sale of product manufactured with the use of patented process
v
or the patented article for commercial use) for the—
(1) transfer of all or any rights (including the granting of a
licence) in respect of a patent; or
(2) imparting of any information concerning the working of,
or the use of, a patent; or
(3) use of any patent; or
(4) rendering of any services in connection with the activities
referred to in (1) to (3) above.
3 Lumpsum “Lump sum” includes an advance payment on account of such
royalties which is not returnable

(3) Tax on income from transfer of Carbon credits [Section 115BBG]

(i) Carbon credits is an incentive given to an industrial undertaking for reduction of the
emission of GHGs (Green House gases).
(ii) A reduction in emissions entitles the entity to a credit in the form of a Certified Emission
Reduction (CER) certificate. The CER is tradable and its holder can transfer it to an entity
which needs Carbon Credits to overcome an unfavourable position on carbon credits.
(iii) To bring clarity on the issue of taxation of income from transfer of carbon credits and to
encourage measures to protect the environment, section 115BBG provides that where the
total income of the assessee includes any income from transfer of carbon credit, such
income shall be taxed at a concessional rate of 10% (plus applicable surcharge and cess)
(iv) No expenditure is allowed - No expenditure or allowance in respect of such income shall
be allowed under the Act.
(v) Meaning of "Carbon credits": Carbon credits in respect of one unit shall mean reduction of
one ton of carbon dioxide emissions or emissions of its equivalent gases which is validated
by the United Nations Framework on Climate Change and which can be traded in market at
its prevailing market price.
 avv DIRECT TAX LAWS
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SIGNIFICANT SELECT CASES
[Link]. Case Law
1. Secunderabad Club v. CIT [2023] 457 ITR 263 (SC)
Issue Facts, Analysis and Decision
Does the principle of mutuality Facts of the case: The assessee-club
apply to interest income derived deposited surplus funds as term deposits with
from fixed deposits made with the various banks (who were the club members). It
banks by the clubs if such banks claimed interest earned on said deposits as
are members of the club? exempt from income-tax applying the principle
of mutuality.
Analysis: The principle of mutuality works on
the triple test, namely-
(i) Complete identity between the
contributors and participators;
(ii) Action of the participators and
contributors must be in furtherance of the
mandate of the associations or the Clubs. The
mandate of the Club is a question of fact that
has to be determined from the Memorandum or
Articles of Association, Rules of Membership,
Rules of the Organization, etc., and must be
construed broadly.
(iii) There must be no scope for profiteering
by the contributors from a fund made by them,
which could only be expended or returned to
themselves.
Applying the above principles to the facts of
the case, it was observed that in relation to
transactions, namely, the deposit of surplus
funds earned by the club, in banks which are
members of the club, the principle of mutuality
applies till the stage of deposit of funds and
would lose its application, once the funds are
deposited as fixed deposit in the banks. This is
because the funds would be exposed to
commercial banking operations, which means
that the deposits could be used for lending to
ASSESSMENT OF VARIOUS ENTITIES 9.163

third parties and earning a higher interest

thereon by paying a lower interest rate on vthe
fixed deposits to the club. The bank utilising
the funds of the club deposited in fixed deposit
receipts for their banking business would
completely rupture the "privity of mutuality",
and as a result, the element of complete
identity between the contributors and
participators would be lost. Consequently, the
first condition for the claim of mutuality is not
satisfied.
If the surplus fund is not applied for the
common purpose of the club or towards the
benefit of the members of the club directly but
is invested with a third party who has the right
to utilise the said funds, subject to payment of
interest on it and repayment of the principal
when desired by the club, then, in such an
event, the club loses its control over the said
funds. Furthermore, as the bank utilises the
fixed deposit amounts for its banking business,
the club's identity with the funds is
compromised. The bank's ability to derive
profits by lending the amount at a higher
interest rate, while paying a lower rate of
interest on the fixed deposit made by the club,
further disrupts the essential identicality
between contributors and participators in the
mutual relationship.
Conversely, when a club provides its facilities
to members who contribute to its income, the
principle of mutuality applies due to the identity
between contributors and participants.
However, where the same facilities are offered
to non-members or the public to generate
additional income, it transforms into a
commercial transaction, and the principle of
mutuality no longer applies.
For the triple test to apply to the different and
varied transactions of the club, it is necessary
 avv DIRECT TAX LAWS
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to lift the veil and discern the nature of each
transaction: whether there is third-party
intervention, which is the reason for earning
the income, or it is an income generated
between the members and the club, as such,
i.e., only between the members of the club.
When the transactions of the club are viewed
in the aforesaid prism, then, in each of the
transactions, whether the principle of mutuality
would apply has to be discerned.
Decision:
Accordingly, the Supreme Court held that the
interest income earned on fixed deposits made
with the banks by the appellant club has to be
treated like any other income from other
sources within the meaning of section 2(24).
Conversely, if any income is earned by the
club through its assets and resources from
persons who are not members of the club,
such income would also not be covered under
the principle of mutuality. It would be liable to
be taxed under the provisions of the Income-
tax Act.
2. ITO v. Venkatesh Premises Co-operative Society Ltd. (2018) 402 ITR 670 (SC)
Issue Decision
Are non-occupancy charges, The doctrine of mutuality is based on the
transfer charges, common amenity common law principle that a person cannot
fund charges received by co- make a profit from himself. Accordingly, the
operative societies from its transfer charges, non-occupancy charges
members exempt on the basis of common amenity fund charges and other
the doctrine of mutuality? charges received by a co-operative society
from its members are exempt owing to
application of the doctrine of mutuality.
3. CIT v. Govindbhai Mamaiya (2014) 367 ITR 498 (SC)
Issue Analysis and Decision
Where land inherited by three Three brothers inherited a property consequent to
brothers is compulsorily acquired by demise of their father. A part of this bequeathed
 ASSESSMENT OF VARIOUS ENTITIES 9.165

the State Government, would the land was acquired by the State Government and
resultant capital gain be assessed compensation was paid for it. In this case,vthe
in the status of “Association of property in question came to the assessees’
Persons” (AOP) or in their individual possession through inheritance i.e., by operation
status? of law. It is not a case where any ‘association of
persons” was formed by volition of the three
brothers. Further, even the income earned in the
form of interest is not because of any business
venture of the three assessees, but is the result of
the act of the Government in compulsorily
acquiring the said land. Thus, the basic test to be
satisfied for making an assessment in the status of
AOP is absent in this case. Hence, the income
from asset inherited by the legal heirs is taxable in
their individual hands and not in the status of AOP.
4. Joint CIT v. Rolta India Ltd. (2011) 330 ITR 470 (SC)
Issue Analysis and Decision
Can interest u/s 234B and 234C be Section 115JB(5) provides that all other
levied where a company is provisions of the Income-tax Act, 1961 shall
assessed on the basis of book apply to every assessee, being a company,
profits u/s 115JB? mentioned in that section. Section 115JB is a
self-contained code pertaining to MAT, and by
virtue of sub-section (5) thereof, the liability for
payment of advance tax would be attracted.
Therefore, if a company defaults in payment of
advance tax in respect of tax payable u/s
115JB, it would be liable to pay interest under
sections 234B and 234C.
5. Madras Gymkhana Club v. DCIT (2010) 328 ITR 348 (Mad.)
Issue Analysis and Decision
Would the interest earned on The assessee-club providing facilities like gym,
surplus funds of a club deposited library, etc., to its members earned interest
with institutional members satisfy from fixed deposits which it had made by
the principle of mutuality to escape investment of its surplus funds with its
taxability? corporate members.
Interest earned from investment of surplus
funds in the form of fixed deposits with
institutional members does not satisfy the
 avv DIRECT TAX LAWS
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avv
principle of mutuality and hence cannot be
claimed as exempt on this ground. The interest
earned is, therefore, taxable.
6. Sind Co-operative Housing Society v. ITO (2009) 317 ITR 47 (Bom)
Issue Analysis and Decision
Can transfer fees received by a co- Transfer fees received by a co-operative
operative housing society from its housing society, whether from outgoing or from
incoming and outgoing members be incoming members, is not liable to tax on the
exempt on the ground of principle of ground of principle of mutuality since the
mutuality? 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 income, can have no application
since the co-operative housing society is not a
trade or professional association.
7. CIT v. Anil Hardware Store (2010) 323 ITR 368 (HP)
Issue Analysis and Decision
In a case where the partnership The manner of fixing the remuneration of the
deed does not specify the partners has been specified in the partnership
remuneration payable to each deed. In a given year, the partners may decide
individual working partner but lays to invest certain amounts of the profits into
down the manner of fixing the other ventures and receive less remuneration
remuneration, would the assessee- than that which is permissible under the
firm be entitled to deduction in partnership deed, but there is nothing which
respect of remuneration paid to debars them from claiming the maximum
partners? amount of remuneration payable in terms of
the partnership deed. The method of
remuneration having been laid down; the
assessee-firm is entitled to deduct the
remuneration paid to the partners u/s 40(b)(v)
 ASSESSMENT OF VARIOUS ENTITIES 9.167

8. CIT v. Trans Asian Shipping Services (P) Ltd (2016) 385 ITR 637 (SC)
v
Issue Analysis and Decision
Can income derived by an Indian The requirement of producing a certificate
shipping company from slot would not apply when entire ship is not
charter arrangement in other ships chartered and the arrangement pertains only to
be computed applying the special purchase of slots, slot charter etc. The legal
provisions under Chapter XII-G of fiction created by section 115VG(4) is to be
the Income-tax Act, 1961, relating given proper meaning.
to Tonnage Tax Scheme, in spite Accordingly, income from slot charter
of non-fulfillment of the condition arrangement in other ships can be computed
of holding a valid certificate in applying the special provisions under Chapter
respect of such ships indicating its XII-G.
net tonnage in force?
Note: As per section 115VG(4), for the
purposes of Chapter XII-G, the tonnage shall
mean the tonnage of a ship or inland vessel,
as the case may be, indicated in the certificate
referred to in section 115VX and includes the
deemed tonnage computed in the prescribed
manner. The manner has been prescribed in
Rule 11Q of the Income-tax Rules, 1962.
Further, the Explanation to section 115VG(4)
provides that for the purposes of this sub-
section, 'deemed tonnage' shall be the
tonnage in respect of an arrangement of
purchase of slots, slot charter and an
arrangement of sharing of break-bulk vessel.
Rules 11Q(1) provides that for the purpose of
Explanation to section 115VG(4), deemed
tonnage in respect of an arrangement of
purchase of slots and slot charter shall be
computed on the following basis:
2.5 TEU = 1 Net Tonnage (1NT)
Where TEU is Twenty-foot Equivalent Unit
(Container of this size)
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9. CIT v. Metal and Chromium Plater (P) Ltd. [2019] 415 ITR 123 (Mad)
Issue Analysis and Decision
Should capital gains exempt under Capital gains which forms part of the net profit
section 54EC, which forms part of in the statement of profit and loss of the
the net profit in the statement of assessee-company, in respect of which
profit and loss of the assessee- exemption under section 54EC is available
company, be taken into account for while computing total income under the regular
calculation of tax on book profits as provisions of the Income-tax Act, 1961, should
per section 115JB? not be taken into account for calculation of
minimum alternate tax on book profits under
section 115JB.
Note – The following is an extract of Circular
No.13/2001 dated 9.11.2001, issued by the
CBDT at the time of insertion of section 115JB
in the Income-tax Act, 1961 -
“It may be emphasised that the new provision
of section 115JB is a self-contained code. Sub-
section (1) lays down the manner in which
income-tax payable is to be computed. Sub-
section (2) provides for computation of "book
profit". Sub-section (5) specifies that save as
otherwise provided in this section, all other
provisions of this Act shall apply to every
assessee, being a company mentioned in that
section. In other words, except for substitution
of tax payable under the provision and the
manner of computation of book profit, all the
provisions of the tax including the provision
relating to charge, definitions, recoveries,
payment, assessment, etc., would apply in
respect of the provisions of this section.”
The CBDT Circular clarifies that except for
substitution of tax payable under the provision
and manner of computation of book profit, all
other provisions relating to charge, definitions,
recoveries, payment, assessment, etc., would
apply in respect of section 115JB. Therefore,
“book profit” for levy of MAT has to be
computed in the manner laid down under
ASSESSMENT OF VARIOUS ENTITIES 9.169

section 115JB i.e., by making the adjustments

as specified in the Explanations contained v
therein to the net profit as per the statement of
profit and loss. This implies that exemptions
and deductions available under the regular
provisions of the Act would not be available
unless expressly provided for in the
Explanations to section 115JB [For example,
income exempt under section 10, 11 and 12 of
the Income-tax Act, 1961 have to be deducted
while computing book profit for levy of MAT, if
credited to the statement of profit and loss, by
virtue of specific provision in clause (ii) of
Explanation 1 below section 115JB(2)].
Therefore, it appears that the intent of sub-
section (5) is to make applicable other
provisions like payment of advance tax,
interest under sections 234B and 234C, return
filing, penal and prosecution provisions under
the Income-tax Act, 1961 etc. to a case where
tax is computed under section 115JB. The
Madras High Court has, however, in this case
interpreted sub-section (5) of section 115JB to
also permit adjustment for exemption under
section 54EC while computing MAT, even
though the same is not expressly provided for
in the Explanations to section 115JB.
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TEST YOUR KNOWLEDGE

Questions
1. XYZ Ltd. is engaged in the manufacture of textile since 01-04-2009. Its Statement of Profit
& Loss shows a profit of ` 700 lakhs after debit/credit of the following items:
(a) Depreciation calculated on the basis of useful life of assets as per provisions of the
Companies Act, 2013 is ` 50 lakhs.
(b) Employer's contribution to EPF of ` 2 lakhs and Employees' contribution of ` 2 lakhs
for the month of March 2026 were remitted on 30th June, 2026.
(c) The company appended a note to its Income Statement that industrial power tariff
concession of ` 2.5 lakhs was received from the State Government and credited the
same to Statement of P & L.
(d) The company had provided an amount of ` 25 lakhs, being sum estimated as
payable to workers based on agreement to be entered with the workers union
towards periodical wage revision once in 3 years. The provision is based on a fair
estimation of wages and reasonable certainty of revision once in 3 years.
(e) The company had made a provision of 10% of its debtors towards bad and doubtful
debts. Total sundry debtors of the company as on 31-03-2026 was ` 200 lakhs.

(f) A debtor who owed the company an amount of ` 40 lakhs was declared insolvent
and hence, was written off by debit to Statement of Profit and loss.
(g) Sundry creditors include an amount of ` 50 lakhs payable to A & Co, towards supply
of raw materials, which remained unpaid due to quality issues. An agreement has
been made on 31-03-2026, to settle the amount at a discount of 75% of the
outstanding. The amount waived is credited to Statement of Profit and Loss.
(h) The opening and closing stock for the year were ` 200 lakhs and ` 255 lakhs,
respectively. They were overvalued by 10%.
(i) Provision for gratuity based on actuarial valuation was ` 500 lakhs. Actual gratuity
paid debited to gratuity provision account was ` 300 lakhs.
(j) Commission of ` 1 lakhs paid to a recovery agent for realization of a debt. Tax has
been deducted and remitted as per Chapter XVIIB of the Act.
 ASSESSMENT OF VARIOUS ENTITIES 9.171

(k) The company has purchased 500 tons of industrial paper as packing material at a
v
price of ` 30,000/ton from PQR, a firm in which majority of the directors are partners.
PQR's normal selling price in the market for the same material is ` 28,000/ton.
Additional Information:
(i) There was an addition to Plant & Machinery amounting to ` 50 lakhs on 10-06-2025,
which was used for more than 180 days during the year. Additional depreciation has
not been adjusted in the books.
(ii) Normal depreciation calculated as per Income-tax Rules, 1962 is ` 80 lakhs.

(iii) The company had credited a sub-contractor an amount of ` 10 lakhs on 31-03-2025

towards repairing a machinery component. The tax so deducted was remitted on
31-12-2025.

(iv) The company has collected ` 7 lakhs as GST from its customers and paid the same
on the due dates. However, on an appeal made, the High Court directed the
Department to refund ` 3 lakhs to the company. The company, in turn, refunded ` 2
lakhs to the customers from whom the amount was collected and the balance of ` 1
lakh is still lying under the head “Current Liabilities”.
Compute total income and tax liability for A.Y. 2026-27. Ignore MAT provisions and the
provisions of section 115BAA.
Note - The turnover of XYZ Ltd. for the P.Y.2023-24 was ` 405 crore.
2. Parik Hospitality Limited is engaged in the business of running hotels of 3 -star category.
The company's Statement of Profit and Loss for the previous year ended 31 st March 2026
shows a profit of ` 152 lakhs after debiting or crediting the following items:
(a) Payment of ` 0.25 lakh and ` 0.30 lakh in cash on 3 rd December 2025 and 10th
December 2025, respectively, for purchase of raw corn to Mr. Raja, an agriculturist,
and Mr. Khalid, a spice trader for purchase of masala used for corn products,
respectively.

(b) Contribution towards employees' pension scheme notified by the Central

Government under section 80CCD for a sum of ` 3 lakhs calculated at 12% of
aggregate of basic salary and dearness allowance (forming part of retirement
benefits) payable to the employees in terms of employment.
 avv DIRECT TAX LAWS
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(c) Payment of ` 6.50 lakhs towards transportation of various materials procured by one
of its hotels to M/s. Bansal Transport, a partnership firm, without deduction of tax at
source. The firm opts for presumptive taxation under section 44AE and has furnished
a declaration to this effect. It also furnished its Permanent Account Number in the
tender document.
(d) Profit of ` 12 lakhs on sale of a plot of land to Avimunya Limited, a domestic
company, the entire shares of which are held by the assessee company. The plot
was acquired by Parik Hospitality Limited on 1 st June 2024.
(e) Contribution of ` 2.50 lakhs to Indian Institute of Technology with a specific direction for
use of the amount for scientific research programme approved by the prescribed
authority.
(f) Expense of ` 10 lakhs on foreign travel of two directors for a collaboration
agreement with a foreign company for a brewery project to be set up. The
negotiation did not succeed, and the project was abandoned.
(g) Fees of ` 1 lakh paid to independent directors for attending Board meeting without
deduction of tax at source under section 194J.
(h) Depreciation charged ` 10 lakhs.
(i) ` 10 lakhs, being the additional compensation received from the State Government
pursuant to an interim order of Court in respect of land acquired by the State
Government in the previous year 2023-24.
(j) Dividend received from a foreign company ` 5 lakhs in which it holds 15% of the
equity share capital.
Additional information:
(i) As a corporate debt restructuring, the bank has converted unpaid interest of ` 10
lakhs upto 31st March 2025 into a new loan account repayable in five equal annual
installments. The first installment of ` 2 lakhs was paid in March 2026 by debiting
new loan account.
(ii) Depreciation as per Income-tax Act, 1961` 15 lakhs.
(iii) The company received a bill for ` 2 lakhs on 31 st March 2026 from a supplier of
vegetables for supply made in March 2026. The bill was omitted to be recorded in
the books in March 2026. The bill was paid in April 2026 and the necessary entry
was made in the books then.
 ASSESSMENT OF VARIOUS ENTITIES 9.173

(iv) Dividend of ` 7 lakhs is distributed on 25.09.2026 to its shareholders.

v
Compute total income of Parik Hospitality Limited for the Assessment Year 2026-27 indicating
the reason for treatment of each item assuming that the company is not eligible for deduction
u/s 35AD. Ignore the provisions relating to minimum alternate tax and the provisions of
section 115BAA.
3. Hyper Ltd. engaged in diversified activities, earned a profit of ` 14,25,000 after debit/credit
of the following items to its statement of profit and loss for the year ended on 31.3.20 26:

(a) Items debited to Statement of Profit and Loss `

Provision for loss of subsidiary 85,000
Provision for income-tax demand 1,05,000
Depreciation 3,60,000
Interest on deposit credited to buyers on 31.3.2026 for advance 1,00,000
received from them, on which tax was deducted in April 2026 and was
deposited on 31.7.2026
(b) Items credited to Statement of Profit and Loss
Long term capital gain on sale of equity shares on 5.10.2025 on which 3,60,000
securities transaction tax was paid at the time of acquisition and sale
Income from units of UTI (Gross) 75,000
The company provides the following additional information:
(i) Depreciation includes ` 1,50,000 on account of revaluation of fixed assets.
(ii) Depreciation allowable as per Income-tax Rules is ` 2,80,000.
(iii) Brought forward Business Loss/Unabsorbed Depreciation:
F.Y. Amount as per books Amount as per Income-tax
Loss Depreciation Loss Depreciation
` ` ` `
2022-23 2,50,000 3,00,000 2,00,000 2,50,000
2023-24 Nil 2,70,000 1,00,000 1,80,000
2024-25 3,50,000 3,15,000 1,20,000 2,10,000
 avv DIRECT TAX LAWS
9.174
avv
You are required to:
(i) compute the total income of the company for the assessment year 2026-27 giving
the reasons for treatment of items and
(ii) examine the applicability of section 115JB of the Income-tax Act, 1961, and compute
book profit and the tax credit to be carried forward.
Assume the tax rate applicable to Hyper Ltd for the P.Y. 2025-26 is 30%. Ignore the
provisions of section 115BAA.
4. The profit as per the Statement of profit and loss of XYZ Ltd., an Indian company, for the
year ended 31.3.2026 is ` 190 lakhs arrived at after making the following adjustments:
Particulars ` (in lakhs)
(i) Depreciation on assets 100
(ii) Reserve for currency exchange fluctuation 50
(iii) Provision for tax 40
(iv) Proposed dividend 120

Following further information are also provided by company:

(a) Provision for tax includes ` 2 lakhs of interest payable on income-tax.

(b) Depreciation includes ` 40 lakhs towards revaluation of assets.

(c) Amount of ` 50 lakhs credited to statement of P & L was drawn from revaluation
reserve.

(d) Balance of statement of profit and loss shown in balance sheet at the asset side as
at 31.3.2025 was ` 30 lakhs which includes unabsorbed depreciation of ` 10 lakhs.
Compute the book profit under section 115JB for the year ended 31.3.2026.
5. Mr. Harish, aged 66, running business as a proprietor furnishes the particulars of his
income for the year ended 31.03.2026 as under:
(a) Net Profit of ` 3,65,500 from the wholesale business of textiles and fabrics arrived at
after charge of following expenses in the Profit & Loss Account:
(i) Personal travelling expenses of ` 12,750.
(ii) Purchase of furniture for shop on 13.6.2025 of ` 25,000 but charged in shop
expenses.
 ASSESSMENT OF VARIOUS ENTITIES 9.175

(b) He owns a house with two floors constructed with the financial assistance of HDFC,
out of which ground floor is used by him for self-use and first floor was let out onv rent
for ` 8,500 p.m. from April 2025. The municipal tax paid for the whole house was of
` 2,500 and interest paid on housing loan for the construction was ` 52,000. Both the
floors of the house are identical.
(c) He deposited insurance premium on the life of self of ` 12,500, wife ` 13,500, son
and daughter of ` 28,000, repaid housing loan of ` 50,000 and paid ` 55,000 by
credit card for health insurance of himself and his family.
Compute the total income and the amount of tax liability of Mr. Harsh on such income for
the Assessment Year 2026-27 assuming that he has exercised the option to shift out of the
default tax regime under section 115BAC.

6. PQR LLP, a limited liability partnership set up a unit in Special Economic Zone (SEZ) in the
financial year 2019-20 for production of washing machines. The unit fulfills all the conditions
of section 10AA of the Income-tax Act, 1961. During the financial year 2024-25, it has also
set up a warehousing facility in a district of Tamil Nadu for storage of agricultural produce. It
fulfills all the conditions of section 35AD. Capital expenditure in respect of warehouse
amounted to ` 75 lakhs (including cost of land ` 10 lakhs). The warehouse became
operational with effect from 1 st April 2025 and the expenditure of ` 75 lakhs was capitalized
in the books on that date.
Relevant details for the financial year 2025-26 are as follows:
Particulars `
Profit of unit located in SEZ 40,00,000
Export sales of above unit received in India in convertible foreign 80,00,000
exchange on or before 30.9.2026
Domestic sales of above unit 20,00,000
Profit from operation of warehousing facility (before considering 1,05,00,000
deduction under Section 35AD).

Compute income tax (including AMT under Section 115JC) liability of PQR LLP for
Assessment Year 2026-27.
7. Victory Polyfibres, a partnership firm, has earned a gross total income of ` 300 lakhs for the
year ended 31-3-2026. The firm has not undertaken any international transaction or
specified domestic transaction during the said year.
 avv DIRECT TAX LAWS
9.176
avv
The above income includes a profit of ` 220 lakhs from an undertaking having a turnover of
` 80 crores. This is the fifth year and deduction under section 80-IA is available to the
extent of ` 200 lakhs.
There are some grey areas in the taxation workings and hence, the assessee is contemplating
to file the return of income on 7-12-2026, after seeking clarifications from tax experts.
Advise the assessee-firm by working out the total income and tax payable, where the return
is filed on 31-10-2026 or when the same is filed on 7-12-2026.
What is the practical solution as regards obtaining clarifications, which might or might not
have an impact on the total income? You may ignore interest under section 234A, 234B,
234C and 234F while making the computation in support of your advice.
8. T and Q are individuals, aged 28 years and 30 years respectively, who constitute an
Association of Persons, sharing profit and losses in the ratio of 2:1. For the accounting year
ended 31st March 2026, the Profit and Loss account of the business is as under:
Figures are in ` ‘000s
Cost of goods sold 4,250 Sales 4,900
Remuneration to: Dividend from Indian companies 25
T 130 Long term capital gains (computed) 640
Q 170
Employees 256
Interest to:
T 48.3
Q 35.7
Other expenses 111.7
GST penalty due 39
Net profit 524.3
5,565 5,565

Additional information furnished:

(i) Other expenses included:
(a) wrist watches costing ` 2,500 each were given to 12 dealers, who had
exceeded the sales quota prescribed under a sales promotion scheme;
(b) employer’s contribution of ` 6,000 to the Provident Fund for the month of
November, 2025 was paid on 14th January 2026.
 ASSESSMENT OF VARIOUS ENTITIES 9.177

(c) ` 30,000 was paid in cash to an advertising agency for publicity.

(ii) v
Outstanding GST penalty was paid on 15 th October 2026. The penalty was imposed
for non-filing of returns and statements by the due dates.
T and Q had, for this year, income from other sources of ` 4,60,000 and ` 2,32,000
respectively.
Required to:
(i) Compute the total income of the AOPs for the assessment year 2026-27; and
(ii) Discuss the tax implication for that year in the hands of the individual members.
9. The assessee, Pandey Co-operative Housing Society, is a registered co-operative housing
society, formed with the objective of maintaining the property owned by it, to effect repairs
and maintenance of the common property of the members, and to confer to the members,
the usual rights and privileges. For the assessment year 2026-27, the assessee has
received ` 3 lakhs as transfer fees from the transferor members and like amount from the
transferees, who at the time of transfer, were not members of the society. Discuss the
eligibility to tax the aforesaid receipts in the hands of the assessee.
10. M/s. Beta & Co., a partnership firm in India, is engaged in development of software and
providing IT enabled services through two units, one of which is located in a notified Special
Economic Zone (SEZ) in Noida (commenced operations from 01.04.2013) and the other
located in a domestic tariff area (DTA). The particulars relating to previous year 2025-26
furnished by the assessee are as follows:
Total Turnover: SEZ unit ` 210 lakhs; DTA unit ` 90 lakhs
Export Turnover: SEZ unit ` 150 lakhs received in India in convertible foreign exchange on
or before 30.9.2025; DTA unit ` 50 lakhs
Profit: SEZ unit ` 50 lakhs; DTA unit ` 40 lakhs.
Amount debited to Statement of Profit and Loss and credited to Special Economic Zone Re -
Investment Reserve Account ` 20 lakhs.
Considering that the firm has no other income during the year, compute the tax liability of
the firm for the A.Y. 2026-27 by integrating, analysing and applying the relevant provisions
of income-tax law.
 avv DIRECT TAX LAWS
9.178
avv
11. Lambda Ltd. is engaged in the manufacture of fabrics since 01-04-2013. Its Statement of
Profit and Loss for the previous year ended 31 st March, 2026 shows a profit of ` 750 lakhs
after debiting or crediting the following items:
(a) Depreciation charged on the basis of useful life of assets as per Companies Act is
` 52 lakhs.
(b) Industrial power tariff concession of ` 4.80 lakhs, received from Maharashtra State
Government was credited to Statement of profit and loss.
(c) The company had provided ` 18 lakhs, being sum fairly estimated as payable with
reasonable certainty, to workers on agreement to be entered with the workers union
towards periodical wage revision once in every three years.
(d) Dividend received from a US company ` 12 lakhs.

(e) Loss ` 17 lakhs, due to destruction of a machine worth ` 24 lakhs by fire due to
short circuit and ` 3 lakh received as scrap value. The insurance company did not
admit the claim of the company on charge of gross negligence.

(f) Provision for gratuity based on actuarial valuation was ` 320 lakhs. Actual gratuity
paid debited to gratuity provision account was ` 160 lakhs.
(g) Advertisement charges ` 2.30 lakhs, paid by cheque for advertisement published in
the souvenir of a political party registered with the Election Commission of India.
(h) Long term capital gain ` 3 lakhs on sale of equity shares on 12.4.2025 on which
Securities Transaction Tax (STT) was paid at the time of acquisition and sale.
Additional Information:
(i) Normal depreciation computed as per Income-tax Rules is ` 71 lakhs (after giving
effect to the scrap value).
(ii) GST ` 8 lakhs collected from its customers was paid by the company on the due
dates. On an appeal, the High Court directed the GST department to refund ` 3
lakhs to the company. The company in turn refunded ` 2 lakhs to the customers from
whom it was collected and the balance ` 1 lakh is still lying under the head "Current
Liabilities".
Compute the total income of Lambda Ltd. for the A.Y. 2026-27 by analyzing and applying
the relevant provisions of income-tax law. Briefly explain the reasons for treatment of each
 ASSESSMENT OF VARIOUS ENTITIES 9.179

item. Ignore the provisions relating to Minimum Alternate Tax. Assume that the company
has not opted for section 115BAA. v

12. X, Y and HUF of Z (represented by Z) are partners with equal shares in profits and losses of
a firm, M/s Popular Cine Vision, which is engaged in the production of TV serials and
telefilms.
The earlier partnership deed did not authorise payment of remuneration or interest to
partners. The partnership deed was revised by the partners on 1 st June 2025 to authorise
payment of remuneration of ` 1 lakh per month to each working partner and simple interest
at 15% per annum on partners’ capital. X, Y and Z are actively associated with the affairs of
the firm.
The Profit & Loss Account of the firm for the year ended 31st March 2026 shows a net profit
of ` 10 lakhs after debiting/crediting the following:
(a) Interest amounting to ` 5 lakhs each was paid to partners on the balances standing
to their capital accounts from 1 stJune, 2025 to 31st March 2026.
(b) Remuneration to the partners including partner in representative capacity ` 30 lakhs.
(c) Interest amounting to ` 2 lakhs paid to Z on loan provided by him in his individual
capacity at 16% interest.
(d) Royalty of ` 5 lakhs paid to partner X, who is a professional script writer, for use of
his scripts as per agreement between the firm and X. The same is authorized by
partnership deed.
(e) Two separate payments of ` 18,000 and ` 15,000 made in cash on 1 st February,
2026 to Altaf, a hairdresser, against his bill for services rendered in January, 2026
and two payments of ` 19,000 and ` 10,000 made in cash on 1 st February and 2nd
February, 2026, respectively, to Priyam, an assistant cameraman, against her bill for
services provided in January, 2026.
(f) Amount of ` 5 lakhs provided in the books on 31 st March 2026 as liability for
remuneration to Shreya, a film artist and a non-resident. Tax deducted at source
under section 195 from the amount so credited was paid on 3 rd June 2026.
(g) Amount of ` 6 lakhs provided as gratuity for the year on the basis of actuarial
valuation. Gratuity actually paid to one retired employee during the year is ` 1.50
lakhs.
(h) Interest of ` 1.20 lakhs received on income-tax refund under section 244(1A) in
respect of A.Y. 2025-26.
 avv DIRECT TAX LAWS
9.180
avv
Compute the total income of the firm for the assessment year 2026-27 stating the reasons
for treatment of each item.
13. The following are the particulars relating to two Indian companies, namely, Alpha Ltd. and
Beta Ltd., which are subject to tax audit u/s 44AB, for A.Y.2026-27 –
Particulars Alpha Ltd. Beta Ltd.
Date of setting up/ registration 1.4.2020 1.3.2024
Main object Manufacture of steel Manufacture of leather
Place Vaishali, Bihar Ranipet, Tamil Nadu
Turnover of P.Y. 2023-24 ` 251 crores -
Turnover of P.Y. 2024-25 ` 401 crores -
Turnover of P.Y. 2025-26 ` 270 crores ` 120 crores
Value of new plant and machinery ` 8 crore ` 5 crore
installed and put to use on 1.11.2025
Gross Total Income of P.Y.2025-26 ` 5 crore ` 5 crore
No. of new employees employed on 50 750
the date of setting up/registration of
the company
No. of new employees employed as on 750 -
1.4.2023
Monthly emoluments to 750
employees employed in the respective
companies as mentioned above, by
ECS through bank account:
250 employees ` 20,000 per ` 21,000 per employee
employee
250 employees ` 25,000 per ` 25,000 per employee
employee
250 employees ` 28,000 per ` 27,000 per employee
employee

From the above details -

(i) Compute the tax liability of Alpha Ltd. and Beta Ltd. for A.Y.2026-27. Alpha Ltd.
has not opted for any concessional rates earlier and want to avail the beneficial tax
rates under the special provisions of the Income-tax Act, 1961 in the P.Y. 2025-26.
Beta Ltd. has already opted for the concessional tax rates under section 115BAB
and wants to continue the same in P.Y. 2025-26. Assume that the gross total
income reflects the computation under the special provisions.
 ASSESSMENT OF VARIOUS ENTITIES 9.181

(ii) Would it be beneficial for Alpha Ltd. to opt for beneficial tax rates in P.Y. 2025-26
instead of paying tax under regular provisions of the Income-tax Act, 1961? v
Examine.

Answers
1. Computation of Total Income of XYZ Ltd. for the A.Y.2026-27
Particulars Amount (`)
Profits and Gains from Business and Profession
Profit as per Statement of profit and loss 7,00,00,000
Add: Items debited but to be considered separately or
to be disallowed
(a) Depreciation as per Companies Act, 2013 50,00,000
(b) Employees’ contribution to EPF 2,00,000
[Since employees’ contribution to EPF has not been
deposited on or before the due date under the PF Act,
the same is not allowable as deduction as per
Explanation 2 below to section 36(1)(va). Since the
same has been debited to Statement of profit and loss, it
has to be added back for computing business income].
(b) Employer’s contribution to EPF Nil
[As per section 43B, employers’ contribution to EPF
is allowable as deduction since the same has been
deposited on or before the due date of filing of return
under section 139(1). Since the same has been
debited to Statement of profit and loss, no further
adjustment is necessary]
(d) Provision for wages payable to workers Nil
[The provision is based on fair estimate of wages and
reasonable certainty of revision, the provision is
allowable as deduction, since ICDS X requires
‘reasonable certainty for recognition of a provision,
which is present in this case. As the provision has been
debited to Statement of profit and loss, no adjustment
is required while computing business income]
(e) Provision for doubtful debts [10% of ` 200 lakhs] 20,00,000
[Provision for doubtful debts is allowable as
deduction under section 36(1)(viia) only in case of
banks, public financial institutions, state financial
corporations, state industrial investment corporations
 avv DIRECT TAX LAWS
9.182
avv
and non-banking financial corporations. Such provision
is not allowable as deduction in the case of a
manufacturing company. Since the same has been
debited to Statement of profit and loss, it has to be
added back for computing business income]
(f) Bad debts written off Nil
[Bad debts write off in the books of account is
allowable as deduction under section 36(1)(vii). Since
the same has already been debited to Statement of
profit and loss, no further adjustment is required]
(i) Provision for gratuity 2,00,00,000
[Provision of ` 500 lakhs for gratuity based on
actuarial valuation is not allowable as deduction as
per section 40A(7). However, actual gratuity of `
300 lakhs paid is allowable as deduction. Hence, the
difference has to be added back]
(j) Commission paid to recovery agent for realization Nil
of a debt.
[Commission of ` 1 lakh paid to a recovery agent for
realisation of a debt is an allowable expense under
section 37 as per DCIT v. Super Tannery (India) Ltd.
(2005) 274 ITR 338 (All). Since the same has been
debited to Statement of profit and loss, and tax has been
deducted at source, no further adjustment is required]
(k) Purchase of paper at a price higher than the fair 10,00,000
market value
[As per section 40A(2), the difference between the
purchase price (` 30,000 per ton) and the fair
market value (` 28,000 per ton) multiplied by the
quantity purchased (500 tons) has to be added back
since the purchase is from a related party, a firm in
which majority of the directors are partners, at a
price higher than the fair market value]
AI(vi) GST not refunded to customers out of GST refund 1,00,000 2,83,00,000
[The amount of GST refunded to the company by the
Government is a revenue receipt chargeable to tax
under section 41(1). Deduction can be claimed of
amount refunded to customers [CIT v. Thirumalaiswamy
Naidu & Sons (1998) 230 ITR 534 (SC)]. Hence, the net
amount of ` 1,00,000 (i.e., ` 3,00,000 minus ` 2,00,000)
would be chargeable to tax]
9,83,00,000
 ASSESSMENT OF VARIOUS ENTITIES 9.183

Less: Items credited but to be considered separately/

permissible expenditure and allowances v
(k) Industrial power tariff concession received from Nil
State Government
[Any assistance in the form of, inter alia, concession
received from the Central or State Government
would be treated as income as per section
2(24)(xviii). Since the same has been credited to
Statement of profit and loss, no adjustment is
required].
(g) Discount given by Sundry Creditors for supply of Nil
raw materials
[Discount of 75% given by Sundry Creditors for
supply of raw materials is taxable under section
41(1). Since the same has already been credited to
Statement of profit and loss, no further adjustment is
required]
(h) Over-valuation of stock [` 55 lakhs × 10/110] 5,00,000
[The amount by which stock is over-valued has to be
reduced for computing business income. ` 50 lakhs,
being the difference between closing and opening
stock, has to be adjusted to remove the effect of
over-valuation]
AI(i) Additional Depreciation 10,00,000
[Additional depreciation@20% is allowable on ` 50
lakhs, being actual cost of new plant & machinery
acquired on 10.06.2025, as the same was put to use
for more than 180 days in the P.Y.2025-26.]
AI(ii) Depreciation as per Income-tax Act, 1961 80,00,000
AI(iii) Payment to a sub-contractor where tax deducted
last year was remitted after the due date of filing 3,00,000 98,00,000
of return
[30% of ` 10 lakhs, being payment to a sub-
contractor, would have been disallowed under
section 40(a)(ia) while computing the business
income of A.Y.2025-26, since tax deducted was
remitted after the due date of filing of return.
However, the same is allowable in A.Y.2026-27,
since the remittance has been made on 31.12.2025]
Total Income 8,85,00,000
 avv DIRECT TAX LAWS
9.184
avv
Computation of tax liability of XYZ Ltd. for A.Y.2026-27
Particulars `
Tax @30% on the above total income (since the turnover exceeded 2,65,50,000
`400 crore in the P.Y. 2023-24)
Add: Surcharge @ 7% (since total income exceeds `1 crore but less
than ` 10 crore) 18,58,500
2,84,08,500
Add: Health and Education cess @ 4% 11,36,340
Total tax liability 2,95,44,840
2. Computation of Total Income of Parik Hospitality Ltd. for the A.Y.2026-27
Particulars Amount (`)
Profit as per Statement of profit and loss 1,52,00,000
Add: Items debited but to be considered separately or to
be disallowed
(a) Payment to middleman for purchase of raw corn 30,000
etc. in an amount exceeding ` 10,000
[Under section 40A(3), disallowance is attracted in
respect of expenditure for which cash payment
exceeding ` 10,000 is made on a day to a person.
Payment of ` 25,000 to farmer for purchase of corn is
covered by exception under Rule 6DD. However,
payment of ` 30,000 to spice trader is not covered
under the exception - CBDT Circular 27/2017 dated
3/11/2017].
(b) Contribution towards employees’ pension scheme -
[Contribution to the extent of 14% of salary (basic
salary + dearness allowance, if it forms part of pay for
retirement benefits) is allowable as deduction under
section 36(1)(iva). Accordingly, no disallowance is
required to be made since contribution made is within
the prescribed limit.]
(c) Payment to transport contractor without deduction -
of tax at source
[Since the contractor opts for presumptive taxation
under section 44AE and furnished a declaration to this
effect, tax is not required to be deducted at source
under section 194C in respect of payment to transport
contractor].
 ASSESSMENT OF VARIOUS ENTITIES 9.185

(e) Contribution to IIT for scientific research -

[Contribution to IIT for scientific research programme v
approved by the prescribed authority qualifies for
deduction @100% under section 35(2AA). Since the
amount of contribution has already been debited to the
statement of profit and loss, there is no further
adjustment required].
(f) Expenses on foreign travel of two directors for a 10,00,000
collaboration agreement which failed to materialize
[Where expenditure is incurred for a project not related
to the existing business and the project was abandoned
without creating a new asset, the expenses are capital
in nature as per Mc Gaw-Ravindra Laboratories (India)
Ltd. v. CIT (1994) 210 ITR 1002 (Guj.). Brewery project
is not related to the existing business of running three -
star hotels]
(g) Fees paid to directors without deducting tax at
source [30% of `1 lakh] 30,000 10,60,000
[Disallowance @ 30% would be attracted under section
40(a)(ia) for non-deduction of tax at source from
director’s remuneration on which tax is deductible
under section 194J]
1,62,60,000
Less: Items credited but to be considered separately/
Expenditure to be allowed
(d) Profit on sale of plot of land to 100% subsidiary 12,00,000
[Profit on sale of plot of land taxable or otherwise under
the head “Capital Gains”. Since this amount has been
credited to the statement of profit and loss, the same
has to be deducted for computing business income].
(h) & AI(ii) Depreciation 5,00,000
[Depreciation allowable under the Income-tax Act, 1961
is ` 15 lakhs whereas the depreciation as per books of
account debited to the statement of profit and loss is
` 10 lakhs. Hence, the additional amount of ` 5 lakhs
has to be deducted while computing business income]
(i) Additional compensation received from State 10,00,000
Government
[Additional compensation is taxable or otherwise under
the head “Capital Gains”. Since the compensation has
been credited to the statement of profit and loss, the same
has to be deducted while computing business income]
 avv DIRECT TAX LAWS
9.186
avv
(j) Dividend received from foreign company 5,00,000
[Dividend received from foreign company is taxable
under the head “Income from other sources”. Since the
said dividend has been credited to the statement of
profit and loss, the same has to be deducted while
computing business income]
AI(i) Interest paid during the year 2,00,000
[Conversion of unpaid interest into loan shall not be
construed as payment of interest for the purpose
section 43B. The amount of unpaid interest converted
into a new loan will be allowable as deduction only in
the year in which such converted loan is actually paid.
Since ` 2 lakhs has been paid in the P.Y.2025-26, the
same is allowable as deduction]
AI(iii) Purchases omitted to be recorded in the books 2,00,000 36,00,000
[Since the purchase is made in March, 2026 (i.e.,
P.Y.2025-26), in respect of which bill of ` 2 lakhs
received on 31.3.2026 has been omitted to be recorded
in the books in that year, it has to be deducted to
compute the business income [Kedarnath Jute
Manufacturing Company Ltd. v. CIT (1971) 82 ITR 363
(SC)]. It is logical to assume that the company is
following mercantile system of accounting].
Income under the head “Profits and Gains of Business 1,26,60,000
or Profession”
Capital Gains
Profit on sale of plot of land to 100% subsidiary -
[Short-term capital gains arise on sale of plot of land held for
less than 24 months. However, in this case, since the
transfer is to a 100% subsidiary company and the subsidiary
company is an Indian company, the same would not
constitute a transfer for levy of capital gains tax as per
section 47(iv).]
Additional compensation received from State -
Government
[Since the additional compensation has been received
pursuant to an interim order of the Court, the same would be
deemed as income chargeable to tax under the head
“Capital Gains” in the year of final order as per section
45(5).]
 ASSESSMENT OF VARIOUS ENTITIES 9.187

Income from Other Sources

Dividend received from foreign company v
[Dividend received from a foreign company is chargeable to
tax under the head “Income from other sources”.] 5,00,000
Gross Total Income 1,31,60,000
Less: Deduction under Chapter VI-A
Deduction u/s 80M in respect of inter-corporate dividends [to
the extent of dividend distributed by it on or before the due 5,00,000
date specified u/s 139(1) of filing return of income]
Total Income 1,26,60,000
3. Computation of total income of M/s Hyper Ltd. for the A.Y. 2026-27
Particulars ` `
Profit as per Statement of Profit & Loss 14,25,000
Add: Items disallowed/considered separately
Provision for loss of subsidiary [since it is not wholly and 85,000
exclusively for the purpose of business of the assessee]
Provision for income-tax [disallowed under section 40(a)(ii)] 1,05,000
Interest on deposit credited to buyers on 31.3.2026 and tax
deducted in April 2026 which was deposited on 31.7.2026
[30% disallowed under section 40(a)(ia) since tax is 30,000
deducted only in the next year].
Depreciation debited to statement of profit and loss [only
depreciation calculated as per the Income-tax Rules, 1962 is 3,60,000 5,80,000
allowable as deduction]
20,05,000
Less: Items credited but not includible under business
income or are exempt under the provisions of the Act
Long-term capital gain on sale of equity shares on which securities
transaction tax was paid, since it is not a business income. 3,60,000
Income from units of UTI, since it is not a business income. 75,000 4,35,000
15,70,000
Less: Depreciation (allowable as per the Income-tax Rules, 2,80,000
1962)
12,90,000
 avv DIRECT TAX LAWS
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Less: Set-off of brought forward business loss and
unabsorbed depreciation
Brought forward business loss under section 72 4,20,000
Brought forward depreciation under section 32 6,40,000 10,60,000
Income from business 2,30,000

Capital Gains
Long term capital gain on sale of equity shares on which
securities transaction tax was paid at the time of acquisition 3,60,000
and sale

Income from Other Sources

Income from units of UTI 75,000
Total Income 6,65,000
Tax on LTCG exceeding ` 1.25 lakhs @ 12.5% of ` 2,35,000 29,375
Tax on other income of ` 3,05,000 @ 30% 91,500
1,20,875
Add: Health and Education cess @ 4% 4,835
Tax Payable as per the Income-tax Act, 1961 1,25,710

Computation of Book Profit under section 115JB

Particulars ` `
Profit as per Statement of Profit & Loss 14,25,000
Add: Net Profit to be increased by the following amounts
as per Explanation 1 below section 115JB(2)
Provision for loss of subsidiary 85,000
Provision for income-tax 1,05,000
Depreciation debited to statement of profit and loss 3,60,000 5,50,000
19,75,000

Less: Net Profit to be reduced by the following amounts

as per Explanation 1 below section 115JB(2)
Depreciation debited to statement of profit and loss (excluding 2,10,000
depreciation on account of revaluation of fixed assets)
(i.e., ` 3,60,000 – ` 1,50,000)
 ASSESSMENT OF VARIOUS ENTITIES 9.189

Brought forward business loss or unabsorbed deprecation as per

books of account, whichever is less, taken on cumulative basis 6,00,000 8,10,000
v
Book Profit 11,65,000
15% of book profit 1,74,750
Add: Health and Education cess @4% 6,990
Minimum Alternate Tax u/s 115JB 1,81,740

In case of a company, it has been provided that where income-tax payable on total income
computed as per the provisions of the Act is less than 15% of book profit, the book profit
shall be deemed as the total income and the tax payable on such total income shall be 15%
thereof plus health and education cess @4%.
Accordingly, in this case, since income-tax payable on total income computed as per the
provisions of the Act is less than 15% of book profit, the book profit of ` 11,65,000 is
deemed to be the total income and income-tax is payable @ 15% thereof plus health and
education cess @4%. The tax liability, therefore, works out to be `1,81,740.
Computation of tax credit
Particulars `
Tax on book profit under section 115JB 1,81,740
Less: Tax on total income computed as per the other provisions of the 1,25,710
Act
Tax credit to be carried forward under section 115JAA [Can be 56,030
carried forward for 15 assessment years succeeding A.Y. 2026-27]
4. Computation of book profit of XYZ Ltd. for the year ended 31.3.2026
Particulars ` `
Profit as per Statement of Profit & Loss 1,90,00,000
Add: Net profit to be increased by the following
amounts as per Explanation 1 below section
115JB(2)
Depreciation on assets debited to Statement of P& L 1,00,00,000
Reserve for currency exchange fluctuation, since the
amount carried to any reserve, by whatever name
called, is to be added back 50,00,000
Provision for tax (See Note below) 40,00,000
Proposed dividend 1,20,00,000 3,10,00,000
5,00,00,000
 avv DIRECT TAX LAWS
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Less: Net profit to be decreased by the following
amounts as per Explanation 1 below section
115JB(2)
Depreciation other than depreciation on revaluation of 60,00,000
assets (` 100 lakhs - ` 40 lakhs)
Withdrawal from revaluation reserve restricted to the 40,00,000
extent of depreciation on account of revaluation of
assets (` 50 lakhs or ` 40 lakhs, whichever is less)
Unabsorbed depreciation or brought forward business
loss, whichever is less, as per the books of account.
Unabsorbed depreciation ` 10 lakhs and brought
forward business loss ` 20 lakhs – whichever is less 10,00,000 1,10,00,000
Book profit 3,90,00,000

Note – For the purpose of section 115JB, book profit means the profit as per the statement
of profit and loss prepared in accordance with Schedule III to the Companies Act, 2013, as
adjusted by certain additions/deductions as specified. One of the adjustments is to add
back income-tax paid or payable, and the provisions therefor. Explanation 2 after sub-
section (2) of section 115JB clarifies that income-tax includes, inter alia, interest on income-
tax. Therefore, the entire provision of ` 40 lakhs for income-tax is added back for computing
book profit for levy of minimum alternate tax.
5. Computation of total income and tax payable by Mr. Harish for the A.Y. 2026-27 under
the normal provisions of the Act
Particulars ` `
Income from house property
Self-occupied portion (50%)
Annual Value under section 23(2) Nil
Less: Deduction under section 24(b)
Interest on housing loan [` 52,000 × 50%] 26,000 (26,000)
Let-out portion (50%)
Income of let out portion being rent of ` 8,500 p.m. received
for 12 months1
Gross Annual Value under section 23(1) (` 8,500 × 12) 1,02,000

1 Rent received has been taken as the GAV in the absence of other information.
 ASSESSMENT OF VARIOUS ENTITIES 9.191

Less: 50% of municipal taxes paid allowable in respect of

rented out portion (i.e., 50% of ` 2,500) 1,250 v
Net Annual Value (NAV) 1,00,750
Less: Deduction under section 24
30% of NAV under section 24(a) 30,225
Interest on housing loan under section 24(b) 26,000 44,525
18,525
Profits and gains of business or profession
Net profit as per profit and loss account of wholesale
business of textiles and fabrics 3,65,500
Add: Expenses charged in profit and loss account either not
allowable or to be considered separately -
Personal travelling expenses of proprietor 12,750
Purchase of furniture wrongly debited to shop 25,000
expenses
4,03,250
Less: Depreciation on furniture @10% on ` 25,000 2,500 4,00,750
Gross Total Income 4,19,275
Less: Deduction under Chapter VI-A
Under section 80C - Life insurance premium
Self 12,500
Wife 13,500
Son and daughter 28,000
- Housing loan repaid 50,000
1,04,000
Under section 80D [Medical insurance premium]
Mediclaim insurance premium of ` 55,000 [maximum
deductible is ` 50,000 where it covers a resident 50,000 1,54,000
senior citizen]
Total Income 2,65,275
Total Income (rounded off) 2,65,280
Tax on total income of ` 2,65,280 Nil
(The basic exemption limit for senior citizen is ` 3,00,000 for
A.Y.2026-27 under the normal provisions of the Act)
 avv DIRECT TAX LAWS
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6. Computation of total income and tax liability of PQR LLP for A.Y.2026-27
(under the regular provisions of the Income-tax Act, 1961)
Particulars ` `
Profits and gains of business or profession
Unit in SEZ 40,00,000
Profit from operation of warehousing facility 1,05,00,000
Less: Deduction under section 35AD [See Note (1) below] 65,00,000
Business income of warehousing facility chargeable to tax 40,00,000
Gross Total Income 80,00,000
Less: Deduction under section 10AA [See Note (2) below] 16,00,000
Total Income 64,00,000
Computation of tax liability (under the normal/regular
provisions)
Tax @ 30% on ` 64,00,000 19,20,000
Add: Health and Education cess @ 4% 76,800
Total tax liability 19,96,800

Computation of adjusted total income of PQR LLP for levy of Alternate Minimum Tax
Particulars ` `
Total Income (as computed above) 64,00,000
Add: Deduction under section 10AA 16,00,000
80,00,000
Add: Deduction under section 35AD 65,00,000
Less: Depreciation under section 32
On building @10% of ` 65 lakhs2 6,50,000 58,50,000
Adjusted Total Income 1,38,50,000
Alternate Minimum Tax @18.5% 25,62,250
Add: Surcharge@12% (since adjusted total income > ` 1 3,07,470
crore)
28,69,720
Add: Health and Education cess@4% 1,14,789
29,84,509
Tax liability under section 115JC (rounded off) 29,84,510

2Assuming the capital expenditure of ` 65 lakhs is incurred entirely on buildings

 ASSESSMENT OF VARIOUS ENTITIES 9.193

Since the regular income-tax liability is less than the alternate minimum tax liability, the
adjusted total income shall be deemed to be the total income and tax is leviable @18.5% v
thereof plus surcharge @ 12% and cess @4%. Therefore, the tax liability is ` 29,84,510.
AMT Credit to be carried forward under section 115JD
`
Tax liability under section 115JC 29,84,510
Less: Tax liability under the regular provisions of the Income-tax Act, 1961 19,96,800
9,87,710

Notes:
(1) Deduction @100% of the capital expenditure is available under section 35AD for
A.Y.2026-27 in respect of specified business of setting up and operating a
warehousing facility for storage of agricultural produce which commences operation
on or after 01.04.2009.
Further, the expenditure incurred, wholly and exclusively, for the purposes of such
specified business, shall be allowed as deduction during the previous year in which it
commences operations of specified business if the expenditure is incurred prior to
the commencement of its operations and the amount is capitalized in the books of
account of the assessee on the date of commencement of its operations.
Deduction under section 35AD would, however, not be available on expenditure
incurred on acquisition of land.
In this case, since the capital expenditure of ` 65 lakhs (i.e., ` 75 lakhs – ` 10 lakhs,
being expenditure on acquisition of land) has been incurred in the F.Y. 2024-25 and
capitalized in the books of account on 1.4.2025, being the date when the warehouse
became operational, ` 65,00,000, being 100% of ` 65 lakhs would qualify for
deduction under section 35AD.
(2) Deduction under section 10AA in respect of Unit in SEZ =
Export turnover of the Unit in SEZ
Profit of the Unit in SEZ× Total turnover of the Unit in SEZ x 50%

` 80,00,000 x 50 % = ` 16,00,000
` 40,00,000 ×
` 1,00,00,000

7. As per section 80AC, while computing the total income of an assessee of a previous year
(P.Y.2025-26, in this case) relevant to any assessment year (A.Y.2026-27, in this case),
 avv DIRECT TAX LAWS
9.194
avv
any deduction is admissible, inter alia, under section 80-IA, such deduction shall not be
allowed unless it furnishes a return of income for such assessment year on or before the
‘due date’ specified in section 139(1).
Since the turnover of the partnership firm has exceeded the prescribed threshold limit in the
previous year 2025-26, it would be subject to audit under section 44AB, in which case the
‘due date’ of filing its return of income for A.Y.2026-27 would be 31st October, 2026 as per
section 139(1).
Computation of total income and tax liability of M/s. Victory Polyfibres for A.Y. 2026-27

I. Where the firm files its return of income on 31 st October 2026:

Particulars ` in lakhs
Gross Total Income 300.00
Less: Deduction under section 80-IA 200.00
Total Income 100.00
Tax liability@ 30% 30.00
Add: Health and Education cess@4% 1.20
Regular income-tax payable 31.20

Computation of Alternate Minimum Tax payable [Section 115JC]

Particulars ` in lakhs
Total Income 100.00
Add: Deduction under section 80-IA 200.00
Adjusted Total Income 300.00
Alternate Minimum Tax (AMT) @ 18.5% on ` 300 lakhs 55.50
Add: Surcharge@12% (Since adjusted total income > ` 1 crore) 6.66
62.16
Add: Health and Education cess@4% 2.49
Total tax payable (AMT) 64.65

Since the regular income-tax payable by the firm is less than the alternate
minimum tax payable, the adjusted total income shall be deemed to be the tota l
income of the firm for P.Y.2025-26 and it shall be liable to pay income-tax on such
total income @ 18.5% [Section 115JC(1)]. Therefore, the tax payable for the A.Y.
2026-27 would be ` 64.65 lakhs.
 ASSESSMENT OF VARIOUS ENTITIES 9.195

Tax credit for Alternate Minimum Tax [Section 115JD]

v
` in lakhs
Total tax payable for A.Y.2026-27 (Alternate Minimum Tax) 64.65
Less: Regular income-tax payable 31.20
To be carried forward for set-off against regular income-tax 33.45
payable (upto a maximum of fifteen assessment years).

II. Where the firm files its return of income on 7 th December 2026:

Where the firm files its return on 7-12-2026, it would be a belated return under
section 139(4). Consequently, as per section 80AC, deduction under 80-IA would
not be available. In such circumstances, the gross total income of ` 300 lakhs
would be the total income of the firm.
Particulars ` in lakhs
Income-tax @ 30% of ` 300 lakhs 90.000
Add: Surcharge @12% (since total income exceeds ` 1 crore) 10.800
Income-tax (plus surcharge) 100.800
Add: Health and Education cess @ 4% 4.032
Total tax liability 104.832

Practical solution regarding obtaining clarifications:

The practical solution regarding obtaining clarifications would be to file the return of income
under section 139(1) on or before the ‘due date’, i.e., 31.10.2026, and claim deduction
under section 80-IA. In such a case, the firm can claim deduction of ` 200 lakhs under
section 80-IA. Thereafter, consequent to the clarifications obtained, if any change is
required, it can file a revised return under section 139(5) by 31.12.2026 which would
replace the original return filed under section 139(1). A revised return filed under section
139(5) would replace the original return filed under section 139(1).
If the firm files the return of income under section 139(1) on or before 31.10.2026, its tax
liability would stand reduced to ` 64.65 lakhs, as against ` 104.832 lakhs to be paid if
return is furnished after due date. Further, it would also be eligible for tax credit for alternate
minimum tax under section 115JD to the extent of ` 33.45 lakhs. Therefore, the firm is
advised to file its return of income on or before 31.10.2026.
 avv DIRECT TAX LAWS
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avv
8. (i) Computation of total income of the AOP for A.Y.2026-27

Particulars `

Profit & gains of business (See Working Note below) 3,12,300

Long term capital gain 6,40,000
Income from other sources - Dividend from Indian companies 25,000
Total income 9,77,300

Working Note - Computation of profits and gains of business

Particulars ` `
Net profit as per profit & loss account 5,24,300
Add: Inadmissible payments
Interest to members T & Q (` 48,300 + ` 35,700) 84,000
Advertising [Disallowance under section 40A(3) 30,000
(100% of ` 30,000 being a cash payment)]
Remuneration to members T & Q (` 1,30,000 + 3,00,000
`1,70,000)
GST penalty (See Note 3 below) 39,000 4,53,000
9,77,300
Less: Income not taxable under this head
Long term capital gain 6,40,000
Dividend from Indian companies 25,000 6,65,000
Profits and gains of business 3,12,300

Notes:
1. Since the employer’s contribution to PF has been paid during the previous
year itself, it is allowable as deduction.
2. Penalty imposed for delay in filing GST return is not deductible since it is on
account of infraction of the law requiring filing of the return within the specified
period. – CIT v. Ratanchand Bholanath (S.S) (1986) 160 ITR 500 (M.P.)
(ii) Tax implication in the hands of members T & Q for the A.Y. 2026-27
Members of the AOPs have to pay tax on their total income taking into account
savings/ investments etc.
 ASSESSMENT OF VARIOUS ENTITIES 9.197

Since one of the members has total income excluding share from AOP more than the
v
basic exemption limit, the AOPs will be chargeable to tax at the maximum marginal rate.
Since the AOPs is taxed at maximum marginal rate, the share income of members is
not taxable in their hands individually as per section 86.
9. 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 where the predominant activity
of such co-operative society is maintenance of property of the society. It was so held by the
Bombay High Court in Sind Co-op Housing Society v. ITO (2009) 317 ITR 47.
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 income, can have no application since the co-operative housing society is not a
trade or professional association.
Therefore, ` 6 lakhs received as transfer fees by Pandey Co-operative Housing Society
from its transferor members and its transferees, is not chargeable to tax.
10. Computation of total income and tax liability of M/s. Beta & Co., a partnership firm, as
per the normal provisions of the Act for A.Y. 2026-27
Particulars `
(in lakhs)
Business income (before deduction under section 10AA)
SEZ Unit 50.00
Add: Amount debited to SEZ Re-investment Reserve 20.00
70.00
DTA Unit 40.00
Gross Total Income 110.00
Less: Deduction u/s 10AA
= ` 70 lakhs × ` 150 lakhs/` 210 lakhs = 50 × 50% (being the 25.00
13th year)
Amount credited to SEZ Re-investment Reserve Account 20.00
whichever is less is deductible 20.00
Total Income 90.00
Tax on total income@30% 27.00
Add: Health and Education Cess@4% 1.08
Tax liability (as per normal provisions) 28.08
 avv DIRECT TAX LAWS
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Computation of Adjusted total income and Alternate Minimum tax of M/s. Beta & Co.,
a partnership firm, as per the provisions of section 115JC for A.Y.2026-27

Particulars ` (in lakh)

Total income as per the normal provisions 90.00
Add: Deduction under section 10AA 20.00
Adjusted total income 110.00
Tax@18.5% of Adjusted Total Income 20.350
Add: Surcharge @12% as the adjusted total income is > ` 1 crore 2.442
22.792
Add: Health and Education cess @4% 0.912
Alternate Minimum Tax as per section 115JC 23.704

Since the tax liability as per the normal provisions of the Act is more than the alternate
minimum tax payable, the total income as per normal provisions shall be liable to tax and
the tax payable for A.Y. 2026-27 shall be ` 28.08 lakhs.
11. Computation of Total Income of Lambda Ltd. for the A.Y. 2026-27
Particulars Amount (`)
I Profits and gains of business and profession
Net profit as per the statement of profit and loss 7,50,00,000
Add: Items debited but to be considered
separately or items of expenditure to be
disallowed
(a) Depreciation as per Companies Act 52,00,000
(c) Provision for wages payable to workers -
[Since the provision is based on a fair
estimate of wages payable with reasonable
certainty, the provision is allowable as
deduction. ICDS X requires a reliable
estimate of the amount of obligation and
‘reasonable certainty’ for recognition of a
provision, which is present in this case.
As the provision of ` 18 lakhs has been
debited to statement of profit and loss, no
adjustment is required while computing
business income]
 ASSESSMENT OF VARIOUS ENTITIES 9.199

(e) Loss due to destruction of machinery by 17,00,000

fire v
[Loss of ` 17 lakhs due to destruction of
machinery caused by fire is not deductible
since it is capital in nature.
Since the loss has been debited to statement
of profit and loss, the same is required to
added back while computing business income]
(f) Provision for gratuity 1,60,00,000
[Provision of ` 320 lakhs for gratuity based
on actuarial valuation is not allowable as
deduction.
However, actual gratuity of ` 160 lakhs paid
is allowable as deduction.
Hence, the difference has to be added back
to income [` 320 lakhs (-) ` 160 lakhs]
(g) Advertisement in souvenir of a political 2,30,000 2,31,30,000
party
[Advertisement charges paid in respect of
souvenir published by a political party is not
allowable as deduction from business profits
of the company. Since the expenditure has
been debited to statement of profit and loss,
the same has to be added back while
computing business income]
9,81,30,000
Add: Income taxable but not credited to
statement of profit and loss
AI(ii) GST not refunded to customers out of GST 1,00,000
refund received from State Govt.
[The amount of GST refunded to the company
by the Government is a revenue receipt
chargeable to tax.
Out of the refunded amount of ` 3 lakhs, the
amount of ` 2 lakh stands refunded to
customers would not be chargeable to tax. 3
The balance amount of ` 1,00,000 lying with
the company would be chargeable to tax]
9,82,30,000

3CIT v. Thirumalaiswamy Naidu & Sons (1998) 230 ITR 534 (SC)
 avv DIRECT TAX LAWS
9.200
avv
Less: Items credited to statement of profit and
loss, but not includible in business income/
permissible expenditure and allowances
(b) Industrial power tariff concession received -
from State Government
[Any assistance in the form of, inter alia,
concession received from the Central or State
Government would be treated as income. Since
the same has been credited to statement of
profit and loss, no adjustment is required]
(d) Dividend received from US company 12,00,000
[Dividend received from foreign company is
taxable under “Income from other sources”.
Since the same has been credited to the
statement of profit and loss, it has to be
deducted while computing business income]
(e) Scrap value of machinery 3,00,000
[Scrap value of machinery, being capital in
nature, has to be reduced from WDV of
machinery. Since the same has been credited
to the statement of profit and loss, it has to be
deducted while computing business income]
(h) Long term capital gains on sale of equity 3,00,000
shares
[The taxability or otherwise of long-term
capital gain on sale of equity shares has to
be considered while computing income
under the head “Capital Gains”. Since such
capital gains has been credited to statement
of profit and loss, the same has to be
reduced to arrive at the business income.]
AI(i) Depreciation as per Income-tax Rules, 1961 71,00,000 89,00,000
Profits and gains from business and profession 8,93,30,000

II Capital Gains
Long term capital gain on sale of equity shares 3,00,000
[Long term capital gains in excess of ` 1.25
lakhs (i.e., ` 1.75 lakhs, being ` 3 lakh – ` 1.25
lakhs) on sale of equity shares on which STT is
paid at the time of acquisition and sale would be
taxable@12.5% u/s 112A, without indexation
benefit.]
 ASSESSMENT OF VARIOUS ENTITIES 9.201

III Income from Other Sources

Dividend received from foreign company 12,00,000
v
[Dividend received from a foreign company is
chargeable to tax under the head” Income from
other sources”]
Gross Total Income 9,08,30,000
Less: Deduction under Chapter VI-A
Under section 80GGB [Contribution by a company to
a registered political party is allowable as deduction,
since payment is made otherwise than by cash.
Expenditure incurred by an Indian company on
advertisement in souvenir published by such political
party tantamount to contribution to such political 2,30,000
party.]
Total Income 9,06,00,000

12. Computation of Total Income of M/s. Popular Cine Vision for the A.Y.2026-27
Particulars ` `
Profits and Gains from Business or Profession
Net Profit as per Profit & Loss A/c 10,00,000
Add: Expenses disallowed or considered separately:
Interest to partners in excess of 12% (Note 1) 3,00,000
Disallowance under section 40A(3) for aggregate cash
payment exceeding ` 10,000 in a single day (Note 5) 52,000
Provision for gratuity (Note 7) 4,50,000
Partners’ Remuneration 30,00,000
Royalty paid to Partner X (Note 4) 5,00,000 43,02,000
53,02,000
Less: Interest on income-tax refund (Note 8) 1,20,000
Book Profit 51,82,000
Less: Partners’ remuneration allowable under section
40(b)(v)
(i) As per limit prescribed in section 40(b)
On first ` 6,00,000 90% 5,40,000
On the balance ` 45,82,000 60% 27,49,200
32,89,200
 avv DIRECT TAX LAWS
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avv
(ii) Remuneration actually paid or payable
(` 1,00,000 × 10 months × 3 partners) +
(Royalty ` 5 lakhs)
(i) or (ii) whichever is less, is deductible 35,00,000 32,89,200
18,92,800
Income from other sources
Interest on income-tax refund 1,20,000
Gross Total Income 21,02,800
Deductions under Chapter VI-A Nil
Total Income 21,02,800

Notes:
1. As per section 40(b), simple interest at 12% p.a. to partners relating to the period
after the date of partnership deed is allowable. Excess interest @ 3% paid from 1 st
June 2025 to 31st March 2026 is to be disallowed. Excess interest of 3% being
`15,00,000 x 3/15 = ` 3,00,000.
2. Even though Z is a partner in a representative capacity, he is still a partner.
Therefore, remuneration to Z should also be subject to the limits prescribed in
section 40(b). This view finds support from the decision of the Supreme Court in the
case of Rashik Lal & Co. vs CIT (1998) 229 ITR 458 (SC).
3. As per Explanation 1 to section 40(b), where an individual is a partner in a firm in
representative capacity, the provisions of section 40(b) shall not apply to any interest
payable by the firm to such individual in his personal capacity. Z represents his HUF
in the firm. However, Z gave the loan in his individual capacity. Hence, assuming that
the provisions of section 40A(2) do not get attracted in this case, such interest shall
be allowed as deduction in full even though the interest rate is more than 12% p.a.
4. It may be noted that the limits specified under section 40(b)(v) are applicable in case
of payment of salary, bonus, commission, or remuneration, by whatever name called,
to a working partner. From a plain reading of the section, it is clear that any
remuneration, by whatever name called, paid to a working partner, is subject to the
limits laid down in section 40(b)(v). Therefore, the royalty of ` 5 lakhs paid to partner
X would also be subject to the limits laid down in section 40(b)(v). Hence, the same
has to be added back for computing book profits.
 ASSESSMENT OF VARIOUS ENTITIES 9.203

5. Section 40A(3) provides for disallowance of any expenditure in respect of which

the actual payment exceeding ` 10,000 is made otherwise than by an account v
payee cheque, account payee bank draft or use of ECS through bank account or
through such other electronic mode as may be prescribed in a single day to a person.
Hence, the payments of ` 18,000 and ` 15,000 in cash on 1.2.2026 to Altaf, a
hairdresser, shall be disallowed, since the aggregate payment of ` 33,000
exceeds the limit of ` 10,000.
The payment of bill of the assistant cameraman of ` 19,000 on 1 st February is also
liable for disallowance under section 40A(3) since the aggregate payment in cash on
a single day has exceeded ` 10,000.
6. As per section 40(a)(i), any sum payable to a non-resident shall not be allowed as
deduction, if tax has not been deducted at source or after deduction, has not been
paid on or before the due date specified under section 139(1). Tax deducted from the
amount of remuneration credited to payee's account on 31 st March 2026 has to be
deposited latest by 31 st July 2026/ 31st October 2026 (as the case may be). The firm
has paid the tax on 3 rd June 2026 and hence, the remuneration shall be allowed.
Since the same is already debited to profit and loss account, no further adjustment is
made.
7. As per section 40A(7), any provision made for payment of gratuity to employees on
their retirement or on termination of employment for any reason is disallowed.
However, gratuity of ` 1.50 lakhs paid to retired employees is allowable as
deduction. Hence, the balance provision of ` 4.50 lakhs (i.e., ` 6 lakhs – ` 1.50
lakhs) is to be disallowed.
8. Interest on income-tax refund is assessable under the head "Income from other
sources".
13. (i) Computation of tax liability of Alpha Ltd. and Beta Ltd. under the special
provisions of the Income-tax Act, 1961
Particulars Alpha Ltd. Beta Ltd.
` `
Gross Total Income 5,00,00,000 5,00,00,000
Less: Deduction u/s 80JJAA
Alpha Ltd - [(` 20,000 x 12 x 250) + (` 25,000 x 12 4,05,00,000
x 250)] x 30%
 avv DIRECT TAX LAWS
9.204
avv
Beta Ltd – [(` 21,000 x 12 x 250) + (` 25,000 x 12 x 4,14,00,000
250)] x 30%
Total Income 95,00,000 86,00,000
Computation of tax liability
Tax@22% on ` 95,00,000 [As per section 115BAA] 20,90,000
Tax@15% on ` 86,00,000 [As per section 115BAB] 12,90,000
Add: Surcharge@10% 2,09,000 1,29,000
22,99,000 14,19,000
Add: Health and Education cess@4% 91,960 56,760
Total tax liability 23,90,960 14,75,760

Notes -
(1) Alpha Ltd. is eligible to opt for special provisions under section 115BAA, as
per which the rate of tax would be 22% plus surcharge@10% and HEC@4%.
(2) Both Alpha Ltd. and Beta Ltd. are eligible to claim deduction u/s 80JJAA,
which is a permissible Chapter VI-A deduction while computing total income
under section 115BAA and 115BAB.
In case of Alpha Ltd, 30% of the additional employee cost of new employees
employed in the P.Y. 2023-24, can be claimed as deduction u/s 80JJAA for
P.Y.2025-26. Out of 750 employees, 250 employees whose emoluments are
` 20,000 p.m., 250 employees whose emoluments are ` 25,000 p.m. qualify
as additional employees and 250 employees whose emoluments exceed
` 25,000 p.m. do not qualify as additional employees.
Similarly, in case of Beta Ltd, 30% of the additional employee cost of new
employees employed in the P.Y. 2023-24, can be claimed as deduction u/s
80JJAA for P.Y.2025-26. Out of 750 employees, 250 employees whose
emoluments are ` 21,000 p.m., 250 employees whose emoluments are
` 25,000 p.m. qualify as additional employees and 250 employees whose
emoluments exceed ` 25,000 p.m. do not qualify as additional employees.
(ii) Computation of tax liability of Alpha Ltd. as per the regular provisions of the Act
Particulars Alpha Ltd.
`
Gross Total Income (computed under the special provisions) 5,00,00,000
Less: Additional Depreciation [10% of ` 8 crore, since the plant
and machinery has been put to use for less than 180 days in 80,00,000
the P.Y.2025-26]
 ASSESSMENT OF VARIOUS ENTITIES 9.205

Gross Total Income (computed under the regular 4,20,00,000

provisions of the Act) v
Less: Deduction u/s 80JJAA
[(` 20,000 x 12 x 250) + (` 25,000 x 12 x 250)] x 30% 4,05,00,000
Total Income 15,00,000
Computation of tax liability
Tax@25% on ` 15,00,000 [Since turnover of P.Y.2023-24 is 3,75,000
less than ` 400 crore]
Add: Surcharge (Not applicable, since total income is less than Nil
` 1 crore)
3,75,000
Add: Health and Education cess@4% 15,000
Total tax liability 3,90,000

Since the tax liability under the regular provisions of the Act is ` 3,90,000 vis-à-vis
tax liability of ` 23,90,960 computed under section 115BAA, it is not beneficial for
Alpha Ltd. to opt for the special provisions under section 115BAA for A.Y.202 6-27.
Hence, Alpha Ltd. should not opt for the special provisions under section 115BAA for
A.Y.2026-27.
CHAPTER a
10

ASSESSMENT OF TRUSTS AND

INSTITUTIONS, POLITICAL PARTIES
AND OTHER SPECIAL ENTITIES

LEARNING OUTCOMES
After studying this chapter, you would be able to -
❑ identify the inclusions in the definition of “charitable purpose”, to appreciate whether a trust or
institution would qualify for the benefit of exemption under sections 11 and 12;
❑ appreciate the conditions to be fulfilled by a trust or institution to claim benefit of exemption under
section 11 or under section 10(23C);
❑ appreciate the procedure to be followed for approval/registration of a trust or institution;
❑ analyse the special provision under section 13, which specifies scenarios when a trust or
institution shall not be eligible to claim exemption under section 11 or section 12
❑ examine the special provisions relating to taxability of anonymous donations received by a trust
or institution;
❑ examine the special provision relating to taxability of certain specified income of a trust or
institution under section 115BBI
❑ appreciate the special provisions for taxability of accreted income of certain trusts and institutions;
❑ identify the income of political parties which are exempt from tax and the conditions to be satisfied
to avail the exemption;
❑ examine the conditions to be satisfied by an electoral trust to avail exemption in respect of
voluntary contributions received by it;
❑ examine the special provisions relating to taxation of business trusts, securitisation trusts
and investment fund and compute the tax liability in the hands of such trusts/fund and the
unit holders/investors.

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 10.2 DIRECT TAX LAWS

CHAPTER OVERVIEW

Taxation
Special Taxation
Regime of
Provisions Regime of Taxation of
Charitable/ Taxation of
relating to Securiti- Investment
Religious Business
Taxation of Political sation trust funds and
trusts Trusts and
Discretion- Parties & and its unit
[First unitholders
ary Trusts Electoral investors holders
Regime [Section
Trusts [Section [Section
and 115UA]
[Sections 115TA to 115UB]
Second
13A & 13B] 115TCA]
Regime]

10.1 INTRODUCTION
Non-profit organisations in India cater to socio-economic and other needs of common people in the
country. Hence, the Government encourages such organisations with philanthropic objective by
providing tax exemptions subject to compliance of certain conditions. In this chapter, we will be
discussing the income tax exemptions and related aspects of trusts and institutions engaged in
charitable activities, political parties, electoral trusts and other special entities such as securitization
trusts, business trusts and investment funds.
Chapter III of the Income-tax Act,1961, which covers incomes that are exempt from tax, also contains
the provisions pertaining to exemption in respect of charitable trusts and institutions, political parties,
electoral trusts and exemptions in respect of income of special entities like securitization trusts,
business trusts and investment fund.
A) Charitable or religious trusts/institutions can avail income-tax exemption under two different
independent regimes.
• The first regime pertains to the exemption available under section 10(23C), which inter
alia exempts income received by any person on behalf of university, or other
educational institution or any hospital.

• The second regime pertains to the exemption under section 11 that provides for
exemption in respect of income derived from property held under trust wholly for
charitable or religious purposes.

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Therefore, a trust or institution can choose to opt for an exemption either under the first
regime i.e., under section 10(23C) or the second regime i.e., under section 11, as it deems
appropriate depending on its objects and activity.
It is noteworthy that the broad features and conditions for availing exemption under both
regimes are largely similar. The Finance Act, 2022 made significant amendments to ensure
harmonization and consistency in the exemption provisions under both the regimes. Prior to
these amendments, there were inconsistencies and gaps in both regimes, wherein certain
conditions stipulated for availing exemption under section 11 were absent in section 10(23C).
Therefore, the Finance Act 2022 has rationalised the same by ensuring that there is a level
playing field between the two alternate regimes.
Exemption provisions in respect of charitable or religious trusts
University or other educational institution, hospital or Trust for charitable or religious
other medical institution, other fund or institution for purposes
charitable purposes, any trust or institution wholly for [Sections 11 to 13 – Second
public religious purposes or wholly for religious and Regime]
charitable purposes [Section 10(23C) – First Regime]

Note: Since both the regimes offer almost similar benefits and the procedural aspects or
conditions for availing benefits are largely aligned, amendments have been made by the
Finance (No.2) Act, 2024 for discontinuation of approval under the First Regime [i.e. under
sub-clauses (iv), (v), (vi) and (via) of section 10(23C)]. Accordingly, application for approval
or renewal of approval under First Regime cannot be made on or after 1 st October 2024.
Consequently, with effect from 1 st October 2024, trusts or institutions desirous of availing
exemption shall make an application for registration under the Second Regime only.

It is important to note that, the trust which were approved or made application for
approval before 1 st October 2024 and got approval, thereafter, are eligible to claim
exemption under first regime till the validity of such approval.
B) Political Party and Electoral Trust
Section 13A exempts certain categories of income derived by a political party and section
13B exempts voluntary contributions received by electoral trusts.
C) Securitisation Trust, Business Trust and Investment Fund
The Income-tax Act, 1961 provides pass-through status to certain entities such as
Securitisation Trusts, Business Trusts and Investment Fund in respect of certain incomes.
Such incomes are taxable in the hands of unitholders/investors. Exemption provisions in
respect of certain incomes in the hands of these entities and unitholders are contained in

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 10.4 DIRECT TAX LAWS

Chapter III of the Income-tax Act, 1961. Further, the Income-tax Act, 1961 also contains
special provisions relating to Securitization trust, Business Trusts and Investment Fund under
Chapter XII-EA, XII-FA and XII-FB, respectively.
General Discussion on Trusts
Non-Profit Organisations intending to carry on charitable or religious activities are normally set up
either as a trust or a society or a company registered under section 8.
Trust is the most common and preferred legal form. Therefore, before considering the income -tax
exemption provisions governed under section 10(23C) or section 11 to 13, let us see briefly what
exactly the term trust signifies, the types of trusts and the manner of their creation. Though this
aspect of the topic does not strictly fall within the purview of income-tax, such a general knowledge
would be useful in understanding the provisions of tax laws relating to charitable trusts.

Meaning of certain terms

• is an obligation annexed to the ownership and arising out of a confidence

Trust reposed in and accepted by the owner if declared and accepted by him for
the benefit of another or of another and the owner.

Author of the trust • the person who reposes or declares the confidence

Trustee • the person who accepts the confidence

Beneficiary • the person for whose benefit the confidence is accepted

Trust property • the subject matter of the trust

Beneficial interest or
• is his right against the trustees or owner of the trust property
interest of the beneficiary

Instrument of trust • the instrument, if any, by which trust is declared

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Trusts can be broadly classified into two groups - Public and Private.

Types of Trusts

Public Trust [Sections 11 to 13] Private Trust

Specific Discretionary

Beneficiaries & shares of Beneficiaries or shares of

beneficiaries specified beneficiaries not specified

Distinction between a public and private trust

The distinction between a public and private trust is that, whereas in the former, the beneficiaries
are the general public or a class thereof, in the latter they are specific persons. While in the former,
the beneficiaries constitute a body which is incapable of ascertainment, in the latter they are persons
who are ascertained or capable of being ascertained. Generally private trusts are formed for the
convenience of individuals and families. The private trust does not enjoy any tax exemption .
Private trusts are governed by the Indian Trust Act, 1882. This Act does not apply to the following:
(i) The rules of Mohammedan law as to waqf;
(ii) The mutual relations of the members of undivided family as determined by any customary or
personal law;
(iii) Public or private religious or charitable endowments; and
(iv) Trust to distribute prizes taken in war among the captors.
On the other hand, Public trusts are constituted mainly for the benefit of the public at large. There
are three requirements for creation of a public trust.
There are three requirements for creation of a public trust. They are
(i) a declaration of trust which is binding on the settlor,
(ii) setting apart definite property and depriving himself of the ownership, and
(iii) a statement of objects for which the property is thereafter to be held. In the case of a private
trust also, more or less similar requirements exist.
Public trust enjoys tax exemption under the Income-tax Act subject to compliance of certain
conditions, that are discussed in detail in this chapter.

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 10.6 DIRECT TAX LAWS

10.2 CHARITABLE OR RELIGIOUS TRUSTS AND

INSTITUTIONS
1. Exemption in respect of income of universities, hospitals, educational
institutions, medical institutions etc. [Section 10(23C)]
Exemption is available under section 10(23C) in respect of any income received by any person on
behalf of the certain funds and institutions. In particular, the exemption available under first regime
is with regard to income of universities, educational institutions, hospitals and other medical
institutions covered under sub-clauses (iiiab), (iiiac), (iiiad), (iiiae), (iv), (v), (vi) and (via) of section
10(23C). The brief summary of the exemptions available is encapsulated in the following table:

Section Activity Scope Exemption Conditions

10(23C)(iiiab) Education Wholly or substantially financed by the
Government.
10(23C)(iiiac) Medical Wholly or substantially financed by the
Government
10(23C)(iiiad) Education Aggregate annual receipts do not
exceed five crore rupees
10(23C)(iiiae) Medical Aggregate annual receipts do not
exceed five crore rupees
10(23C)(iv) Charitable purpose, which is important Trust or institution approved on or
for India & its states before 1 st October 2024 and
10(23C)(v) Wholly for public religious purposes or application for approval was filed
wholly for public religious & charitable before the said date and got approval
purposes thereafter.

10(23C)(vi) Education, whose aggregate annual Trust or institution approved on or

receipts exceed five crore rupees before 1 st October 2024 and
application for approval was filed
10(23C)(via) Medical, whose aggregate annual
before the said date and got approval
receipts exceed five crore rupees
thereafter.

Broadly, exemption of any income received by any person on behalf of universities, educational
institutions, hospitals and other medical institutions under section 10(23C) is available in the
following manner:

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(1) Universities or Educational Institutions or Hospitals or Medical Institutions

substantially financed by the Government:
• any university or other educational institution wholly or substantially financed by
the Government which exists solely for educational purposes and not for profit [Sub-
clause (iiiab)].
• any hospital or other institution wholly or substantially financed by the
Government, which exists solely for philanthropic purposes and not for profit and
which exists for the reception and treatment of persons suffering from illness or mental
defectiveness or for the reception and treatment of convalescing persons or persons
requiring medical attention or rehabilitation [Sub-clause (iiiac)].

If the government grant to a university or other educational institution, hospital or other

institution during the relevant previous year exceeds 50% of the total receipts (including
any voluntary contributions), of such university or other educational institution, hospital or
other institution, as the case may be, then, such university or other educational institution,
hospital or other institution shall be considered as being substantially financed by the
Government for that previous year [Rule 2BBB].

(2) Universities or Educational Institutions or Hospitals or Medical Institutions whose

annual receipts not exceed ` 5 crore:

• any university or other educational institution existing solely for educational purposes
and not for profit and its aggregate annual receipts do not exceed ` 5 crore
[Sub-clause (iiiad)].
• any hospital or other institution for the reception and treatment of persons suffering
from illness or mental defectiveness or for the reception and treatment of convalescing
persons or persons requiring medical attention or rehabilitation, existing solely for
philanthropic purposes and not for profit, if its aggregate annual receipts do not
exceed the prescribed limit of ` 5 crore [Sub-clause (iiiae)].
• Where a person has receipts from an institution specified in sub-clause (iiiad) as well
as from an institution specified in sub-clause (iiiae), whose combined receipts
exceeds ` 5 crores, then, the said person shall not be eligible for exemption
under the respective sub-clauses (iiiad) & (iiiae).

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 10.8 DIRECT TAX LAWS

(3) Universities or Educational Institutions or Hospitals or Medical Institutions or

Specified Charitable Institutions exempted subject to certain conditions:
• any other fund or institution for charitable purposes approved by the Principal
Commissioner or Commissioner having regard to the objects of the fund or
institution and its importance throughout India or throughout any State or States
[Sub-clause (iv)];
• any trust (including any other legal obligation) or institution wholly for public
religious or wholly for public religious and charitable purposes approved by the
Principal Commissioner or Commissioner having regard to ensure the income
applies for the objects of the fund or institution [Sub-clause (v)];
• any other university or educational institution existing solely for educational purposes
and not for purposes of profit and which may be approved by the Principal
Commissioner or Commissioner other than referred in (1) and (2) above
[Sub-clause (vi)];
• any other hospital, or other medical institution other than referred in (1) and (2) above
approved by the Principal Commissioner or Commissioner [Sub-clause (via)].
However, no approval would be granted for an application made on or after 1.10.2024.

Note - The conditions and norms for availing the exemption under section 10(23C)(iv), (v), (vi) &
(via) [First regime] are largely similar as those for availing exemption under section 11 to 13 [Second
Regime]. Henceforth, in this chapter, reference to First regime would refer to section
10(23)(iv)/(v)/(vi)/(via). The comparative table of the corresponding provisions under the First and
Second regime are given under para 10.3, which will help students co-relate the relevant provisions
under the First regime with the provisions of sections 11 to 13 under the Second Regime discussed
later on in this Chapter.

ILLUSTRATION 1

An educational institution having annual receipts of ` 3.80 crore during the P.Y. 2025-26, has availed
exemption under section 10(23C)(iiiad). The Assessing Officer has denied the exemption on the
grounds that the educational institution has not made any application to the prescribed authority for
approval under the said section 10(23C)(iiiad). Examine the action of the Assessing Officer in
denying the exemption.

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SOLUTION

As per section 10(23C)(iiiad), income of any university or other educational institution existing solely
for educational purposes and not for purposes of profit would be exempt if the aggregate annual
receipts of such university or educational institution do not exceed ` 5 crores. Therefore, the
exemption available under this section can be availed without making any application to the
prescribed authority.
Therefore, the action of the Assessing Officer in denying the exemption to the educational institution
is not correct.

ILLUSTRATION 2

A not for profit trust undertakes philanthropic activities through an educational institution and a
hospital. During the P.Y. 2025-26, the trust had annual receipts of ` 3 crores from its educational
institution and ` 4 crore from the hospital. During the P.Y. 2025-26, it desires to avail exemption
under section 10(23C)(iiiad) and 10(23C)(iiiae), as the individual threshold under each of the sub -
clauses, is less than ` 5 crores. Can it do so? Examine.

SOLUTION

As per Explanation to section 10(23C)(iiiae), it has been clarified that the limit of annual receipts of
` 5 crore is qua ‘taxpayer’ and not qua ‘activity’. Therefore, if the aggregate annual receipts from
educational activity and medical activity exceeds ` 5 crores, then, exemption under sub-clause (iiiad)
and (iiiae) cannot be availed by the trust.
Since, in the present case, the aggregate annual receipt of ` 7 crores (` 3 crores of educational
institution and ` 4 crores from hospital) exceeds the threshold of ` 5 crores, exemption under section
10(23C)(iiiad) and (iiiae) cannot be availed, even though the individual receipts from educational
institution and hospital have not exceeded ` 5 crores.

2. Charitable or Religious Trusts and Institutions [Sections 11 to 13] -

Second Regime
The second regime of exemption is available under the Section 11. The second regime is more
exhaustive in scope as it is available for any philanthropic organisation involved in charitable or
religious purposes. The second regime is more popular and widely adopted by non -profit
organisations. It is imperative to note that an assessee can opt to avail exemption only under one of
the regime depending upon its objects and purpose. An overview and specifics pertaining to the
second exemption regime is provided below.

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 10.10 DIRECT TAX LAWS

Overview

• Exclusion of the following income from total income of the trust:

• Income derived from property held under trust wholly or partly for charitable
Section 11 and religious purposes, applied for such purposes; and
• Income in the form of voluntary contributions made with a specific direction
that they shall form part of the corpus of the trust
• Income derived by a trust from voluntary contributions (other than corpus
donations) deemed to be income derived from property held under trust for
the purposes of section 11;
Section 12
• Value of medical and educational services made available to specified
persons deemed to be income of the trust running a hospital or medical or
educational institution notwithstanding the provisions of section 11(1).
Section 12A • prescribes the conditions for availing the benefits u/s 11 and 12.
• prescribes the procedure framework for registration with the income-tax
Section 12AB
authorites to avail the exemption u/s 11 & 12 .
• enumerates the circumstances under which the exemption available u/s 11
Section 13
and 12 will be denied

3. First and Second Regime – A Comparison

In the following table, Column (2) mentions the relevant provisos in section 10(23C) [under the first
regime under sections 10(23C)(iv)/(v)/(vi)/(via)] and Column (3) mentions the corresponding
provisions under the second regime under sections 11 to 13. Column (4) contains the subject matter
of the relevant provision pertaining to both regimes.
(1) (2) (3) (4)
First Regime [Section Second Regime
Sl. No. 10(23C)(v)/(v)/(vi)/(via)] [Sections 11 to
13]
Relevant proviso to Corresponding Subject matter (in brief)
section 10(23C) and provision in the
the Explanations Second regime
thereto [Sections 11 to
13]
(1) 1st proviso 12A(1)(ac) Application to PC or Commissioner
for approval before 1 st October
2024/ registration of trust/institution
and the time limits for making such
application
Note – The procedure for approval
contained in 1st proviso to section

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10(23C) is not discussed in the
chapter since no further application
for approval can be made on or
after 1st October 2024.
(2) 2nd proviso 12AB(1) Grant of approval on receipt of
application before 1 st October
2024/ passing an order of
registration of trust/ institution or
rejection of the application by PC or
Commissioner and period of
validity of approval/registration
Note – The procedure for approval
contained in 2st proviso to section
10(23C) is not discussed in the
chapter since no further application
for approval can be made on or
after 1st October 2024.
(3) 3rd proviso
(i) Explanation 1 11(1)(d) Corpus donations not to be
included in income subject to
investment in forms and modes
specified in section 11(5)
(ii) Explanation 1A Explanation 3A Conditions for treatment of
[Applies only in case of to section 11 voluntary contribution received for
section 10(23C)(v)] renovation or repair of temple/
church/mosque etc. (where they
form part of property held under
trust) as corpus donation, at the
option of the trust
(iii) Explanation 1B Explanation 3B Deemed income in the year of
[Applies only in case of to section 11 violation of conditions mentioned in
section 10(23C)(v)] Sl. No. (3)(ii) above.
(iv) Explanation 2 and its Explanation 4 to Amount spent out of –
clauses (i), (ii) and (iii) section 11 and − corpus donations excluded
its clauses (i), (ii) from total income or
and (iii) − loan or borrowing
not to be treated as application for
charitable purposes [Clause (i) and
(ii)]
Amount credited or paid out of
current year income of the trust to
fund/trust/institution by way of
donation other than corpus

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donation would be allowed as

application to the extent of 85% of
such amount paid or credited.
(v) Explanation 3 and its 11(2) and its first Conditions stipulated for treating
first proviso proviso the amount accumulated or set
apart beyond 15% as deemed
application
(vi) Explanation 4 11(3) Deemed income in case of non-
fulfilment of conditions in Sl. No.
(3)(v) above and the previous year
in which taxable
(vii) Explanation 5 11(3A) Application to A.O. to permit
application of accumulated income
for other purposes in line with the
objects of the trust or institution
Proviso Proviso A.O. cannot allow application of
such accumulated income by way
of amount credited or paid to
another trust or institution
(4) 7th proviso 11(4A) Maintenance of separate books of
accounts in case of carrying on of
business incidental to the objects of
the trust or institution for claiming
exemption of income from such
business
(5) 8th proviso 1st proviso to Where an application is made
section 12A(2) under Sl. No. (1) above, the
relevant A.Y. from which the
exemption provisions would apply
Note – The procedure for approval
contained in 8 th proviso to section
10(23C) is not discussed in the
chapter since no further application
for approval can be made on or
after 1st October 2024.
(6) 9th proviso 12AB(3) Time limit for passing order
granting approval/registration
under Sl. No. (2) above.
Note – The procedure for approval
contained in 9 th proviso to section
10(23C) is not discussed in the
chapter since no further application

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for approval can be made on or
after 1st October 2024.
(7) 10th proviso 12A(1)(b) Requirement to maintain
prescribed books of account and
get the same audited and furnish
audit report on or before the
specified date.
(8) 12th proviso Explanation 2 to Contribution towards the corpus of
section 11(1) another trust or institution out of
current year income not to be
treated as application of income
(9) 13th proviso Explanation 3 to Disallowances under sections
section 11(1) 40(a)(ia) and 40A(3) and (3A) to
apply in determining the amount of
application
(10) 14th proviso Explanation to Contribution to any trust or
section 11(2) institution out of accumulated
income not to be treated as
application of income
(11) 15th proviso 12AB(4) PC/Commissioner to call for
documents or information in case
he notices specified violations or on
receipt of reference from A.O. or
selection of case as per risk
management strategy of CBDT;
and pass an order cancelling or
refusing to cancel
approval/registration of trust on or
before the specified date/time limit.
(i) Explanation 1 12AB(5) Meaning of “specified date”/time
limit
(ii) Explanation 2 Explanation to Meaning of “specified violation”
section 12AB(4)
(12) 16th proviso 13(7) Anonymous donation referred to in
section 115BBC to be included in
total income.
(13) 18th proviso 13(8) Inclusion of income of trust or
[Relevant only for institution having object of
section 10(23C)(iv) and advancement of any object of
(v)] general public utility in total
income, if it carries on activity in the
nature of trade commerce or
business for consideration and the

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 10.14 DIRECT TAX LAWS

aggregate receipts from such

activity exceeds 20% of total
receipts.
(14) 19th proviso 11(7) Exemptions under section 10
[except section 10(1)] not to apply
to trust or institution approved u/s
10(23C) or registered under section
12AA/12AB
Explanation First Proviso to If trust or institution approved u/s
section 11(7) 10(23C) or registered u/s
12AA/12AB is notified u/s 10(23EA)
or u/s 10(23EC) or 10(23ED) or u/s
10(46) or u/s 10(46A), the approval
u/s 10(23C) or registration u/s
12AA/12AB, as the case may be,
would become inoperative from the
date of notification u/s 10(23EA) or
u/s 10(23EC) or 10(23ED) or u/s
10(46) u/s 10(46A) or from 1st April
of the P.Y. for which exemption is
claimed under section 10(46B).
(15) 20th proviso 12A(1)(ba) Return of income to be furnished in
accordance with section
139(4C)/(4A) within the time
allowed u/s 139(1) or 139(4).
(16) 21st proviso 13(1)(c) Income applied for benefit of
person referred to in section 13(3)
to be deemed income of the trust or
institution in the previous year of
application [after taking into
account the provisions of sections
13(2)/(4)/(6)].
(17) 22nd proviso 13(10) In case of non-maintenance of
books of account or failure to get
them audited or failure to file return
of income or inclusion of income in
total income due to carrying on of
activities in the nature of trade,
commerce, business (refer point 13
above), income to be computed as
per normal provisions after allowing
deduction of revenue expenditure
subject to certain conditions
stipulated thereunder.

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 ASSESSMENT OF TRUSTS AND INSTITUTIONS, 10.15
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Explanation Explanation Disallowances under sections

40(a)(ia) and 40A(3) and (3A) to
apply in determining the amount of
revenue expenditure deductible
(18) 23rd proviso 13(11) In computing income under regular
provisions as per Sl. No. 17 above,
no deduction in respect of any
expenditure or allowance or set-off
of any loss shall be allowed to the
assessee under any provision of
the Act.
(19) Explanation 1 to section 11(6) If acquisition of asset has been
10(23C) claimed as application, then, no
deduction for depreciation is
allowable.
(20) Explanation 2 to section Explanation 5 to Excess application of an earlier
10(23C) section 11(1) previous year not allowed to be set-
off or claimed as deduction or
allowance while calculation of
income required to be applied or
accumulated in the relevant
previous year.
(21) Explanation 3 to section Explanation to Sum payable by a trust or
10(23C) section 11 institution to be considered as
application of income during the
P.Y. in which such sum is actually
paid by it, irrespective of the
method of accounting regularly
employed by it.
Proviso Proviso If such sum is already claimed as
application in any earlier previous
year, it will not be allowed as
application again in any
subsequent P.Y. on payment basis.
Note –It may be noted that in certain provisions mentioned in the table above, there may be some
differences between the corresponding provisions in the first and second regime. The same have
been brought out at the relevant places in the course of discussions in the ensuing paragraphs in
this chapter relating to the provisions in the second regime [i.e., sections 11 to 13]. The above table
will help you co-relate the corresponding provisions in the first regime [Section 10(23C)(iv)/(v)/
(vi)/(via)].

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 10.16 DIRECT TAX LAWS

4. Income of Charitable Trusts and Institutions

I. Income from property held under trust
Subject to the provisions of sections 60 to 63, the income of a religious or charitable trust or
institution, to the extent specified in the Act, is exempt from tax when certain prescribed
conditions are fulfilled. The relevant income does not even form part of the total income of
the trust or institution.
Income from property held for charitable or religious purposes in India [Section 11(1)] -
The following income shall not be included in the total income of the previous year of the
person in receipt of the income:
(a) Income derived from property held under trust wholly for charitable or religious
purposes to the extent such income is applied in India for such purpose. Further, a
minimum 85% of the income derived to be applied for charitable or religious purpose.
(b) Income derived from property held under trust in part only for such purpose, to the
extent such income is applied in India for such purposes.
(c) Income derived from property held under trust,

- created on or after 1.4.1952 for charitable purpose which tends to promote

international welfare in which India is interested to the extent to which such
income is applied to such purpose outside India. This does not cover religious
trusts.

- trust for charitable or religious purposes, created before 1.4.1952, to the extent
to which such income is applied for such purposes outside India.

In both the cases, the CBDT should have, by general or special order, directed that
such income shall not be included in the total income of the person in receipt of such
income.

(d) Income in the form of voluntary contributions made with a specific direction that they
shall form part of the corpus of the trust or institution.
Such voluntary contributions received as corpus must be invested or deposited in one
or more of the forms or modes specified in section 11(5) maintained specifically for
such corpus, for claim of exemption.

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II. Voluntary Contributions [Section 12]- Any voluntary contribution received by a trust
created wholly for charitable or religious purposes or by an institution established wholly for
such purposes shall, for the purposes of section 11, be deemed to be income derived from
property held under trust wholly for charitable or religious purposes. However, corpus
donations (i.e., contributions made with a specific direction that they shall from part of the
corpus of the trust or institution) shall not be treated as income, provided they are invested
in the modes specified under section 11(5) [Section 12(1)].
The value of any services, being medical or educational services, made available by any
charitable or religious trust running a hospital or medical institution or an educational
institution, to any person referred under section 13(3), would be deemed to be income of
such trust or institution derived from property held under trust wholly for charitable or religious
purposes during the previous year in which such services are so provided and shall be
chargeable to income-tax.
III. Income should be applied for charitable or religious purposes - One of the primary
objectives of providing exemption under section 11 is that the income of the NPO should be
applied wholly towards charitable or religious purpose. The income -tax act has not defined
the term religious purpose. The shorter Oxford English Dictionary defines the term as follows:

“Devoted to religion; exhibiting the spiritual or practical effects of religion, following the
requirements of religion; pious, godly, devout”.
However, with regards to the definition of the term ‘Charitable Purpose’ , section 2(15) states
that ‘charitable purpose’ includes-
• relief of the poor,
• education,
• yoga,
• medical relief,
• preservation of environment (including watersheds, forests and wildlife) & preservation
of monuments or places or objects of artistic or historic interest and
• the advancement of any other object of general public utility.
Advancement of any other object of general public utility: The definition of “charitable purpose”
includes “any other object of general public utility” The question arises as to what is an object
of “general public utility”. This expression has not been defined anywhere in the Act.

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In CIT v. Gujarat Maritime Board (2007) 295 ITR 561, the Supreme Court observed that the
Gujarat Maritime Board was established for the predominant purpose of development of minor
ports within the State of Gujarat, the management and control of the Board was essentially
with the State Government and there was no profit motive. The assessee, Gujarat Maritime
Board, was under a legal obligation to apply its income which was directly and substantially
from the business held under trust for the development of minor ports in Gujarat. Therefore,
the Supreme Court held that the assessee was entitled to be registered as “charitable trust”
under section 12A.
A number of entities functioning on commercial basis claim exemption of their income either
under section 10(23C) or section 11 on the foundation that they are charitable institutions.
This is based on the contention that they are engaged in the “advancem ent of an object of
general public utility” as is included in the fourth part of the present definition of “charitable
purpose”. There were many decisions rendered in the past supporting the view that if
unconnected business is held under a trust for promoting the object of general public utility
and if profits are used for promoting such objects, income thereof shall be exempt, for
example, the decision of the Supreme Court in CIT v. Madras Stock Exchange Ltd. (1981)
130 ITR 184. However, such a claim in respect of an activity carried out on commercial basis,
goes against the basic intention of the provision.
“Advancement of any other object of general public utility” would not be a charitable
purpose: In order to limit the ambit of the phrase “advancement of any other object of general
public utility”, section 2(15) provides that “the advancement of any other object of general
public utility” would not be a charitable purpose if it involves the carrying on of –
(a) any activity in the nature of trade, commerce or business or,
(b) any activity of rendering of any service in relation to any trade, commerce or business,
for a fee or cess or any other consideration, irrespective of the nature of use or application of
the income from such activity, or the retention of such income, by the concerned entity.
Thus, 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, or any activity of rendering any service in relation to a ny trade, commerce or
business, for a cess or fee or any other consideration, irrespective of the nature of use or
application, or retention, of the income from such activity, unless,-
(1) such activity is undertaken in the course of actual carrying out of such advancement
of any other object of general public utility; and

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(2) the aggregate receipts from such activity or activities, during the previous year, does
not exceed 20% of the total receipts, of the trust or institution undertaking such
activity or activities, for the previous year.
Therefore, in effect, “advancement of any other object of general public utility” would continue
to be a “charitable purpose”, if the activity in the nature of trade, commerce or business is
undertaken in the course of actual carrying out of such advancement of any other object o f
general public utility and the aggregate receipts from any activity in the nature of trade,
commerce or business, or any activity of rendering any service in relation to any trade,
commerce or business does not exceed 20% of the total receipts of the trust or institution
undertaking such activity or activities, for the previous year.

ILLUSTRATION 3
An institution having its main object as “advancement of general public utility” received
` 30 lakhs in aggregate during the P.Y.2025-26 from an activity in the nature of trade. The
total receipts of the institution, including donations, was ` 140 lakhs. It applied 85% of its
total receipts from such activity during the same year for its main object i.e., advancement of
object of general public utility.
(i) What would be the tax consequence of such receipt and application thereof by the
institution?
(ii) Would your answer be different if the institution’s total receipts had been ` 150 lakhs
(instead of ` 140 lakhs) in aggregate during the P.Y.2025-26?
(iii) What would be your answer if the main object of the institution is “relief of the poor”
and the institution receives ` 30 lakhs from a trading activity, when its total receipts
are ` 140 lakhs and applies 85% of the said receipts for its main object?

SOLUTION

(i) As the main object of the institution is “advancement of object of general public utility”,
the institution will lose its “charitable” status for the P.Y.2025-26, since it has received
` 30 lakhs from an activity in the nature of trade, which exceeds ` 28 lakhs, being
20% of the total receipts of the institution undertaking that activity for the previous
year. The application of 85% of such receipt for its main object during the year would
not help in retaining its “charitable” status for that year. The institution will lose its
charitable status and consequently, the benefit of exemption of income for the
P.Y.2025-26, irrespective of the fact that its approval is not withdrawn or its registration
is not cancelled.

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(ii) If the total receipt of the institution is ` 150 lakhs, and the institution receives ` 30
lakhs in aggregate from an activity in the nature of trade during the P.Y.2025-26, then
it will not lose its “charitable” status since receipt of upto 20% of the total receipts of
the institution in a year from such activity is permissible. The institution can claim
exemption subject to fulfilment of other conditions under sections 11 to 13. Further,
such activity should also be undertaken in the course of actual carrying out of such
advancement of any other object of general public utility.
(iii) The restriction regarding carrying on a trading activity for a cess, fee or other
consideration will not apply if the main object of the institution is “relief of the poor”.
Therefore, receipt of ` 30 lakhs from a trading activity by such an institution will not
affect its “charitable” status, even if it exceeds 20% of the total receipts of the
institution. The institution can claim exemption subject to fulfilment of other conditions
under sections 11 to 13.

ILLUSTRATION 4

“Save Wild Life” an institution having its main object as ‘preservation of wildlife’, used the
entire income derived from an activity in the nature of trade for its main object during the
previous year ended on 31.03.2026. Would such utilization of its income be treated as
utilisation for “charitable purpose”? Examine. Would your answer be different, if the main
object of the institution is “advancement of object of general public utility”?

SOLUTION

Section 2(15) defines “charitable purpose” to include relief of the poor, education, yoga,
medical relief, preservation of environment (including watersheds, forests and wildlife) and
preservation of monuments or places or objects of artistic or historic i nterest and the
advancement of any other object of general public utility. However, the “advancement of any
other object of general public utility” shall not be a charitable purpose, if the institution is
carrying on any activity in the nature of trade, commerce or business, or any activity of
rendering any service in relation to any trade, commerce or business, for a cess or fee or any
other consideration, irrespective of the nature of use or application, or retention, of the income
derived from such activity.

Therefore, preservation of wildlife is included in the definition of “charitable purpose” under

section 2(15). Further, an institution having the preservation of wildlife as its main object
would not be subject to the restrictions which are applicable to the “advancement of any other

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object of general public utility”. Such institution would continue to retain its “charitable” status,
even if it derives income from an activity in the nature of trade.

However, if an institution having its main object as “advancement of any other object of
general public utility”, derives income from an activity in the nature of trade during a financial
year, it would lose its “charitable” status for that year, even if it applies such income for its
main objects.

It may be noted that if the receipts from such activity does not exceed 20% of the total receipts
in that year, then, the institution would not lose its “charitable” status, even if its main object is
“advancement of any other object of general public utility”, if such activity is undertaken in the
course of actual carrying out of such advancement of any other object of general public utility.

Circular No.11/2008 dated 19.12.2008

Exemption under section 11 in case of an assessee claiming both to be a charitable

institution as well as a mutual organisation

The proviso to section 2(15) will apply only to entities whose purpose is advancement of any
other object of general public utility i.e., the last limb of the definition of charitable purpose
contained in section 2(15). Hence, such entities will not be eligible for exemption under
section 11 or under section 10(23C), if they carry on commercial activities. Whether such an
entity is carrying on an activity in the nature of trade, commerce or business is a question of
fact which will be decided based on the nature, scope, extent and frequency of the activity.

There are industry and trade associations who claim exemption from tax under section 11 on
the ground that their objects are for charitable purpose as these are covered under any other
object of general public utility. Under the principle of mutuality, if trading takes place between
persons who are associated together and contribute to a common fund for the financing of
some venture or object and in this respect have no dealings or relations with any outside
body, then any surplus returned to the persons forming such association is not chargeable to
tax. In such cases, there must be complete identity between the contributors and the
participants.
Therefore, where industry or trade associations claim to be both charitable institutions as well
as mutual organizations and their activities are restricted to contributions from and
participation of only their members, these would not fall within the purview of the proviso to
section 2(15) owing to the principle of mutuality. However, if such organizations have dealings

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with non-members, their claim to be charitable organizations would be governed by the

additional conditions stipulated in the proviso to section 2(15).
In the final analysis, however, whether the assessee has, for its object, the advancement of
any other object of general public utility is a question of fact. If such assessee is engaged in
any activity in the nature of trade, commerce or business or renders any service in relation to
trade, commerce or business, it would not be entitled to claim that its object is charitable
purpose. In such a case, the object of general public utility will be only a mask or a device to
hide the true purpose which is trade, commerce or business or the rendering of any service
in relation to trade, commerce or business. Each case would, therefore, be decided on its
own facts and no generalization is possible.
Circular No.395, dated 24.9.1984– Promotion of sports and games is considered to be a
charitable purpose within the meaning of section 2(15). Therefore, an association or
institution engaged in the promotion of games and sports can claim exemption under
section 11.

A trust will be treated as a charitable trust under section 2(15) even if its object involves the
carrying on of an activity for profit. Such a trust will not be denied exemption under section
11 on the ground that its objects are non-charitable.

IV. Charitable trust engaged in business activity- Section 11(4A) provides that the exemption
under the respective regime, would be available in respect of income, being profits and gains
from business activity if ––
(a) such business is incidental to the attainment of the objects of the trust/institution; and
(b) separate books of account are maintained by such trust/institution in respect of such
business.
Cases where trust property consists of a business undertaking -Section 11(4) clarifies
that for the purposes of section 11, property held under trust may consist of a business
undertaking so held. If that be so, the trustees may claim that the income of such undertaking
enjoys exemption under section 11. Section 11(4) provides that -
(a) The Assessing Officer shall have the power to determine the income of the undertaking
in accordance with the provisions of the Act relating to assessment, and

(b) Where the income determined by the Assessing Officer is in excess of that shown in
the books of the undertaking, such excess shall be deemed to be applied to purposes
other than charitable or religious purposes.

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ILLUSTRATION 5
NSN, a charitable educational trust approved under section 10(23C)(vi), is running a school.
It operates a stationery shop outside the school campus. A sum of ` 75 lakhs has been
derived as net income from such business activity, which has been applied towards the
objectives of the trust in providing education. The trust maintains separate books of accounts
for the business activity. Examine the taxability of application of the income, if the income so
derived relates to the previous year 2025-26.
SOLUTION
The trust objective of providing education is a charitable purpose as per section 2(15). The
trust in the given case runs a stationery shop business, whose income is applied towards the
objectives of the trust. In this case, the business income from the stationery shop will be
eligible to avail exemption in respect of profits and gains of business, if such business is
incidental to the attainment of the objectives of the trust and separate books of account are
maintained in respect of such business.
Therefore, in the given case, the profit from the business shall be eligible for exemption under
section 11, assuming that the said business is incidental to the attainment of the objects of
the trust (i.e., education) and books of account for such business activity is maintained
separately.

5. Conditions for availing exemption under First Regime and Second

Regime
Conditions for availing exemption under both the regimes i.e., section 10(23C)(iv)/(v)/(vi)/(via) are
largely similar. It is essential to satisfy the following conditions for availing exemption under these
regimes:
(I) Registration for claiming exemption
The primary condition for a trust or institution or fund to avail exemption in both the regimes,
is that the trust or institution must be approved under section 10(23C) or registered under
section 12AB, as the case may be. Failure to register will deprive tax exemption for such trust
or institution.
The procedure for obtaining registration for exemption to a trust or fund or institution had
undergone a significant change from April 1 st, 2021. Prior to the change in the registration
procedure, a taxpayer desirous of availing exemption under this section must submit an
application to the Commissioner of Income-tax, within a specified time limit. The
Commissioner, on detailed verification and enquiry, will grant registration or refusal of the

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exemption application. This process was time consuming and also paved way for prolonged
litigation.
Some of the key aspects of change in the registration procedure is that the registration
process is made online and the approvals are valid only for a certain time period. Closure to
the expiry of the validity period, the taxpayer must apply for renewing the registration. Failure
to renew the exemption approval will not entitle the taxpayer to avail the exemption any
further. The procedure for registration under the second regime i.e. under section 12AB in
below Table:
Table : Procedure & Timelines for availing exemption under section 12AB
read with section 12A(1)(ac) 1
Section Case Time limit for Time limit for Validity Period Registration
12A(1)(ac) making the passing order granted is
application by the PC/C applicable
[Section from
12AB(3)]
(1) (2) (3) (4) (5) (6)
Clause (i) Re-registration Within three Order to be Five years A.Y. from
of the months from passed within 3 [Section which
institutions or April 1, 20212 in months from 12AB(1)(a)/(b)] registration
funds which Form No. 10A end of the Where the total was earlier
were already month when income of a granted
registered application was trust or [Proviso to
under section made. institution section
12A/section without giving 12A(2)]
12AA. prior to effect to the
1.4.2021 provisions of
Clause (ii) Renewal of at least six within 6 months section 11 and A.Y.
registration/ months prior to from the end of 12 does not immediately
approval for the expiry of the quarter in exceed ` 5 following the
trust/ the five-year which crores during F.Y. in which
institution validity in Form application was each of the two application is
already No. 10AB. received after P.Y’s, made [Section
registered satisfying preceding the 12A(2)]
under section himself about P.Y. in which
12AB or the application is

1 For detailed study of procedure, manner and form applicable for making application for registration or
provisional registration, students are advised to refer Rule 17A of the Income -tax Rules, 1962 available at
[Link]
2 As per the provision, the effective date for making application is 30.06.2021. However, this date is extended

upto 30.06.2024 vide Circular No. 7/2024, dated 25.04.2024.

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approved u/s genuineness of made, the
10(23C)(iv)/ activities and registration
(v)/(vi)/(via) compliance of would be valid
and whose other laws, as for 10 Years.
period of 5 are material for
years is due to the purpose of
expire. achieving its
Clause (iii) Final At least six objects. For First of the
registration months prior to this purpose, A.Y. for which
where a trust/ the expiry of the PC or C it was
institution is the provisional shall call for provisionally
provisionally registration or such registered
registered u/s approval documents or [Proviso to
12AB or information and section
or make inquiries
provisionally 12A(2)]
approved within six as he thinks
u/s10(23C) months of necessary.
(iv)/(v)/(vi)/ commence- If not satisfied,
(via) as the ment of pass an order
case may be activities, in writing
whichever is rejecting such
earlier, in Form application and
No. 10AB. also cancelling
Clause (iv) To revive At least six its registration A.Y.
inoperative months prior to after giving immediately
registration of the commence- opportunity of following the
trust/ ment of the AY being heard. F.Y. in which
institution on from which the application is
account of said made [Section
grant of registration is 12A(2)]
approval as sought to be
provided in made operative
first proviso to in Form No.
section 11(7) 10AB.
Clause (v) The trust or Within a period A.Y.
institution has of thirty days immediately
adopted or from the date of following the
undertaken the said F.Y. in which
modifications adoption or application is
of the objects modification, in made [Section
which do not Form No. 10AB 12A(2)]
conform to the
conditions of
registration.

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Clause (vi) In any other At least one Within one Three years the A.Y. for
case (for e.g., month prior to month from the [Section which
first time the commence- end of the 12AB(1)(c)] registration is
applications) ment of the month in which sought in
[See Note previous year the application Form 10A,
below] relevant to the is made order where the
assessment to be passed application is
year in which for provisional filed within the
the registration registration stipulated
is sought in without time limit3
Form No. 10A. detailed
enquiry.

Note – A trust which has already commenced its activities and has not availed exemption
under first regime or second regime for any P.Y. ending on or before the date of such
application, need not first apply for provisional registration in Form 10A. It can at any time
after the commencement of such activities directly apply for final registration in Form 10AB.
The PC or C after following the compliances stipulated in Column (4) [corresponding to clause
(iii) of Section 12A(1)(ac)], can grant approval within 6 months from the end of the month in
which application is received. If not satisfied, he can pass an order in writing rejecting such
application after affording it a reasonable opportunity of being heard. For such
trust/fund/institution, registration would be valid for 5 years or 10 years, as the case may be
[Section 12AB(1)(b)]. Exemption under section 11 and 12 is applicable from the A.Y.
immediately following the F.Y. in which such application is made.

Thus, only the trusts/funds/institutions which have not commenced activities are required to
get provisional registration and will fall within the scope of section 12AB(1)(c).
Condonation of delay in making application for registration / renewal of registration u/s 12A
A trust or an institution is entitled to claim exemption under second regime if it makes an
application for registration/renewal, as the case may be, to the PC or C within prescribed
time. Non filing of application within the time specified in section 12A(1)(ac) renders the
applicant ineligible to claim the exemption.
In such cases, in order to avoid difficulty and potential adverse consequences, with effect
from 1st October 2024, where an application is filed beyond the time limit specified in section

3 The CBDT Circular 6/2023 dated 24.5.2023 clarifies that the provisional registration shall be effective from
the assessment year relevant to the previous year in which the application is made. However, it appears that
the intent is to make the same applicable from the assessment year for which the registration is sought,
provided the application is filed within the time limit mentioned in Column (3).

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12A(1)(ac), the PC or C, may, if he considers that there is a reasonable cause for delay in
filing the application, condone such delay and such application shall be deemed to have been
filed within time.
ILLUSTRATION 6
A public trust has commenced its activities of providing “relief to poor” in the year 2023-24.
The trust intends to claim benefits of sections 11 and 12 from A.Y. 2026-27. It approaches
you in October, 2025. Total income of the trust for P.Y. 2023-24 and P.Y. 2024-25 was
` 20 lakhs and ` 45 lakhs, respectively. Advise the trust as to the time limit for making an
application for registration, time limit for granting approval by the Principal Commissioner or
Commissioner and the period for which the approval is valid.
SOLUTION
In order to avail the exemption under section 11, the trust has to obtain registration under
section 12AB read with section 12A(1)(ac). A trust which has already commenced its activities
can directly apply for final registration. In the present case, the trust has to apply for
registration after commencing its activities but on or before 31.3.2026 to avail the exemption
for A.Y. 2026-27. Accordingly, the time limit for making application, time limit for granting
registration and period of validity would be as follows:
S. Particulars Time Limit
No
1 Registration application to Application for final registration to be made in Form
be filed online as 10AB at any time after the commencement of such
prescribed under Rule 17A activities.
2 Grant of registration by the Grant registration within 6 months from the end of
Principal Commissioner or the quarter in which application was received after
Commissioner satisfying himself about the genuineness of
activities and compliance of other laws, as are
material for the purpose of achieving its objects. For
this purpose, the PC or C shall call for such
documents or information and make inquiries as he
thinks necessary.
If not satisfied, pass an order in writing rejecting
such application after giving opportunity of being
heard.
3 Validity period of the Registration is valid for ten years effective from the
approval A.Y. immediately following the F.Y. in which
application is made.

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ILLUSTRATION 7
Help All, a trust created on 1 st April 2024 for providing relief to the poor, applied for registration
under section 12AB on 28 th February 2025. The Commissioner denied registration on the
ground that the trust had not commenced any charitable activity, due to which he could not
satisfy himself about the genuineness of the trust. Is the ground for denial of registration by
the Commissioner justified in this case? Discuss.
SOLUTION
Section 12AB read with section 12A(1)(ac)(vi) provides that in case of a trust seeking
registration for first time, provisional registration will be provided for a period of three years
without detailed enquiry by the prescribed income-tax authority even in cases where activities
of the entity are yet to begin.
Hence, the Commissioner cannot deny registration on the ground that activities have not
commenced. The Commissioner can make detailed enquires and call for information when
the trust applies to convert its provisional registration into a final registration as stipulated
under section 12A(1)(ac)(iii) read with section 12AB.

(II) Cancellation of Registration/approval [Section 12AB(4) & (5)]

The Principal Commissioner of Income-tax (PCIT) or Commissioner Income-tax (CIT) can

cancel registration or provisional registration or approval or provisional approval of a trust or
an institution granted under either the first regime i.e., section 10(23C) or under the second
regime i.e., section 11 read with section 12AB.

Situations in which registration/approval can be cancelled

The registration can be cancelled in the following situations:

• The PCIT or CIT has noticed the occurrence of one or more specified violations
during any previous year; or

• The PCIT or CIT has received a reference from an Assessing Officer under the
second proviso to section 143(3) for any previous year to withdraw the approval or
registration due to occurrence of a specific violation; or

• The case of the institution has been selected in accordance with risk management
strategy, formulated by the CBDT from time to time for any previous year.

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Procedure for cancellation

The PCIT or CIT in this regard shall
• call for such documents or information from the trust or institution, or make such
inquiry as he thinks necessary in order to satisfy himself about the occurrence or
otherwise of any specified violation;
• pass an order in writing, cancelling the registration or approval of such trust or
institution, after affording a reasonable opportunity of being heard, for such previous
year and all subsequent previous years, if he is satisfied that one or more specified
violations have taken place;
• pass an order in writing, refusing to cancel the registration or approval of such
trust or institution, if he is not satisfied with the occurrence of one or more specified
violations;
• forward a copy of the order cancelling the registration or refusing to cancel the
registration to the Assessing Officer and to such trust or institution.
Time limit for passing the order
The order cancelling or refusing to cancel registration has to be passed before the expiry of
a period of six months, from the end of the quarter in which the first notice is issued
by the PCIT or CIT, calling for any document or information, or for making any inquiry.
Meaning of Specified Violation: Specified violation
(a) where any income derived from property held under trust, wholly or in part for
charitable or religious purposes, has been applied, other than for the objects of the
trust or institution; or
(b) the trust or institution has income from profits and gains of business which is not
incidental to the attainment of its objectives or separate books of account are not
maintained by such trust or institution in respect of the business which is incidental
to the attainment of its objectives; or
(c) the trust or institution has applied any part of its income from the property held under
a trust for private religious purposes, which does not enure for the benefit of the
public; or
(d) the trust or institution established for charitable purpose created or established after
the commencement of this Act, has applied any part of its income for the benefit of
any particular religious community or caste; or

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(e) any activity being carried out by the trust or institution—

(i) is not genuine; or
(ii) is not being carried out in accordance with all or any of the conditions subject
to which it was registered; or
(f) the trust or institution has not complied with the requirement of any other law, and
the order, direction or decree, by whatever name called, holding that such non -
compliance has occurred, has either not been disputed or has attained finality.
(g) the application for approval under first regime or registration under second regime
contains false or incorrect information.

Note – Cancellation procedure for approval granted under first regime is similar as prescribed
above for second regime. However, the situations mentioned in (c) and (d) are mentioned
only in the case of a trust or institution registered under section 11.

(III) Mandatory filing of return [Section 12A(1)(ba)]:

In order to avail of exemption under any of these regimes, the entities approved under first
regime and entities registered under second regime are required to file the return of income
under section 139(4C) or under 139(4A), respectively within the time allowed under section
139(1) [i.e., on or before the due date of filing return of income] or section 139(4) [ upto 31st
December of the relevant assessment year], if the total income without giving effect to the
provisions of
− section 10, in case of first regime approved entities or
− section 11 and 12 in case of second regime approved entities,
exceeds the maximum amount which is not chargeable to income-tax.
(IV) Maintenance of Books of account & Other Documents and Audit of accounts [Section
12A(1)(b)]:
With effect from A.Y. 2023-24, where the total income of the trust or institution or fund referred
under these two regimes without giving effect to the provisions of section
10(23C)(iv)/(v)(vi)(via) or section 11 and 12, as the case may be exceeds the maxi mum
amount which is not chargeable to income-tax in any previous year, such entities shall
− keep and maintain books of account and other documents in such form and manner
and at such place,

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− get the accounts audited by a chartered accountant and the report of such audit in the
prescribed form duly signed and verified by such accountant and setting forth such
prescribed particulars, should be furnished on or before the specified date i.e., one
month prior to the due date for filing return of income.

Rule 16CC and Rule 17B prescribe that the report of audit of the accounts of
a trust or institution is required to be furnished in
(a) Form No. 10B where -
(I) the total income of such trust or institution, without giving effect to the
provisions of 10(23C)(iv)/(v)(vi)(via) or sections 11 and 12, exceeds
` 5 crores during the previous year; or
(II) such trust or institution has received any foreign contribution during
the previous year; or
(III) such trust or institution has applied any part of its income outside
India during the previous year;
(b) Form No. 10BB in other cases.

The term “books or books of account” as defined under section 2(12A) includes ledgers, day-
books, cash books, account-books and other books, whether kept in the written form or in
electronic form or in digital form or as print-outs of data stored in such electronic form or
in digital form or in a floppy, disc, tape or any other form of electro-magnetic data storage device.
Prescribed books of account and documents
Rule 17AA prescribes the following books of account and other documents to be maintained
by the entities under both the regimes:
(a) books of account, including the following, namely: -
(i) cash book;
(ii) ledger;
(iii) journal;
(iv) copies of bills, whether machine numbered or otherwise serially numbered,
wherever such bills are issued by the assessee, and copies or counterfoils of
machine numbered or otherwise serially numbered receipts issued by the
assessee;

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(v) original bills wherever issued to the person and receipts in respect of payments
made by the person;
(vi) any other book that may be required to be maintained in order to give a true
and fair view of the state of the affairs of the person and explain the transactions
effected;
(b) books of account, as referred in clause (a), for business undertaking referred in section
11(4);
(c) books of account, as referred in clause (a), for business carried on by the assessee
other than the business undertaking referred in section 11(4);
(d) other documents for maintaining,
(i) record of all the projects and institutions run by the person
(ii) record of income of the person during the previous year, in respect of -
(I) voluntary contribution containing details of name of the donor, address,
permanent account number (if available) and Aadhaar number (if
available);
(II) income from property held under trust referred to under section 11 along
with list of such properties;
(III) income of fund or institution or trust or any university or other educational
institution or any hospital or other medical institution other than the
contribution referred in items (I) and (II);
(iii) record of the following, out of the income of the person during the previous year,
namely:-
(I) application of income, in India,
(II) amount credited or paid to any fund or institution or trust or any university
or other educational institution or any hospital or other medical institution
referred to in first and second regime;
(III) application of income outside India;
(IV) deemed application of income;
(V) income accumulated or set apart which has not been applied or deemed
to be applied containing details of the purpose for which such income
has been accumulated;

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(VI) money invested or deposited in the forms and modes specified in section
11(5);
(VII) money invested or deposited in the forms and modes other than those
specified in section 11(5);
(iv) record of the following, out of the income of the person of any previous year
preceding the current previous year, namely -
(I) application out of the income accumulated or set apart containing details
of year of accumulation, amount of application during the previous year
out of such accumulation, name and address of the person to whom any
credit or payment is made and the object for which such application is
made;
(II) application out of the deemed application of income;
(III) application, other than the application referred in item (I) and item (II),
out of income accumulated during any preceding previous year
containing details of year of accumulation, amount of application during
the previous year out of such accumulation, name and address of the
person to whom any credit or payment is made and the object for which
such application is made;
(IV) money invested or deposited in the forms and modes specified in section
11(5);
(V) money invested or deposited in the forms and modes other than those
specified in section 11(5);
(v) record of voluntary contribution made with a specific direction that they shall
form part of the corpus.
(vi) record of contribution received for the purpose of renovation or repair of temple,
mosque, gurdwara, church or other place notified under section 80G(2)(b)
which is being treated as corpus as referred section 10(23C) or in section 11(1).
(vii) record of loan or borrowings
(viii) record of properties held by the assessee
(ix) record of specified persons, as referred to in section 13(3) and transactions
undertaken by the fund or institution or trust with such specified persons .

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Place of maintenance of books of account and other documents

The books of account and other documents shall be kept and maintained by the trust/
institution at its registered office.
Such books of accounts may be kept at such other place in India as the management may
decide by way of a resolution and where such a resolution is passed, these entities should,
within seven days thereof, intimate the jurisdictional Assessing Officer in w riting giving the
full address of that other place and such intimation shall be duly signed and verified by the
person who is authorized to verify the return of income under section 140.

Time period
These books of account and other documents shall be kept and maintained for a period of
ten years from the end of the relevant assessment year.

However, where the assessment in relation to any assessment year has been reopened under
section 147, the books of account and other documents which were kept and maintained at the
time of reopening of the assessment shall continue to be so kept and maintained till the
assessment so reopened has become final.
V. Application of Income – Key Considerations under both regime: We have seen that the
exemption is limited to the extent to which such income is applied. Is it necessary that the
entire income should be so applied? The Act gives a concession here. It is possible to claim
the exemption even if the trust or institution applies only 85% of the income derived from the
trust property for the purpose of the trust, during the relevant previous year.
An accumulation not exceeding 15% of the income from such property is permissible. For
computing this 15%, voluntary contributions referred to in section 12 shall be deemed to be
part of the income. The exemption under both regime will be available only if at least 85% of
the income is applied for charitable or religious purposes in India during the year and the
remaining amount i.e., 15% is invested in the forms or modes specified under section 11(5)4.
Some relevant considerations for determining application of income are discussed below:
(A) Inability to apply in full 85% of the income - It is clear from the above discussion
that free accumulation not exceeding 15% of income 5 from property is permissible.
Hence, the balance 85% must be applied during the previous year for the purposes
for which the trust has been created.

4Circular No. 335 [F. No. 180/9/81-IT(A-I)], dated 13-4-1982.

5Asper the Supreme Court ruling in CIT v. Programme for Community Organisation (2001) 116 Taxman 608,
15% of gross receipts would be eligible for accumulation under section 11(1)(a).

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However, it is possible that the trust is unable to apply the minimum of 85% of its
income during the previous year due to either of the following reasons.
(1) The whole or any part of the income has not been received during that year.
(For e.g., if the assessee follows accrual basis of accounting wherein the
income has been recognised but not received)
(2) Any other reason (For e.g., late receipt of the income making it impossible to
spend it before the end of the year)
- In the first situation, wherein the whole or any part of the income has not
been received during that year, the period of application is extended to
cover the previous year in which the income is actually received and the
previous year immediately following the year. However, the amount
which may be so claimed to have been so applied during the subsequent
previous year cannot exceed the amount of the income which had not
been received earlier but received during a subsequent previous year.

- In the second case, the period of application is extended to the previous

year immediately following the previous year in which the income was
derived.

Example 1
During the previous year ending 31 st March, 2026, a charitable trust earned an income
of ` 1,00,000 but it received only ` 60,000 in that year. The balance of ` 40,000 is
received during the previous year 2026-27.
`
Total income earned during the P.Y.2025-26 1,00,000
Less: Permissible accumulation @15% of ` 1,00,000 15,000
Balance 85% of income to be applied during the P.Y.2025-26 85,000
Less: Amount deemed to be applied would be the amount not
received during the P.Y. 2025-26 40,000
Amount to be applied in the P.Y. 2025-26 45,000
Balance amount received in P.Y.2026-27 to be applied in the 40,000
P.Y.2026-27 or P.Y.2027-28.
Note - Since this amount of ` 40,000 is received during the P.Y. 2026-27, this can
be applied in the P.Y.2026-27 or in the P.Y.2027-28.

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Example 2
A trust receives a sum of ` 50,000 on 30th March, 2026. Its previous year ends on
31-3-2026.
It is obvious that it is impossible to apply the requisite sum within one day. Therefore,
it has been provided that such sum can be applied at any time during the immediately
following previous year i.e., up to 31-3-2027.
(B) Procedural Formalities: For exercising an option for availing the extended period for
application in the above two situations [Clause (2) of Explanation 1 to section 11(1)],
the trust has to exercise an option in writing that the income applied later as
prescribed may be deemed to be income applied to the relevant charitable
purposes during the previous year in which the income was derived. Such option
has to be exercised at least 2 months before the due date for filing return of income
specified under section 139(1).
The income so deemed to have been applied shall, however, not be taken into account
in calculating the amount of income applied to such purposes, during the previous year
in which the income is actually received or during the immediately following previou s
year, as the case may be.

Thus, in Example 1 given above, the amount of ` 40,000 received subsequently in

the previous year 2026-27 and applied to charitable purposes in the previous year
2026-27, will, by virtue of the option exercised by the trust, be deemed to be applied
for charitable purposes in the previous year 2025-26 itself. Therefore, such an
amount will not be taken into consideration in determining the amount of income
applied for charitable purposes in the previous year 2026-27.
Section 11(1B) also provides that where the income for which an option has been
exercised as discussed above, is not actually applied, it is to be treated as the income of-
− the previous year immediately following the previous year in which the income
was received in case of first situation or
− the previous year immediately following the previous year in which it was
derived, in case of second situation.

Note: The option for availing the benefit for extended period for application of income
in the two situations mentioned above is not available to trust or institution availing
exemption under the first regime i.e., section 10(23C).

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(C) Amounts not treated as application of income or not allowable as deduction

(i) Amount credited or paid out of income of any trust by way of corpus
donation not to be considered as application [Explanation 2 to section
11(1)]- Any amount credited or paid, out of income derived from property held
under trust, to any fund or trust or institution or any university or other
educational institution or any hospital or other medical institution referred to
in section 10(23C)(iv)/(v)/(vi)/(via) or other trust or institution registered
under section 12AA or 12AB, as the case may be, being contribution with a
specific direction that it shall form part of the corpus, shall not be treated as
application of income for charitable or religious purpose [Explanation 2 to
section 11(1)].
(ii) Only 85% of the amount credited or paid by way of donation (other than
corpus donations) to another trust or institution out of current year
income would be considered as application [Explanation 4(iii) to section
11(1)]: Any amount credited or paid by way of donation, other than corpus
donations, to any fund or trust or institution or any university or other
educational institution or any hospital or other medical institution referred to in
10(23C)(iv)/(v)/(vi)/(via) or other trust or institution registered under section
12AB, as the case may be, out of current year income shall be treated as
application for charitable or religious purposes only to the extent of 85% of
such amount credited or paid.
Accordingly, CBDT has, vide Circular No. 3/2024 dated 06.03.2024, reiterated
that eligible donations made by a trust/institution to another trust/institution
under any of the two regimes shall be treated as application for charitable or
religious purposes only to the extent of 85% of such donations. It means that
when a trust/institution in either regime donates ` 100 to another
trust/institution in either regime, it will be considered to have applied 85%
(` 85) for the purpose of charitable or religious activity.
It is clarified that 15% (` 15) of such donations by the donor trust/institution
shall not be required to be invested in specified modes under section 11(5) as
the entire amount of ` 100 has been donated to the other trust/institution and
is accordingly eligible for exemption under the first or second regime.
This is illustrated by the following example where Trust 1, Trust 2 and Trust 3 are
trusts or institutions under any of the two regimes. Further, Trust 1 is making eligible
donation to Trust 2 and Trust 2 is further making eligible donation to Trust 3.

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S. Particulars Trust 1 Trust 2 Trust 3

No
1. Income (A) 300 100 100
2. Income which is required to 255 85 85
be applied (B = 85% of A)
3. Application of income
4. Donation to other trusts 100 100 Nil
under the first or second
regime (C)
5. Amount to be considered as 85 85
application of income
against the donations at
row no. 3 [as per clause (iii)
of the Explanation 2 to third
proviso to section I0(23C)
or clause (iii) of the
Explanation 4 to section
11(1) (D = 85% of C)
6. Balance income for 200 Nil 100
application (E = A - C)
7. Application other than SI. 170 Nil 85
No. 4 (F = 85% of E)
8. Remaining income which 30 Nil 15
may be accumulated
without Form No. I0/ 9A (G
= 15% of E)
9. Funds required to be 30 Nil 15
invested in section 11(5)
modes (H = G)
10. Exemption of income (I = C 300 100 100
+ F + G)

(iii) Amount credited or paid, out of accumulated income of any trust, to any
trust or institution registered under section 12AA/12AB or referred to in
section 10(23C)(iv)/(v)/(vi)/ (via), not considered as application of income
[Explanation to section 11(2)]
Any amount credited or paid, out of income derived from property held under
trust, which is not applied, but is accumulated or set apart, to any trust or
institution registered under section 12AA/12AB, or to any fund or institution or
trust or any university or other educational institution or any hospital or other

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medical institution referred to in sub-clause (iv)/(v)/(vi)/(via) of section 10(23C),

shall not be treated as application of income for charitable or religious purpose,
either during the period of accumulation or thereafter.
Note – Any contribution to another trust or institution out of accumulated income
will not be treated as application. Contribution to another trust or institution
towards corpus will not be deemed as application even if it is out of current year
income.
(iv) Provisions of sections 40(a)(ia), 40A(3) and 40A(3A) apply in case of
application of income by trust [Explanation 3 to section 11(1)] – In case
where an expenditure is incurred on which tax is deductible at source under
Chapter XVII-B and such tax has not been deducted or after deduction, has not
been paid on or before the due date under section 139(1), 30% of sum paid
would not be treated as application of income in that year. The same would be,
however, be treated as application in the year in which tax is deducted and
paid.
Likewise, where the trust incurs any expenditure in respect of which a payment
or aggregate of payments made to a person in a day, otherwise than by an
account payee cheque/ bank draft/ ECS or through such other prescribed
electronic mode [Credit card, debit card, net banking, IMPS (Immediate
Payment Services), UPI (Unified Payment Interface), RTGS (Real Time Gross
Settlement), NEFT (National Electronic Fund Transfer), BHIM (Bharat Interface
for Money) Aadhar Pay], exceeds ` 10,000, the same would not be considered
as application of income.
(v) Income received for repairs and renovation of temples, mosques etc.
[Explanation 3A to section 11(1) - This provision would apply where the
property held under a trust or institution includes any temple, mosque,
gurdwara, church or other place notified under section 80G(2)(b).
In such a case, any sum received as a voluntary contribution by such trust or
institution for the purpose of renovation or repair of such temple, mosque,
gurdwara, church or other place, may, at its option, be treated as forming part
of the corpus of the trust or the institution, provided such corpus is:
(a) applied by the trust or institution only for the purpose for which
contribution was made;
(b) not utilised for making contribution or donation to any person;

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(c) separately identifiable; and

(d) invested or deposited in the forms and modes specified in section 11(5).
However, in case such trust or institution has violated any of the above
conditions, such sum treated as corpus will be deemed as income of the
previous year during which violation takes place.
(vi) Corpus donations utilised by fund/trust/institution towards its objects
shall not be treated as application of income – Under both the exemption
regimes, corpus donations received by a fund/trust/institution etc. are exempt
from income, if the corpus donations are received with a specific direction that
they shall form part of the corpus and the said corpus contribution is invested
in any of the modes specified under section 11(5) [Section 11(1)(d].
Therefore, corpus donations being exempt income, any application made from
corpus donation shall not be treated as application of income [Explanation 4(i)
to section 11(1)].
However, the amount not so treated as application thereof, shall be treated as
application for charitable or religious purposes in the previous year in which the
amount is invested or deposited back, into one or more of the forms or modes
specified in section 11(5) maintained specifically for such corpus, from the
income of that year and to the extent of such investment or deposit , subject to
the satisfaction of conditions which are required to be satisfied in case of
application for charitable or religious purposes. These conditions are as follows:
(1) Application should be in India except with the approval of the Board in
accordance with the provisions of section 11(1)(c).
(2) Application should not be by way of donation to the corpus of another
trust or institution.
(3) TDS, if applicable, should be deducted on such application.
(4) Application whereby payment or aggregate of payments made to a person
in a day does not exceed ` 10,000 otherwise than by way otherwise than
by an account payee cheque/ bank draft/ ECS or through such other
prescribed electronic mode [Credit card, debit card, net banking, IMPS
(Immediate Payment Services), UPI (Unified Payment Interface), RTGS
(Real Time Gross Settlement), NEFT (National Electronic Fund Transfer),
BHIM (Bharat Interface for Money) Aadhar Pay].

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(5) Carry forward and set off of excess application is not allowed.
(6) Application is allowed in the year in which it is actually paid.
(7) Application should not directly or indirectly benefit any person referred
to in section 13(3) and the income of the trust or institution should not
enure any benefit to such person.
(8) If the trust or institution invests or deposits back the amount into corpus
within 5 years of application from the corpus, only then such investment/
depositing back into corpus will be allowed as application for charitable
or religious purposes.

Note - No application would be allowed for amount invested or deposited back

in modes specified under section 11(5), where application was made out of
corpus on or before 31.3.2021.
ILLUSTRATION 8
XYZ Charitable Trust is an educational institution registered under section
12AB of the Income-tax Act. During the Financial Year 2025-26, the trust
receives a corpus donation of ` 25 lakhs with a specific direction that the corpus
fund should be utilised for setting up a science laboratory. The trust intends to
set up the lab only during P.Y. 2027-28 and will utilize the funds only during
that financial year. In this regard, the trust wants to understand whether the
corpus donations are exempt u/s 11(1)(d) of the Income-tax Act, 1961.
SOLUTION
As per section 11(1)(d), voluntary contributions made with a specific direction
that they shall form part of the corpus of the trust is an exempted income.
However, in order to avail the exemption by the trust, such corpus donations
must be invested or deposited in one or more of the forms or modes specified
in section 11(5). Failure to deposit the same in the prescribed modes, will result
in inclusion of corpus donation as an income of the XYZ Charitable trust.
(vii) Application out of loan/borrowings not to be treated as application of
income - Application for charitable or religious purposes, from any loan or
borrowing, shall not be treated as application of income for charitable or
religious purposes [Explanation 4(ii) to section 11(1)].
However, the amount not so treated as application or part thereof, shall be
treated as application in the previous year in which the loan or borrowing or

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part thereof is repaid from the income of that year to the extent of such
repayment subject to satisfaction of conditions which are required to be
satisfied in case of application for charitable or religious purposes. These
conditions are as follows:
1. Application should be in India except with the approval of the Board in
accordance with the provisions of section 11(1)(c).
2. Such application should not be in the form of corpus donation to another
trust.

3. TDS, if applicable, should be deducted on such application.

4. Application whereby payment or aggregate of payments made to a
person in a day does not exceed ` 10,000 otherwise than by way of an
account payee cheque/ bank draft/ ECS or through such other
prescribed electronic mode [Credit card, debit card, net banking, IMPS
(Immediate Payment Services), UPI (Unified Payment Interface), RTGS
(Real Time Gross Settlement), NEFT (National Electronic Fund
Transfer), BHIM (Bharat Interface for Money) Aadhar Pay].
5. Carry forward and set off of excess application is not allowed.

6. Application is allowed in the year in which it is actually paid.

7. Application should not directly or indirectly for the benefit of any person
referred to in section 13(3) and the income of the trust or institution
should not enure any benefit to such person.
8. Repayment of loan is made within a period of 5 years from the end of the
previous year in which such application was made from loan or borrowing.

Note - Application from any loan or borrowing made on or before 31.3.2021 will
not be treated as application. This is because upto 31.3.2021, the amount
applied out of loan or borrowing was allowed as application. Hence, at the time
of repayment, it cannot be claimed as application once again.

(viii) No set off or deduction allowable of any excess application of earlier

previous year [Explanation 5 to section 11(1)] – No set off or deduction or
allowance of any excess application of any of the year preceding the previous
year shall be made for computation of income required to be applied or
accumulated during the previous year. For example, excess application in

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A.Y. 2025-26 cannot be reduced to determine the income to be applied or

accumulated during the P.Y. 2025-26 (A.Y. 2026-27).
(ix) No deduction for depreciation where cost of asset has been claimed as
application of income – Income for the purposes of application under section
11 shall be determined without allowing any deduction or allowance for
depreciation or otherwise, in respect of any asset, the cost of acquisition of
which has been claimed as an application of income under this section in the
same or any other previous year [Section 11(6)].
ILLUSTRATION 9
MSO Foundation, a registered charitable institution set up on 1 st April, 2024 is
engaged in providing education in hotel management. The organization
acquires a building in July 2025 for using the same for holding classes and
office activities. It has approached you for your opinion on its eligibility to claim
the cost of the building and also depreciation thereon in the current year and
the subsequent year. Advise the institution indicating the reasons.
Would your advise change, if building has been acquired out of loan taken in
July 2025 from bank, to be repaid in installments over a period of 7 years?

SOLUTION
15% of income from property held for charitable purposes is exempt from tax
under section 11. The remaining 85% of such “income” would be exempt if it is
“applied” for charitable purposes in India.
Application of the amount can be for revenue or capital purposes. As long as
the expenditure is incurred out of income earned by the trust and for the
purposes of carrying on the objects of the trust, it would be treated as
application of income even if such expenditure is for capital purposes.
Therefore, since the building is acquired by the organization for holding classes
and office activities, which is for the purposes of carrying on the objects of the
charitable institution i.e., for providing education in hotel management, the cost
of the building would be treated as application of income.
However, section 11(6) provides that where the cost of building is claimed as
application, no other deduction for depreciation or otherwise would be allowed
as an application of income in respect of such asset for the same or any other
previous year.

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If building has been acquired out of loan taken from bank, then, cost of building
cannot be claimed as application. Repayment of loan would be treated as
application in the year of repayment to the extent of amount repaid for a period
of 5 years from the end of the previous year in which building was acquired.
The repayment made upto 31.3.2031 would be eligible to be treated as
application in the respective year of repayment. Repayment made thereafter
i.e. from 1.4.2031 cannot be treated as application.
Alternatively, since cost of building is not claimed as application, depreciation
on such building can be claimed as deduction. However, if deduction in respect
of depreciation is claimed, then, it is possible to take a view that repayment of
loan may not be eligible to be treated as application.
(x) Expenditure allowed only on actual payment basis – Previously, the term
“application” included expenses that accrued during the year, even if they are
not actually paid. However, with effect from A.Y. 2022-23, any sum payable by
any trust or institution shall be treated as application of income only in the
previous year when such sum is actually paid by it. This is irrespective of the
previous year in which the liability to pay such sum was incurred or method of
accounting regularly employed by it. Thus, expenditure is allowed as
application only when the payment is actually made and not when the liability
is incurred [Explanation to section 11].
However, where during any previous year, any sum has already been claimed
to have been applied by the trust or institution, such sum would not be allowed
as application in any subsequent previous year based on actual payment.
For example, if a trust has incurred ` 2,00,000 in the P.Y. 2020-21 and claimed
the same as application of income in that year and subsequently, the actual
payment is made in the P.Y. 2025-26. Since such sum was already claimed as
application in the P.Y. 2020-21, the same would not be allowed as application
in the P.Y. 2025-26, on the basis of actual payment.

ILLUSTRATION 10
VPS Foundation, a charitable institution registered under section 12AB set up
on 1st August 2023 is engaged in providing education in sports management.
The Foundation follows accrual basis of accounting and during the previous
year 2025-26, has accrued staff’s salary expenses pertaining to the month of
March 2026 amounting to ` 5 lakhs. The salary was paid during the first week
of April 2026. KS, the tax advisor of the foundation has advised them that the

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salary expenses provided for in the accounts will not be treated as an

application of income for the previous year 2025-26. Examine.

SOLUTION
Upto Assessment Year 2021-22, an expenditure could be regarded as an
application of income even if it was not actually paid. However, effective from
assessment year 2022-23, Explanation to section 11 provides that any sum
payable by an institution shall be considered as an application of income only
in the previous year in which such sum is actually paid by it. This is irrespective
of the previous year in which the liability to pay such sum is incurred by the
institution according to the method of accounting regularly employed by it.
Therefore, the tax advisor’s statement is correct.
(D) Instances where capital gains would be deemed to have been applied for
charitable purposes [Section 11(1A)]
(a) Transfer of a capital asset held under trust wholly for charitable or
religious purposes [Section 11(1A)(a)]- Where the whole of the net
consideration from the transfer of the capital asset is utilised for acquiring a
new capital asset which is held under trust wholly for charitable or religious
purposes, the entire amount of capital gains arising from the transfer would be
deemed to have been applied for charitable or religious purposes. If, however,
only a part of the net consideration is utilised in acquiring the new capital asset,
the amount of capital gains deemed to have been utilised for charitable or
religious purposes shall be equal to the excess of the proceeds utilised over
the cost of the asset transferred.
Example 3
Original cost of capital asset transferred ` 1,00,000
Consideration for which it is transferred ` 1,50,000
Situation 1 Cost of new capital asset acquired ` 1,50,000
Situation 2 Cost of new capital asset acquired ` 1,20,000
Amount that will be deemed to have been applied for charitable purposes.
Situation 1 ` 50,000
Situation 2 ` 20,000

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(b) Transfer of a capital asset held under trust in part only for charitable and
religious purposes [Section 11(1A)(b)] - Where only a part of a capital asset
has been transferred, only the “appropriate fraction” of the capital gain arising
from the transfer shall be deemed to have been applied to charitable or religious
purposes. Where the whole of the net consideration is utilised in acquiring the
new capital asset, the whole of the appropriate fraction of such capital gain will
be deemed to have been so applied. In any other case, the exemption will be
limited to so much of the appropriate fraction of the amount utilised for acquiring
the new asset as exceeds the appropriate fraction of the cost of the transferred
asset.
“Appropriate fraction” means the fraction which represents the extent to which
the income derived from the capital asset transferred was applicable to
charitable or religious purposes before such transfer.
Example 4
A capital asset is being held under trust. Two-thirds of the income derived
from such capital asset are being utilised for the charitable purposes of the
trust. The asset is being transferred.
Cost of transferred asset ` 1,20,000
Net consideration ` 1,80,000
Cost of new asset acquired ` 1,50,000
Capital gains ` 60,000 [` 1,80,000 – ` 1,20,000]
Appropriate fraction 2/3rd
Income represented by ‘appropriate fraction’ = 2/3 rd of ` 60,000 = ` 40,000
Since the entire net consideration has not been utilised in acquiring the new
asset, the amount deemed to have been utilised for charitable purpose will
be (2/3 rd of ` 30,000, being the difference between cost of new asset and
cost of transferred asset) = ` 20,000.

Note – There is no provision akin to section 11(1A) in the first regime under section
10(23C).

VI. Accumulation of Income:

Conditional accumulation - Under both regimes, application of income derived from property
held under trust for charitable purposes in India is the main condition for grant of exemption to
trust or institution in respect of income derived from property held under such trust. In case such

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income cannot be applied during the previous year, the same can be accumulated and applied
for such purposes, subject to satisfaction of the conditions provided therein.
Both regimes permit accumulation of 15% of the income indefinitely by the trust or institution.
However, 85% of income can only be accumulated for a period not exceeding 5 years subject
to the conditions that such person submits the prescribed form i.e., Form 10 to the Assessing
Officer and the money so accumulated or set apart is invested or deposited in the specified
forms or modes.
As per section 11(2), the conditions for accumulation are as follows:
(1) such person should furnish a statement in the prescribed form (Form 10) and in the
prescribed manner to the Assessing Officer, stating the purpose for which the income
is being accumulated or set apart and the period for which the income is being
accumulated or set apart, which shall, in no case, exceed five years.
In computing the period of five years, the period during which the income could not be
applied for the purpose for which it is so accumulated or set apart, due to an order or
injunction of any court, shall be excluded.
(2) the money so accumulated or set apart should be invested or deposited in the modes
specified in section 11(5).

(3) the statement in Form 10 should be filed at least 2 months prior to the due date of
filing return of income specified under section 139(1).
As per section 13(9), in case the statement in Form 10 is not submitted on or before the due
date under section 139(1), then, the benefit of accumulation would not be available and such
income would be taxable at the applicable rate. Further, the benefit of accumulation would
also not be available if return of income is not furnished on or before the due date of filing
return of income specified in section 139(1).

Note – Section 11(2) stipulates the conditions for accumulation, on fulfillment of which the
income so accumulated or set apart would not be included in the total income of the previous
year of the trust. The condition stipulated in clause (c) of Section 11(2) is that the statement
in Form 10 has to be furnished at least 2 months prior to the due date of filing of return of
income u/s 139(1). However, as per section 13(9), the income accumulated would not be
excluded from total income if Form 10 is not submitted on or before the due date under section
139(1). Section 13(9) permits exclusion of accumulated income from total income of the
previous year, if Form 10 is filed on or before the due date under section 139(1). CBDT
Circular No.6/2023 dated 24.5.2023 clarifies that the statement of accumulation in Form No.

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10 is required to be furnished at least two months prior to the due date of furnishing return of
income so that it may be taken into account while auditing the books of account. However,
the accumulation/deemed application shall not be denied to a trust as long as the statement
of accumulation/deemed application is furnished on or before the due date of furnishing the
return as provided in section 139(1).

Consequences on failure to satisfy the conditions of accumulation [Section 11(3)]

Where the accumulated income of the trust -
(a) is applied to purposes other than charitable or religious purposes or to the objects for
which first regime entities are established; then such income shall be deemed to be
the income of such person in the concerned previous year in which it is so appl ied.
(b) ceases to be accumulated or set apart for application; then such income shall be
deemed to be the income of such person in the previous year in which the income
ceases to be so accumulated or set apart.
(c) ceases to remain invested or deposited in any of the forms or modes specified in
section 11(5); then such income shall be deemed to be the income of such person in
the previous year, in which the income ceases to remain invested or deposited as per
modes in section 11(5).
(d) is not utilised for the purpose for which it is accumulated or set apart during the period
specified under the statement for accumulation; such income shall be deemed to be
income of such person of the previous year being the last previous year of the period
for which the income is so accumulated or set apart.
(e) is credited/paid to any trust or fund or institution registered under section
12AA/12AB/section 10(23C)(iv)/(v)/(vi)/(via); such income shall be deemed to be
income in the previous year when it is so credited or paid.
As per section 11(3A), where due to circumstances beyond the control of the person in receipt of
the income, any income invested or deposited cannot be applied for the purpose for which it was
accumulated or set apart, the Assessing Officer may, on an application made to him in this behalf,
allow such person to apply such income for such other purpose in India as is specified in the
application by such person and as is in conformity with the objects of the trust.
However, the Assessing Officer shall not allow application of such income by way of payment
or credit to any trust or fund or institution registered under section 12AA/12AB/section
10(23C)(iv)/(v)/(vi)/(via).

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In case of a trust or institution which has deposited its income in forms or modes specified
under section 11(5) is dissolved, the Assessing Officer may allow application of such income
by way of payment or credit to a trust or institution registered under section 12AA/12AB or
fund or trust or institution referred to section 10(23C)(iv)/(v)/(vi)/(via) [This provision is
mentioned only with reference to the second regime].

ILLUSTRATION 11
A charitable institution registered under section 12AB of the Income-tax Act, 1961 filled in
Form No.10 for seeking permission to accumulate unapplied income under section 11(2) of
the Act for the objects of the institution and submitted it to the Assessing Officer along with
the resolution for accumulation. The Assessing Officer found that the objects for which
accumulation was sought were not particularised in as much as they covered the entire range
of objects of the institution. Can the Assessing Officer deny the benefit of accumulation in
such a case?

SOLUTION

Section 11(2) permits a charitable trust or institution to accumulate its unspent income where 85%
of the income is not applied or is not deemed to have been applied to charitable or religious
purposes in India during the previous year. The institution or trust has to specify, in the statement
furnished to the Assessing Officer, the purpose for which the income is being accumulated or set
apart and the period for which such income is to be accumulated or set apart.
In the given case, the assessee institution sought the permission of the Assessing Officer to
accumulate unapplied income for the objects of the institution. The institution had not stated
any objects in particular for which the unspent income was sought to be accumulated or set
apart. In Bharat Krishak Samaj vs. Deputy Director of Income-tax (Exemption) (2008) 306
ITR 153 (Del.), it was held that it is not necessary for a charitable trust to particularize each
and every object for which accumulation is sought. It is enough if the assessee seeks
permission for accumulation for the objects of the trust. Therefore, the Assessing Officer
cannot deny the benefit of accumulation in such a case.

ILLUSTRATION 12
A charitable institution registered under section 12AB of the Income-tax Act, 1961 for the
previous year ended 31 March 2026, filled in Form No.10 for seeking permission to
accumulate unapplied income for a period of five years under section 11(2) of the Act for the
objects of the institution and submitted it to the Assessing Officer along with the resolution

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for accumulation. The charitable institution could not utilise the accumulated income within
the period of five years. Examine the consequences of the same for the charitable institution
with regards to the accumulated income.

SOLUTION
Section 11(3) provides for consequences when an assessee registered under section 12AB
fails to satisfy the conditions of 11(2) accumulation. In this regard, the charitable institution
has not utilised the accumulated income of P.Y. 2025-26 within a period of five years as
specified in Form 10. Hence, by virtue of section 11(3), the said income will be deemed to be
the income of the charitable institution of the previous year, being the last previous year of
the period for which the income accumulated is not utilised. Hence, the said income will be
taxable in the 5th year as it is the last previous year of the period of accumulation.

Modes specified in section 11(5):

(1) Investment in Government Saving Certificates.
(2) Deposits with Post Office Savings Banks.

(3) Deposit with Scheduled banks or Co-operative Banks.

(4) Investment in units of the Unit Trust of India.
(5) Investment in Central or State Government Securities.
(6) Investments in debentures issued by or on behalf of any company or corporation.
However, both the principal and interest thereon must have been guaranteed by the
Central or the State Government.
(7) Investment or deposits in any public sector company.
Where an investment is made in the shares of any public sector company and such public
sector company ceases to be a public sector company, the investment so made shall be
deemed to be an investment made for a period of three years from the date of such
cessation and in the case of any other investment or deposit, till the date of its maturity.
(8) Investment in bonds of approved financial corporation providing long term finance for
industrial development in India and eligible for deduction under section 36(1)(viii).
(9) Investment in bonds of approved public companies whose principal object is to provide
long-term finance for construction or purchase of houses in India for residential
purposes and eligible for deduction under section 36(1)(viii).

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(10) Deposits with or investment in any bonds issued by a public company formed and
registered in India with the main object of carrying on the business of providing long -
term finance for urban infrastructure in India.
"Long-term finance" means any loan or advance where the terms under which moneys
are loaned or advanced provide for repayment along with interest thereof during a
period of not less than five years.
"Urban infrastructure" means a project for providing potable water supply, sanitation
and sewerage, drainage, solid waste management, road, bridges and flyovers or urban
transport.
(11) Investment in immovable property excluding plant and machinery, not being plant and
machinery installed in a building for the convenient occupation thereof.
(12) Deposits with Industrial Development Bank of India.
(13) Any other mode of investment or deposit as may be prescribed. Rule 17C
specifies the following other modes:
(i) Investments in units issued under any scheme of mutual fund referred to in
section 10(23D);
(ii) Any transfer of deposits to Public Account of India;
(iii) Deposits made with an authority constituted in India or under any law enacted
either for the purpose of dealing with and satisfying the need for housing
accommodation or for the purpose of planning, development or improvement of
cities, towns and villages, or for both;
(iv) investment by way of acquiring equity shares of a ‘depository’;
(v) investment by a recognized Stock Exchange, in the equity shares of a company
promoted by it to acquire the membership rights of other stock exchanges,
where at least 51% of the paid-up share capital is held by the Stock Exchange
and the balance is held by its members;
(vi) investment made by a person, authorised under section 4 of the Payment and
Settlement Systems Act, 2007, in the equity share capital or bonds or
debentures of a company —
(A) which is engaged in operations of retail payments system or digital
payments settlement or similar activities in India and abroad and is
approved by the Reserve Bank of India for this purpose; and

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(B) in which at least 51% of equity shares are held by National Payments
Corporation of India.
(vii) investment made by a person, authorised under section 4 of the Payment and
Settlement Systems Act, 2007, in the equity share capital or bonds or
debentures of Open Network for Digital Commerce Ltd, being a company
incorporated under section 7(2) read with section 8(1) of the Companies Act,
2013, for participating in network based open protocol models which enable
digital commerce and interoperable digital payments in India;
(viii) investment by way of acquiring equity shares of an incubatee by an incubator;
(ix) investment by way of acquiring shares of National Skill Development
Corporation;
(x) investment in debt instruments issued by any infrastructure finance company
registered with RBI;
(xi) investment in Stock Certificate as defined in of Sovereign Gold Bonds Scheme,
2015.
(xii) investment by way of acquiring units of POWERGRID Infrastructure
Investment Trust.

ILLUSTRATION 13
A charitable trust derives its income from the business of providing mineral water to various
companies situated in Software Technology Park in Hyderabad. A sum of ` 30 lakhs has
been derived as net income from such business activity, which has been applied for the object
of general public utility. The total receipts of the trust during the P.Y. 2025-26 was
` 140 lakhs.
Examine the taxability of application of the income, if the income so derived relates to the
previous year 2025-26. Would your answer be different, if the trust runs a school in a
backward district and applies the profits from the business for such school's activity?

SOLUTION
In the first case, net income from the business of supplying mineral water to various
companies i.e., ` 30 lakhs is not eligible for exemption under section 11, since the receipt
from such activity exceeds 20% of total receipts (i.e., 20% of ` 140 lakhs) during the year.
This is because “advancement of any object of general public utility” would not be a charitable
purpose if it involves carrying on of any activity in the nature of trade, commerce or business,

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for example, supply of mineral water for a consideration, as in this case. It is immaterial that
the net income from such business is applied for the object of general public utility. On the
other hand, where the trust runs a school in a backward district, this restriction is not
applicable. The reason is that the restriction contained in section 2(15) is applicable only to
the last limb of the definition of “charitable purpose” i.e. advancement of object of general
public utility. It does not affect the other limbs of the definition viz. “relief of the poor”,
“education”, “medical relief” etc.
Section 11(4) clarifies that “property held under trust” includes a business undertaking so
held. As per section 11(4A), exemption can be availed in respect of profits and gains of
business, if such business is incidental to the attainment of the objectives of the trust and
separate books of account are maintained in respect of such business. Therefore, in the
second case, the profit from the business shall be eligible for exemption under section 11,
assuming that the said business is incidental to the attainment of the objects of the trust (i.e.,
education) and books of account for such business activity is maintained separately.
VII. No claim for exemption under section 10 permissible where trust has been granted
registration/approval for availing exemption under section 11 or under section 10(23C)
Where a trust or an institution or fund has been granted registration/approval for purposes of
availing exemption under second regime, and the registration is in force for a previous year,
then, such trust or institution cannot claim any exemption under any provision of section 10
[other than exemption of agricultural income under section 10(1)].
Prior to 1 st June 2020, the organisation registered u/s 12AA could also avail approval u/s
10(23C) or 10(46) and thus, could avail tax exemption under either of the two sections.
However, with effect from 1 June 2020, the registration granted for availing exemption under
section 11 would become inoperative from the date on which the trust or institution is
approved under section 10(23C) or is notified under section 10(23EC) or under section 10(46)
or under section 10(46A).
Accordingly, the registration granted for availing exemption under section 11 would become
inoperative from the date on which the trust or institution is approved under section 10(23C)
or is notified under section 10(23EA) or section 10(23EC) or section 10(23ED) or section
10(46) or section 10(46A) or from 1st April of the P.Y. for which exemption is claimed under
section 10(46B) [First proviso to section 11(7)].
The trust or institution, whose registration/approval has become inoperative, may apply to get
its registration operative under section 12AB/ 10(23C)(iv)/(v)/(vi)/(via) subject to the condition
that on doing so, the approval under section 10(23C) or notification under section
10(23EA)/(23EC)/ (23ED)/10(46) or 10(46A), as the case may be, to such trust or institution

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shall cease to have any effect from the date on which the said registration/approval becomes
operative and thereafter, it shall not be entitled to exemption under section 10(23C) or under
section 10(23EA)(23EC)/(23ED) or section 10(46) or section 10(46A), as the case may be
[Second proviso to section 11(7)].

6. Denial of Exemption [Section 13]

(A) Income not eligible for exemption under sections 11 and 12
In the following situations, income of a trust, fund or institution will not be eligible for availing
exemption under section 10(23C)(iv)/(v/(vi)/(via) or Section 11 as the case may be.
(a) Income from property held under a trust for private religious purposes - Where
the property is held under a trust for private religious purposes, no part of the income
will be exempt under section 11, if it does not ensure for the benefit of the public
[Section 13(1)(a)].
(b) Income from trust established for benefit of any particular religious community
or caste -Where a trust set up for charitable purposes or a charitable institution has
been established for the benefit of any particular religious community or caste, the
income thereof will not be eligible for exemption under section 11. However, a trust or
institution created or established for the benefit of scheduled caste, backward classes,
scheduled tribes or women and children shall not be treated as a trust or insti tution
created or established for the benefit of a religious community or caste within the
meaning of section 13(1)(b).

Note: The situations referred to in (a) & (b) on non-availability of exemption are with
reference to only income under the second regime.

(c) Income of trust enuring for the benefit of any person referred to in section 13(3)
[Section 13(1)(c)]: Where any part of the income or property of trust or the institution
enures directly or indirectly for the benefit of any person referred to in section 13(3),
then such part of the income shall not be eligible for exemption and the said income
will taxed at 30% under Section 115BBI.

Such part of income or property would not be eligible for exemption and would be
taxed under section 115BBI at 30%. Further, to avoid income of the trusts or
institutions to be used for the benefit of specified persons under section 13(3), penalty
is leviable under 271AAE on the amount of income provided as a benefit.

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Penalty for providing benefit to person referred in section 13(3) [Section

271AAE]
If during any proceeding under this Act, it is found that any person, being any fund or
institution or trust referred under section 10(23C)(iv)/(v)/(vi)/(via) or any trust or
institution referred to in section 11 applied income of the trust or institution, directly or
indirectly, for the benefit of any person referred to in section 13(3), the Assessing
Officer may direct such fund or trust or institution to pay penalty equal to -
(i) 100% of the aggregate amount of income so applied, where the violation is
noticed for the first time during any previous year; and
(ii) 200% of the aggregate amount of income so applied, where violation is noticed
again in any subsequent previous year.

Non-applicability of relaxation u/s 56(2)(x)

The provisions of section 56(2)(x) are not attracted in the hands of the recipient who
receives any sum of money or property from a trust or institution approved u/s 10(23C)
or registered u/s 12AA or 12AB.
However, this relaxation is not available where sum of money or property has been
received by specified persons under section 13(3).

(d) Deposit or investment of funds in impermissible modes [Section 13(1)(d)] -Any

income of a trust or institution, if –
(1) its funds are invested or deposited otherwise than in the forms or modes
specified in section 11(5);
(2) it holds shares in a company other than -
(i) a public sector company; or
(ii) shares prescribed as a form or mode of investment under section
11(5)(xii).
However, these restrictions do not apply in respect of :
(a) any assets forming part of corpus of the trust as on 1-6-1973.
(b) any accretion to the corpus shares mentioned in (a) above by way of bonus
shares allotted to the trust.
(c) debentures issued by or on behalf of any company or corporation and acquired
by the trust before March 1, 1983.

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(d) any asset not covered under section 11(5), where such asset is held for not
more than one year from the end of the previous year in which such asset is
acquired.
(e) any funds representing the profits and gains of business. However, where a
trust has any other income in addition to profits and gains of business, such
relaxation of the restriction will be denied unless the trust keeps separate
accounts for the business. [This is applicable only for the second regime].
Note – Under the first regime, the 3 rd proviso to section 10(23C), requiring investment
or deposit of funds in forms or modes specified under section 11(5), contains similar
exclusions [mentioned in (a), (b), (c) and (d) above]. In addition, voluntary
contributions received and maintained in the form of jewellery, furniture or any other
article as the Board may specify, are also excluded from the applicability of this
requirement under the first regime.
W.e.f. 1 st October 2024, no application for approval can be made under the first
regime, resultantly, certain trusts or institutions need to shift from first regime to
second regime. In order to provide protection to these trusts or institutions the assets
permissible for investment in first regime i.e., mentioned in (a), (b), (c) and (d) above
and voluntary contributions received and maintained in the form of jewellery, furniture
or any other article as the Board may specify are also included under section 13(1)d).
(B) Prohibited use or application -We have noted above that when any part of the income or
any property of the trust whenever created, is, during the previous year, used or applied
directly, for the benefit of any person referred to in section 13(3), the denial of exemption
operates. Section 13(2) specifies a few particular instances where the income or the property
is to be deemed to have been used for the benefit of a person referred to in section 13(3). It
should be noted that those particular instances do not in any way restrict the general meaning
of the expression “used or applied for the benefit of a person”. The provisions of section 13(2)
are as follows:
The income or the property of the trust or institution or any part of such income or property is
to be deemed to have been used or applied for the benefit of a person referred to in section
13(3) in the following cases:
(a) Loan without adequate interest or adequate security - If any part of the income or
the property of the trust or institution is or continues to be lent to any person referred
to in section 13(3) for any period during the previous year without either adequate
security or adequate interest or both.

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(b) Allowing use of property without adequate rent -If any land, building or other
property of the trust or institution is or continues to be, made available, for the use of
any person referred to in section 13(3) for any period during the previous year without
charging adequate rent or other compensation.

(c) Excess payment for services - If any amount is paid out of the resources of the trust
or institution to any of the persons referred to in section 13(3) for services rendered to
the trust or institution but such amount is in excess of a reasonable sum payable for
such services.

(d) Inadequate remuneration for services rendered - If the services of the trust or
institution are made available to any person referred to section 13(3) without ade quate
remuneration or other compensation.

(e) Excess payment for purchase of property - If any share, security or other property
is purchased by or on behalf of the trust or institution from any person re ferred to in
section 13(3) during the previous year for a consideration which is more than
adequate.

(f) Inadequate consideration for property sold - If any share, security or other property
is sold by or on behalf of the trust or institution to any person referred to in section
13(3) during the previous year for a consideration which is less than adequate.

(g) Diversion of income or property exceeding ` 1,000 - If any income or property of

the trust or institution is diverted during the previous year in favour of any person
referred to in section 13(3) provided the aggregate value of such income and property
diverted exceeds ` 1,000.

(h) Investment in substantial interest concerns - If any funds of the trust or institution
are, or continue to remain, invested for any period during the previous year in any
concern in which any person referred to in section 13(3) has a substantial interest.

Section 13(4) provides some respite where the aggregate of the funds invested in the
said concern does not exceed five per cent of the capital of that concern. In such a
case, the exemption under section 11 or 12 will be denied only in relation to such
income as arises out of the said investment. Exemption will not be denied to the
remaining income only due to this reason.

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(C) Prohibited category of persons - Section 13(3) gives the list of persons, use or application
of the income or property of a trust for whose direct or indirect benefit results in a denial of
the exemption contemplated in section 11 for a charitable or religious trust or institution. The
said persons are:

(1) The author of the trust or the founder of the institution.

(2) Any person whose total contribution to the trust or institution, during the
relevant previous year exceeds ` 1 lakh, or, in aggregate up to the end of the
relevant previous year exceeds ` 10 lakh rupees, as the case may be.

(3) Where the author, founder or the person is a HUF, any member of the family.

(4) Any trustee of the trust or manager (by whatever name called) of the institution.

(5) Any relative of any such author, founder, member, trustee or manager as referred to
above.

(6) Any concern in which any of the persons referred to in clauses (1) to (5) except (2)
above has a substantial interest.

Relative - The expression “relative”, in relation to an individual, means -

(a) spouse of the individual;

(b) brother or sister of the individual;

(c) brother or sister of the spouse of the individual;

(d) any lineal ascendant or descendant of the individual;

(e) any lineal ascendant or descendant of the spouse of the individual;

(f) spouse of a person referred to in (b), (c), (d) or (e) above;

(g) any lineal descendant of a brother or sister of either the individual or the spouse of the
individual;

Substantial interest in a concern - Section 13(2)(h), section 13(3) and section 13(4) refers
to cases where a person has a substantial interest in a concern. These references occur
where the “Prohibited use or application” and “Prohibited category of persons” have been
described. The circumstances in which a person shall be deemed to have a substantial
interest in a concern, have been laid down in Explanation 3 to section 13.

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Circumstances when a person is deemed to have substantial interest

in a concern

Where the concern is a company In any other case

If equity shares carrying 20% or more of If such person is entitled, or such

voting power are beneficially owned by person and one or more of the
such person or partly by such person and person referred to in section 13(3)
partly by one or more of the other persons are entitled in the aggregate, to
referred to in section 13(3) at any time receive 20% or more profit of such
during the P.Y. concern at any time during the P.Y.

(D) Exemption not to be denied to charitable trusts providing educational or medical

facilities to specified persons [Section 13(6)]- A charitable or religious trust running an
educational institution or a medical institution or a hospital shall not be denied the benefit of
exemption under section 11 merely due to the reason that the benefit of educational or
medical facilities have been provided to the specified persons referred to in section 13(3).
However, the value of such facilities provided to such specified persons either free of cost or
at a concessional rate would be deemed to be the income of the trust. Such income would
not be eligible for exemption under section 11.
(E) Anonymous donations [Section 13(7)]-The exemption provisions contained in both regimes
shall not be applicable in respect of any anonymous donation referred to in section 115BBC
on which tax is payable in accordance with the provisions of that section. For example, section
11(1)(d) provides that any income in the form of voluntary contributions made with a specific
direction that they shall form part of the corpus of the trust or institution shall not be included
in the total income of such trust/institution for the relevant previous year.

However, if a trust or institution established wholly for charitable purposes receives an

anonymous donation with a specific direction that the donation shall form part of the corpus
of the trust or institution, such anonymous donation would not be exempt by virtue of section
11(1)(d). It would be taxable at 30% as provided in section 115BBC.

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(F) Exemption to be denied to a charitable trust having its main object as “advancement
of any other object of general public utility” if its trading receipts exceed the specified
threshold irrespective of withdrawal of approval or cancellation of registration or
rescindment of notification [Section 13(8)]
(a) Under both regimes, income of any charitable trust or institution is exempt if such
income is applied for charitable purposes in India and such institution is registered
under second regime or approved under first regime.
(b) The definition of “charitable purpose” under section 2(15) provides that 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, or any activity of rendering any service in relation to any trade, commerce
or business, for a cess or fee or any other consideration, irrespective of the nature of
use or application, or retention, of the income from such activity, unless,-
(1) such activity is undertaken in the course of actual carrying out of such
advancement of any other object of general public utility; and
(2) the aggregate receipts from such activity or activities, during the previous year,
does not exceed 20% of the total receipts, of the trust or institution undertaking
such activity or activities, for the previous year .
(c) Thus, a charitable trust or institution pursuing “advancement of object of general public
utility” may be a charitable trust in one year and not a charitable trust in another year
depending on the percentage of receipts from commercial activities vis-à-vis its total
receipts.
(d) Therefore, no exemption would be available to a trust or institution for the previous year
in which the receipts from commercial activities exceed 20% of the total receipts of that
year. However, this temporary excess in one year may not be treated as altering the very
nature of the trust or institution so as to lead to cancellation of registration or withdrawal
of approval or rescinding of notification issued in respect of trust or institution.
(e) Therefore, there is need to ensure that if the purpose of a trust or institution does not
remain charitable in a previous year on account of the commercial receipts exceeding
the specified percentage of total receipts, then, such trust or institution would not be
entitled to get benefit of exemption in respect of its income for that previous year in
which the commercial receipts exceed the specified percentage of total receipts. The
denial of exemption would be compulsory by operation of law and would n ot be

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dependent on any approval being withdrawn or registration being cancelled or a

notification being rescinded.
(f) Accordingly, section 13(8) ensures that such trust and institution does not get benefit
of tax exemption under section 11 or 12 in the year in which its receipts from
commercial activities exceed the specified percentage of total receipts, whether or not
the registration or approval granted or notification issued is cancelled, withdrawn or
rescinded in respect of such trust or institution.
(G) Non-submission of statement in prescribed form and non furnishing of return of
income on or before the due date of filing return of income under section 139(1)
[Section 13(9)]- In case the statement in Form 10 is not submitted and return of income is
not filed on or before the due date of filing return of income under section 139(1), then, the
benefit of accumulation would not be available and such income would be taxable at the
applicable rate. Further, the benefit of accumulation would also not be ava ilable if return of
income is not furnished on or before the due date of filing return of income specified in section
139(1).

Note – Section 11(2) stipulates the conditions for accumulation, on fulfillment of which the
income so accumulated or set apart would not be included in the total income of the previous
year of the trust. The condition stipulated in clause (c) of Section 11(2) is that the statement
in Form 10 has to be furnished at least 2 months prior to the due date of filing of return of
income u/s 139(1). However, as per section 13(9), the income accumulated would not be
excluded from total income if Form 10 is not submitted on or before the due date under section
139(1). Section 13(9) permits exclusion of accumulated income from total income of the
previous year, if Form 10 is filed on or before the due date under section 139(1). CBDT
Circular No.6/2023 dated 24.5.2023 clarifies that the statement of accumulation in Form No.
10 is required to be furnished at least two months prior to the due date of furnishing return of
income so that it may be taken into account while auditing the books of account. However,
the accumulation/deemed application shall not be denied to a trust as long as the statement
of accumulation/deemed application is furnished on or before the due date of furnishing the
return as provided in section 139(1).

7. Manner of computation of income of a trust violating certain

conditions [Sections 13(10) & (11)]
(i) Consequences of failure to comply with stipulated conditions: If a trust or an institution
violates certain stipulated conditions, the income shall be chargeable to tax after allowing

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deduction for expenditure (other than capital expenditure) incurred in India for the objects of
the trust/ institution.
The following are the violations:
- It has receipts from trade, commerce etc. while advancing the object of general public
utility, in excess of 20% of total receipt;
- It fails to maintain prescribed books of account;
- It fails to get its books of account audited and furnish audit report on or before the
specified date;

- It fails to file return of income under section 139(4A) (or 139(4C), as the case may be,
for the first regime trust) within the time stipulated under section 139(1) or 139(4).
(ii) Conditions to be fulfilled for claim of deduction of revenue expenditure: The deduction
for revenue expenditure incurred is subject to fulfilment of the following conditions:
(a) such expenditure is not from the corpus standing to the credit of the trust or institution
as on the end of the financial year immediately preceding the previous year relevant
to the assessment year for which income is being computed;
(b) such expenditure is not from any loan or borrowing;
(c) there is no claim of depreciation on those assets, whose acquisition cost has been
claimed as application of income in any previous year; and
(d) such expenditure is not in form of any contribution or donation to any person.
(iii) Disallowances: While determining the amount of expenditure allowable as deduction, the
following points need to be considered:
(a) Capital expenditure is not allowed as a deduction.
(b) Disallowance under sections 40(a)(ia), on account of non-deduction of tax or non-
payment of tax deducted at source on or before the due date of filing of return, would
be attracted
(c) Disallowance of expenditure in respect of cash payment in excess of ` 10,000 under
section 40A(3) and 40A(3A) would be attracted .
(d) no deduction in respect of any expenditure or allowance or set-off of any loss shall be
allowed to the assessee under any other provision of this Act.

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8. Anonymous donations received by Charitable Trusts/Institutions to

be subject to tax [Section 115BBC]
(i) As per the provisions of the Income-tax Act, 1961, tax exemption under section 10(23C) and
section 11 are available to certain entities, as briefed in the table below, on fulfillment of the
conditions prescribed under the relevant sections –

Entity Applicable section

Charitable or religious trusts/institutions 11
Universities and other educational institutions 10(23C)(iiiad) and (vi)
Hospitals and other medical institutions 10(23C) (iiiae) and (via)
Notified funds or institutions established for charitable 10(23C)(iv)
purposes
Notified trusts or institutions established wholly for 10(23C)(v)
public religious purposes or wholly for public religious
and charitable purposes

(ii) As per section 115BBC anonymous donations received by the above entities are taxed at
30%.
(iii) In order to provide relief to these trusts and institutions and to reduce their compliance
burden, an exemption limit has been introduced, and only the anonymous donations in excess
of this limit would be subject to tax@30% under section 115BBC.
(iv) The exemption limit is the higher of the following –
(1) 5% of the total donations received by the assessee; or
(2) ` 1 lakh.
(v) The total tax payable by such institutions would be –
(1) tax@30% on anonymous donations exceeding the exemption limit as calculated
above; and
(2) tax on the balance income i.e., total income as reduced by the anonymous donations
which have been subject to tax@30% under section 115BBC.
(vi) The following table illustrates the calculation of anonymous donations liable to tax @30%
under section 115BBC –

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I II III IV V VI
Situation Total Anonymous Exemption Anonymous Donations
donations donations [5% of total donations subject to
during the received donations or taxable@30% tax at
year (`) during the ` 1,00,000, (`) normal
year (`) whichever is rates# (`)
higher] (`)
A 15,00,000 4,00,000 1,00,000 3,00,000 12,00,000
B 30,00,000 7,00,000 1,50,000 5,50,000 24,50,000
C 40,00,000 10,00,000 2,00,000 8,00,000 32,00,000
# It is possible to take a view that the remaining donations reflected in Column VI which are
taxable at normal rates would be eligible for application of income and thereby, the benefit of
exemption under section 11 can be claimed in respect of such donations.
(vii) For this purpose, “anonymous donation” means any
voluntary contribution referred to in section 2(24)(iia), Section 115BBC does not
where the person receiving such contribution does not apply to trust or institution
maintain a record of the identity indicating the name and wholly for religious
address of the person making such contribution and such purposes.
other particulars as may be prescribed.
(viii) However, the above provision does not apply to a trust or institution created or established
wholly for religious purposes.
(ix) Further, anonymous donations to trusts/institutions created or established wholly for religious
and charitable purposes (i.e., partly charitable and partly religious institutions/trusts) would
be taxed only if such anonymous donation is made with a specific direction that such donation
is for any university or other educational institution or any hospital or other medical institu tion
run by such trust or institution. Other anonymous donations received by such
trusts/institutions are not taxable.
(x) Section 13(7) provides that the exemption provisions contained in section 11 or section 12
shall not be applicable in respect of any anonymous donation referred to in section 115BBC
on which tax is payable in accordance with the provisions of that section.
(xi) For example, section 11(1)(d) provides that any income in the form of voluntary contributions
made with a specific direction that they shall form part of the corpus of the trust or institution
and deposited or invested in modes specified u/s 11(5), shall not be included in the total
income of such trust/institution for the relevant previous year. However, if a trust or institution
established wholly for charitable purposes receives an anonymous donation with a specific

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direction that the donation shall form part of the corpus of the trust or institution, such
anonymous donation would not be exempt by virtue of section 11(1)(d). It would be taxable
at 30% as provided in section 115BBC.
(xii) Similarly, section 10(23C) provides that any anonymous donation referred to in section
115BBC on which tax is payable in accordance with the provisions of the said section shall
be included in the total income. Consequently, sections 10(23C) and 13 provide that any
income by way of any anonymous donation which is taxable under the provisions of section
115BBC shall not be excluded from the total income of the trust or institution.

ILLUSTRATION 14
The following trusts claim that anonymous donations received by them during the financial
year 2025-26 are not liable to tax under section 115BBC:

(i) A charitable trust referred to in section 11 which applied the entire amount of
anonymous donations for purposes of the trust during the relevant financial year.
(ii) A trust established wholly for religious purposes which applied 85% of the amount of
anonymous donations for the purposes of the objects of the trust during the relevant
financial year.
Examine the validity of the claim made by the trusts.
SOLUTION
(i) Section 115BBC provides for levy of tax @ 30% on anonymous donation received by,
inter alia, charitable trusts or institutions referred to in section 11 in the following
manner:
(a) the amount of income-tax calculated @30% on the aggregate of anonymous
donations received in excess of 5% of the total donations received by the
assessee or one lakh rupees, whichever is higher; and
(b) the amount of income-tax with which the assessee would have been chargeable
had his total income been reduced by the aggregate of the anonymous
donations received in excess of 5% of the total donations received by the
assessee or ` 1 lakh, as the case may be.
Further, section 13(7) provides that the exemption provisions contained in sections 11
and 12 shall not be applicable in respect of any anonymous donation liable to tax under
section 115BBC. As such, application of the anonymous donations received by the
charitable trust for charitable purposes does not confer any exemption from tax.

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Therefore, the claim for non-taxability under section 115BBC of anonymous donations
received by the charitable trust is not valid in law.
However, a view may be taken that anonymous donation upto higher of 5% of total
donations or ` 1 lakh, which is taxable at normal rates would be eligible for application
of income and thereby, the benefit of exemption under section 11 would apply.
(ii) Section 115BBC(2) provides that the provisions contained in section 115BBC(1)
relating to the taxability of anonymous donations are not applicable to any trust or
institution created or established wholly for religious purposes. As such, the trust
established wholly for religious purposes is not liable to be taxed in respect of the
anonymous donations received by it. Therefore, the claim made by the trust is valid in
law. The application or non-application of such anonymous donation for the purposes
of trust during the relevant financial year is not germane to the issue of taxability under
section 115BBC.

9. Taxation of specified income of NPOs chargeable to tax by

charitable trusts/institutions [Section 115BBI]
(i) Rate of tax on Specified Income
As per section 115BBI specified income of a trust/institution availing exemption under the first
regime [section 10(23C)(iv)/(v)/(vi)/(via))] or second regime [Section 11], would be
chargeable at the rate of 30%.
(ii) No deduction for expenditure or allowance

Further, no deduction in respect of any expenditure or allowance or set-off of any loss would
be allowed under any provisions of the Income-tax Act, 1961 while computing specified
income.
(iii) Meaning of “Specified Income”
“Specified income” means:
(a) income accumulated or set apart in excess of 15% of the income, where such
accumulation is not allowed under any specific provision of the Income-tax Act, 1961.
(b) deemed income on account of violation of certain conditions stipulated for
accumulation of income under section 11(3) and corresponding provision in section
10(23C).
(c) deemed income on account of violation of deemed application provisions specified
under 11(1B) read with Explanation 1 below to section 11(1).

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(d) any income which is not exempt under section 10(23C) on account of violation of the
provisions of clause (b) of the third proviso to section 10(23C) i.e., invested in
impermissible mode or which is not excluded from the total income as per section
13(1)(d).
(e) any income which is applied for the benefit of any specified prohibited person referred
to in section 13(3).
(f) any income derived from a property held under trust for a charitable purpose which
tends to promote international welfare in which India is interested to the extent to which
such income is not applied towards charitable purposes outside India.

ILLUSTRATION 15
SR Trust is a registered charitable trust under section 12AB. During the P.Y.2025-26, the trust had
applied ` 5 lakh for the benefit of the trustee and ` 3 lakh for the benefit of Mr. Satish, who has
donated ` 15 lakh to the trust upto 31.3.2026. Also, an amount of ` 2 lakh set apart in the
P.Y.2023-24 by the trust for charitable purposes u/s 11(2) has been utilized in the P.Y. 2025-26 for
making donation to another registered charitable trust with similar object as SR Trust. What is the
amount of “specified income” liable to tax@30% under section 115BBI for A.Y. 2026-27?

SOLUTION

Section 115BBI provides for levy of tax @ 30% on certain “specified income” of a trust. Section
115BBI defines “specified income” to include income which has been applied for the benefit of
prohibited persons u/s 13(3), which includes, inter alia, trustee of the trust and a person who has
made substantial contribution to the trust (i.e., whose total contribution during the relevant
P.Y. exceeds ` 1 lakh or in aggregate upto 31.3.2026 is more than ` 10,00,000). Specified income
also includes deemed income on account of violation of certain conditions stipulated in section 11(3)
for accumulation of income. Donation to another charitable trust out of accumulated income is one
such violation. Accordingly, “specified income” of SR Trust liable to tax@30% under section 115BBI
for A.Y. 2026-27 would be ` 10 lakh [` 5 lakh (amount applied for the benefit of the trustee) + ` 3
lakh (amount applied for the benefit of Mr. Satish) + ` 2 lakh (donation made to another trust out of
accumulated income of an earlier previous year].

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10. Tax on accreted income of certain trusts and institutions

[Chapter XII-EB]
(1) Background for introduction of Exit Tax
(i) As per section 2(24), "income" includes any voluntary contribution received by a
charitable trust or institution or a fund.

(ii) Sections 11 and 12 and section 10(23C)(iv)/(v)/(vi)/(via) provide exemption to trusts

or institutions or funds or education institutions or hospitals in respect of income
derived from property held under trust and voluntary contributions, subject to the
conditions stipulated thereunder.
(iii) The exemption is subject to the condition that the income derived from property held under
trust should be applied for charitable purposes; and where such income cannot be applied
during the previous year, it has to be accumulated and invested in the modes prescribed
and applied for such purposes in accordance with specified conditions.
(iv) If the accumulated income is not applied in accordance with the conditions provided in the
said section within a specified time, then such income is deemed to be taxable income of
the trust or the institution. Section 12AA or 12AB or section 10(23C) (iv) /(v)/ (vi)/ (via)
provides for registration/approval of the trust or institution which entitles them to be able to
get the benefit of sections 11 and 12 and section 10(23C) (iv) /(v)/ (vi)/ (via). It also provides
the circumstances under which the registration can be cancelled. Section 13 of the Act
provides for the circumstances under which exemption under section 11 or 12 or section
10(23C) (iv) /(v)/ (vi)/ (via) in respect of whole or part of income would not be available to
a trust or institution or funds or education institutions or hospitals.
(v) A society or a company or a trust or an institution carrying on charitable activity may –
(1) voluntarily wind up its activities and dissolve; or
(2) merge with any other charitable or non-charitable institution; or
(3) convert into a non-charitable organization.

There is, however, no specific provision in the income-tax law as to how the assets of
such a charitable institution should be dealt with.
(vi) Under section 11, certain amount of income of prior period can be brought to tax on
failure of certain conditions. However, there is no provision in the Income -tax Act,
1961, which ensure that the corpus and asset base of the trust accreted over a per iod

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of time, with promise of it being used for charitable purpose, continues to be utilised
for charitable purposes and is not used for any other purpose.
(vii) Consequently, it is always possible for charitable institutions to transfer assets to a
non-charitable institution.
(viii) In order to ensure that the benefit conferred over a period of time by way of exemption
is not misused and to plug the gap in law that allows the charitable trusts having built
up corpus/wealth through exemptions being converted into non-charitable
organisation with no tax consequences, Chapter XII-EB imposes additional income-
tax in the nature of an exit tax when the organization is converted into a non-charitable
organization or gets merged with a non-charitable organization or does not transfer
the assets to another charitable organisation.

(ix) Upto A.Y.2022-23, the provisions of the Chapter XII-EB comprising of sections 115TD,
115TE and 115TF were made applicable to only the trusts or institutions under the
second regime. With effect from A.Y. 2023-24, the provisions of Chapter XII-EB also
extended to trusts or institutions or fund approved under first regime.
For this purpose, term “specified person” has been inserted to include within its ambit
the trust or institution under first regime and provisions of section 115TD, 115TE and
115TF has been amended.
(x) For the purposes of section 115TD, 115TE and 115TF, “Specified person” means
(a) any fund or institution or trust or any university or other educational institution
or any hospital or other medical institution referred to in section 10(23C)(iv)/
(v)/ (vi)/(via); or
(b) a trust or institution registered under section 12AA or section 12AB.
(2) Salient Features:
Section Provision
(i) 115TD(1) Circumstances where levy of tax on accreted income is attracted:
The accreted income of a specified person shall be taxable at the
maximum marginal rate@34.944% on –
(1) conversion into a form not eligible for grant of registration under
section 12AA or section 12AB or approval under section 10(23C)
(iv) /(v)/ (vi)/ (via); or

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(2) merger with an entity not having similar objects and registered
under section 12AA or section 12AB or approved under section
10(23C) (iv) /(v)/ (vi)/ (via); or
(3) non-distribution of assets on dissolution to any other specified
person within a period of 12 months from the end of the month
in which the dissolution takes place.
This levy of exit tax shall be in addition to income chargeable in the
hands of the entity.
W.e.f. A.Y. 2025-26, section 12AC has been inserted to provide that
where a trust or institution approved under the first regime or registered
under the second regime, as the case may be, merges with another trust
or institution, the exit tax provisions contained in Chapter XII-EB i.e., exit
tax would not apply if –
• the other trust or institution has same or similar objects.
• the other trust or institution is approved under the first regime or
registered under the second regime; and
• the said merger fulfils the conditions as may be prescribed.
(ii) 115TD(3) Deemed conversion into non-eligible form - Circumstances:
A specified person shall be deemed to have been converted into any
form not eligible for registration under section 12AA or section 12AB
or approval under section 10(23C) (iv) /(v)/ (vi)/ (via) in a previous
year, if, —
(i) the registration granted to it under section 12AA or section
12AB or approval under section 10(23C) (iv) /(v)/ (vi)/ (via) has
been cancelled; or
(ii) it has adopted or undertaken modification of its objects which
do not conform to the conditions of registration and,—
(a) it has not applied for fresh registration under section
12AA or section 12AB or approval under section
10(23C)(iv) /(v)/ (vi)/ (via) in the said previous year; or
(b) it has filed application for fresh registration u/s 12AA or
12AB or approval under section 10(23C)
(iv)/(v)/(vi)/(via) but the said application has been
rejected; or
(iii) it has failed to make an application for –
(a) reapproval/re-registration; or

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(b) renewal of approval/registration where the period of

approval/registration is due to expire; or
(c) final approval/registration within the period specified under
clause (i)/(ii)/(iii) of the first proviso to section 10(23C) or
clause (i)/(ii)/(iii) of section 12A(1)(ac), as the case may
be, which expires in the said previous year.
(iii) 115TD(2) Meaning of Accreted Income:
Aggregate FMV of total assets of the specified person as on the specified
date
Less
Total liability of the specified person computed in accordance with the
prescribed method of valuation [See Method of Valuation prescribed by
CBDT given in pages 10.75 to 10.80]
Notes –
(1) Accreted income attributable to any asset which is established to
have been directly acquired by the specified person out of its
agricultural income exempt under section 10(1) would be ignored.
Liability, in relation to such asset, also has to be ignored.
(2) Accreted income attributable to any asset acquired by the
specified person during the period beginning from the date of its
creation or establishment and ending on the date from which the
registration under section 12AA or section 12AB or approval
under section 10(23C) (iv) /(v)/ (vi)/ (via) became effective6, if the
specified person has not been allowed any benefit of sections 11
and 12 or approval under section 10(23C) (iv) /(v)/ (vi)/ (via) during
the said period, would be ignored. Liability, in relation to such
asset, also has to be ignored.
(3) The asset and the liability of the charitable organisation which
have been transferred on dissolution to another charitable trust or
institution registered under section 12AA or section 12AB or a
fund / institution / trust / university / educational institution /
hospital / medical institution approved under section 10(23C)

6Where the benefit under sections 11 and 12 or section 10(23C) (iv) /(v)/ (vi)/ (via) have been allowed to the trust
or institution in respect of any previous year or years beginning prior to the date from which the registration or
approval under section 12AA or 12AB or under section 10(23C) (iv) /(v)/ (vi)/ (via) became effective, then, the
registration or approval shall be deemed to have become effective from the first day of the earliest previous year.
Accordingly, accreted income attributable to asset acquired during the said period has to be considered. Liability in
relation to such asset has to be reduced.

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within specified time have to be ignored while calculating accreted

income.
Meaning of specified date [Explanation below section 115TD(7)]:
Case Specified Date
(i) conversion of the trust or institution The date of
registered u/s 12AA/12AB or approved conversion
under section 10(23C) (iv) /(v)/ (vi)/ (via)
into a form not eligible for registration u/s
12AA/12AB or under section 10(23C) (iv)
/(v)/ (vi)/ (via)
(ii) merger with an entity not having similar The date of
objects or not registered u/s 12AA/12AB or merger
not approved u/s 10(23C)(iv)/(v)/(vi)/ (via)
(iii) non-distribution of assets on dissolution to The date of
any charitable institution registered u/s dissolution
12AA/12AB or approved u/s 10(23C)
within a period twelve months from
dissolution.
Date of conversion [Explanation below section 115TD(7)]:
Case Specified Date
(i) Where the registration u/s 12AA/12AB The date of the order
or approval granted under section cancelling registration
10(23C) (iv) /(v)/ (vi)/ (via) has been u/s 12AA/12AB or
cancelled approval under
section 10(23C) (iv)/
(v)/(vi)/ (via)
(ii) Where it has adopted or undertaken The date of adoption
modification of its objects which do not or modification of any
conform to the conditions of object.
registration/ approval and has not
made an application for fresh
registration/approval or the application
made has been rejected.
(iii) Where it has failed to make an The last date for
application for – making an application
(a) reapproval/re-registration, for registration or
approval
(b) renewal of approval/ registration
where the period of approval/
registration is due to expire, or

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(c) final approval/registration within

the period specified under
clause (i)/(ii)/(iii) of the first
proviso to section 10(23C) or
clause (i)/(ii)/(iii) of section
12A(1)(ac), as the case may be,
which expires in the said
previous year.
(iv) 115TD(4) Exit tax payable even if no income-tax is payable by the specified
person:
Even if no income-tax is payable by the specified person on its total
income, tax on accreted income shall be payable by the trust or
institution, like any other additional income-tax.
(v) 115TD(5) Period within which tax on accreted income has to be paid to the
credit of the Central Government:
The principal officer or the trustee of the specified person, as the case
may be, and the specified person shall also be liable to pay the tax on
accreted income to the credit of the Central Government within fourteen
days from,—
Circumstance Relevant date
(1) Where the registration or the date on which –
approval granted u/s (a) the period for filing appeal
12AA/12AB or u/s under section 253 against
10(23C)(iv)/(v)/ (vi)/(via) the order cancelling the
has been cancelled registration expires and no
appeal has been filed by
the specified person; (or)
(b) the order in any appeal,
confirming the cancellation
of the registration, is
received by the specified
person.
(2) (i) Where the trust has the end of the previous year
modified its objects and
has not applied for fresh
registration u/s
12AA/12AB or approval
under section 10(23C)(iv)/
(v)/ (vi)/ (via)
(ii) where the trust has
failed to apply for –

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(a) re-registration/re-
approval; or
(b) renewal of
registration/
approval, where the
period of validity of
registration or
approval set to
expire; or
(c) final registration/
approval within the
specified time period
which expires in the
relevant P.Y.
(3) Where the trust has the date on which –
modified its objects and (a) the period for filing appeal
has filed application for under section 253 against
fresh registration u/s the order rejecting the
12AA/12AB or approval application expires an no
under section 10(23C)(iv)/ appeal has been filed by
(v)/(vi)/(via) but the same the specified person; (or)
was rejected (b) the order in any appeal,
confirming the cancellation
of the application, is
received by the specified
person
(4) Where trust has merged the date of merger
with an entity not having
similar objects or not
registered u/s 12AA/12AB
or not approved under
section 10(23C) (iv) /(v)/
(vi)/ (via)
(5) Where the trust fails to the date on which the period of 12
transfer upon dissolution months expires.
all its assets to another
registered trust or
institution or approved
fund or institution within 12
months from the end of the
month in which the
dissolution takes place

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(vi) 115TD(6) No credit available for tax paid on accreted income:

The tax on accreted income shall be treated as final payment of tax in
respect of such income for which no credit can be taken by the specified
person or any other person.
(vii) 115TD(7) Non-availability of deduction under any other provision of the Act:
No deduction is allowable under any other provision of the Act to the
specified person or any other person in respect of the income which has
been charged to tax or the tax thereon.
(viii) 115TE Interest for non-payment of tax within prescribed time:
In case of failure of payment of tax within the prescribed time, a simple
interest@1% p.m. or part of it shall be applicable for the period of non-
payment.
Period of non-payment:
Beginning from Ending with
The date immediately after the last The date on which the tax is
date on which such tax was payable actually paid.
(ix) 115TF Circumstance when specified person is deemed to be assessee-in-
default:
The principal officer or the trustee and specified person shall be
deemed to be assessee-in-default for non-payment of tax and all
provisions related to the recovery of taxes shall apply.
Further, in the case of transfer of assets upon dissolution of the trust
or institution to a recipient, which is not a charitable organisation, the
recipient of assets of the trust shall also be liable to be held as
assessee-in-default in case of non-payment of tax and interest.
However, in such a case, the recipient's liability shall be limited to the
extent to which the assets received by him is capable of meeting the
liability.

Note - As per section 115TD(2), “Accreted Income” means the aggregate FMV of total assets
of the specified person as on the specified date less total liability of such specified person
computed in accordance with the prescribed method of valuation. Accordingly, Rule 17CB
provide for method of valuation of assets and liabilities.

Method of valuation for the purposes of section 115TD(2)

Rule Provision
(1) The aggregate fair market value of the total assets of the specified person, shall be
the aggregate of the fair market value of all the assets in the balance sheet as
reduced by—

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(i) any amount of income-tax paid as deduction or collection at source or as

advance tax payment as reduced by the amount of income-tax claimed as
refund under the Act, and
(ii) any amount shown as asset including the unamortised amount of deferred
expenditure which does not represent the value of any asset.
(2) The fair market value of the asset shall be determined in the following manner,
namely –
(I) Shares and securities
(a) Quoted shares and (i) the average of the lowest and highest
securities price of such shares and securities
quoted on a recognised stock exchange
as on the specified date; or
(ii) where on the specified date, there is no
trading in such shares and securities
on a recognised stock exchange, the
average of the lowest and highest
price of such shares and securities
on a recognised stock exchange on a
date immediately preceding the
specified date when such shares and
securities were traded on a recognised
stock exchange,
(b) Unquoted equity ( A + B − L )  (PV )
shares
PE
where,
A = book value of all the assets in the balance
sheet (other than bullion, jewellery,
precious stone, artistic work, shares,
securities, and immovable property) as
reduced by-
(i) any amount of income-tax paid as
deduction or collection at source or
as advance tax payment as reduced
by the amount of income-tax
claimed as refund under the Act;
and
(ii) any amount shown in the balance
sheet as asset including the
unamortised amount of deferred
expenditure which does not
represent the value of any asset;

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B = fair market value of bullion, jewellery,

precious stone, artistic work, shares,
securities and immovable property as
determined in the manner provided in this
rule;
L= book value of liabilities shown in the
balance sheet, but not including the
following amounts, namely: —
(i) representing contingent liabilities
other than arrears of dividends
payable in respect of the paid-up
capital in respect of equity shares;
(ii) the amount set apart for payment of
dividends on preference shares and
equity shares;
(iii) reserves and surplus, by whatever
name called, even if the resulting
figure is negative, other than those
set apart towards depreciation;
(iv) any amount representing provision
for taxation, other than amount of
income-tax paid as deduction or
collection at source or as advance
tax payment as reduced by the
amount of income-tax claimed as
refund under the Act, to the extent of
the excess over the tax payable with
reference to the book profits in
accordance with the law applicable
thereto;
(v) any amount representing provisions
made for meeting liabilities, other
than ascertained liabilities;
(vi) any amount of cumulative
preference shares;
PE = total amount of paid up equity share
capital as shown in the balance-sheet;
PV = the paid up value of such equity share.
(c) Shares and The fair market value of shares and securities
securities other than other than equity shares shall be estimated to
equity shares be price it would fetch if sold in the open market
on the specified date on the basis of the

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valuation report from a merchant banker or an

accountant in respect of such valuation.
II. Immovable property
The fair market value of an immovable property shall be higher of the
following:
(a) price that the property shall ordinarily fetch if sold in the open market
on the specified date on the basis of the valuation report from a
registered valuer; and
(b) stamp duty value as on the specified date.
III. A business undertaking
The fair market value of a business undertaking, held by a specified
person, shall be its net assets determined in accordance with the following
formula:
Fair market value = (A + B - L),
The value of A, B and L would be determined in the same manner as
discussed above in the case of unquoted equity shares.

IV. Any other asset

The fair market value of any asset, other than those referred to in (I), (II)
and (III), shall be the price that the asset shall ordinarily fetch if sold in the
open market on the specified date on the basis of valuation report from a
registered valuer.
However, in case no valuer is registered for valuation of such assets, the
valuation report shall be obtained from a valuer who is a member of any
one of the professional valuer bodies viz. Institution of Valuers, Institution
of Surveyors (Valuation Branch), Institution of Government Approved
Valuers, Practicing Valuers Association of India, the Indian Institution of
Valuers, Centre for Valuation Studies, Research and Training, Royal
institute of Chartered Surveyors; India Chapter, American Society of
Appraisers, USA; Appraisal institute, USA or a valuer who is appointed by
any public sector bank or public sector undertakings for valuation
purposes.
(3) The total liability of the specified person shall be the book value of liabilities in the
balance sheet on the specified date but not including the following amounts, namely -
(i) capital fund or accumulated funds or corpus, by whatever name called;
(ii) reserves or surpluses or excess of income over expenditure, by whatever
name called;
(iii) any amount representing contingent liability;
(iv) any amount representing provisions made for meeting liabilities, other than
ascertained liabilities;

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(v) any amount representing provision for taxation, other than the amount of tax
paid as deduction or collection at source or as advance tax payment as
reduced by the amount of income-tax claimed as refund under the Act, to the
extent of the excess over the income-tax payable with reference to the income
in accordance with the law applicable thereto.
Expla- Meaning of certain terms
nation Term Meaning
Accountant A fellow of the Institute of Chartered Accountants of India within
the meaning of the Chartered Accountants Act, 1949 who is not
appointed by the specified person as an auditor;
Balance The Balance Sheet of such specified person (including the notes
sheet annexed thereto and forming part of the accounts) as drawn up
on the specified date which has been audited by an accountant.
Quoted A share or security quoted on any recognised stock exchange with
share or regularity from time to time, where the quotations of such shares
security or securities are based on current transaction made in the
ordinary course of business;
Specified The date referred to in Explanation to section 115TD of the Act.
date Meaning of specified date [Explanation below section 115TD]:
Case Specified Date
(i) Conversion into a form not The date of conversion
eligible for registration u/s
12AA/12AB or approved u/s
10(23C)(vi)/(v)/(vi)/(via)

Date of conversion
(a) date of order cancelling registration or approval
(b) date of adoption or modification of any object
(c) last date for making an application for renewal of
registration/ approval or re-registration/re-approval where the
period of validity set to expire or final registration/approval
(ii) merger with an entity not The date of merger
having similar objects or not
registered u/s 12AA/12AB or
not approved u/s
10(23C)(vi)/(v)/(vi)/(via)
(iii) non-distribution of assets on The date of dissolution
dissolution to any charitable

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institution registered u/s

12AA/12AB or approved u/s
10(23C) within a period
twelve months from
dissolution
Stamp duty The value adopted or assessed or assessable by any authority of
value the Central Government or a State Government for the purpose
of payment of stamp duty in respect of an immovable property.
Unquoted Share or security which is not a quoted share or security.
share and
security

10.3 TAXATION OF DISCRETIONARY TRUSTS

Section 164 deals with taxation of trustees of discretionary trusts. This section applies in the case
of a representative assessee referred to in section 160(1)(iii)/(iv) in a case where any income or part
thereof is not specifically receivable on behalf of or for the benefit of any one person or where the
individual shares of the persons on whose behalf or for whose benefit such inc ome or such part
thereof is receivable are indeterminate or unknown.

The representative assessees referred to in clauses (iii) and (iv) of section 160(1) are the Court of
Wards, the Administrator General, the Official Trustee or any receiver or manager including any
person whatever his designation who in fact manages the property on behalf of another, appointed
by or under any order of a Court and a trustee appointed under a trust declared by a duly executed
instrument in writing whether testamentary or otherwise (including any Wakf Validating Act, 1913).
Such a discretionary trust will be liable to tax at the maximum marginal rate of income -tax on their
entire income.
With a view to obviating hardship in genuine cases where the circumstances are such that tax
evasion could not be considered to be main purpose of creating a trust, certain exceptions have
been specified where the trust would not be taxed at the maximum marginal rate. The exceptions
are as under:
(1) Where none of the beneficiaries has any other income chargeable to tax exceeding the
maximum amount not chargeable to income-tax in the case of an AOP and none of the
beneficiaries is a beneficiary under any other trust; or
(2) Where the relevant income or part of the relevant income is receivable under a trust declared
by any person by a will and such trust is the only trust so declared under the will.

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(3) the relevant income or part of relevant income is receivable under a trust created before
1.3.1970 by a non-testamentary instrument and the Assessing Officer is satisfied that the
trust was so created bona fide exclusively for benefit of the dependent relatives of settlor or
where the settlor is a HUF for the benefit of the members of such families in circumstances
where such relatives or members are mainly dependent on the settlor for their support and
maintenance.
(4) In cases where the relevant income is receivable by the trustee on behalf of 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 professions.
In the above four cases the income of the trustees will not be taxed at the maximum marginal rate.
The relevant income or part of relevant income will be taxable as if it were the total income of an
AOP.
Where any income in respect of which a trustee appointed under a trust declared by a duly executed
instrument in writing whether testamentary or otherwise, is liable as a repre sentative assessee
consists of, or includes, profits and gains of business, the above concessional treatment i.e.
assessing the income at the rate applicable to an AOP will apply only if such profits and gains are
receivable under a trust declared by any person by will exclusively for the benefit of any relative
dependent on him for support and maintenance and such trust is the only trust so declared by him.
For the purposes of these provisions, a trust under which a discretionary power is given to the
trustees to decide the allocation of the income every year or a right is given to the beneficiary to
exercise the option to receive the income or not each year will all be regarded as discretionary trusts
and assessed accordingly. This is made clear in Explanation 1 to section 164 which provides as
under:
(a) Any income in respect of which the Court of Wards, the Administrator General, the Official
Trustee, receiver, manager or trustee appointed under a trust declared by a duly executed
instrument in writing (including Wakf deed) is liable as a representative assessee or any part
thereof shall be regarded as not being specifically receivable on behalf or for the benefit of
any person unless the person on whose behalf or for whose benefit such income or such part
thereof is receivable during the previous year is expressly stated in the order of the Court or
the instruments of trust or wakf deed, as the case may be, and is identifiable as such on the
date of such order, instrument or deed.

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(b) The individual shares of the person on whose behalf or for whose benefit such income or part
thereof is receivable will be regarded as indeterminate or unknown unless the individual
shares of such persons are expressly stated in the order of the court or the instrument of trust
or wakf deed, as the case may be, and are ascertainable as such on the date of such order,
instrument or deed.
This Explanation seeks to prevent trustees and beneficiaries from manipulating the arrangements in
such a manner that a discretionary trust is converted into a specific trust whenever it suits them tax-wise.
(1) Income from property held under trust wholly for charitable or religious purposes
[Section 164(2)]: In case the relevant income, (in respect of which the shares of the
beneficiaries are indeterminate or unknown), is derived from property held under trust wholly
for charitable or religious purpose or which is of the nature referred to in section 2(24)(iia)
[voluntary contributions received by a trust] or which is of the nature referred to in sub-section
(4A) of section 11 [business income received by a trust], the tax shall be charged on so much
of the income as is not exempt under section 11 or section 12 as if the income not so exempt
were the relevant income of an association of persons.
However, where the whole or any part of the relevant income is not exempt under section 11
or section 12 because any income thereof is for the benefit of prohibited persons or the rules
with regard to investments in specified channels have not been followed, tax shall be charged
on the relevant income or part of relevant income at the maximum marginal rate.
(2) Income from property held under trust partly for charitable or religious purposes and
partly for other purposes [Section 164(3)]: In case the relevant income is derived from
property held under trust partly for charitable or religious purposes and partly for other
purposes or which is of the nature referred to in section 2(24)(iia) (voluntary contributions
received by a trust) or which is of the nature referred to in sub-section (4A) of section 11
(business income received by a trust) and the individual share of the beneficiaries in the
income applicable to purposes other than charitable or religious purposes is not known, tax
liability will be the aggregate of the following:
(a) the tax which would be chargeable on that part of the relevant income which is
applicable to charitable or religious purposes (as reduced by the income, if any, which
is exempt under section 11 as if such part (or such part so reduced) were the total
income of the association of persons; and
(b) the tax on that part of the relevant income which is applicable to purposes other than
charitable or religious purposes, and which is either not specifically receivable on

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behalf of or for the benefit of any one person or in respect of which shares of
beneficiaries are indeterminate or unknown, at the maximum marginal rate.
However, in the following cases, income will be charged to tax as if it were income of an
association of persons:
(a) where none of the beneficiaries has any other income chargeable to tax exceeding the
maximum amount not chargeable to income-tax in the case of an AOP and none of
the beneficiaries is a beneficiary under any other trust; or
(b) where the relevant income is receivable under a trust created by will and such trust is
the only trust so declared by him; and
(c) where the trust is a non-testamentary one created before March 1, 1970 for the
exclusive benefit (to the extent it is not utilised for charitable or religious purposes) o f
relatives of the settler mainly dependent on the settler for their support or maintenance
or where settler is a Hindu undivided family, for the exclusive benefit of its members
so dependent upon it.

Where the relevant income consists of or includes profits and gains of business, the preceding
concessional method of taxation shall apply only if the income is receivable under a trust
declared by any person by will exclusively for the benefit of any relative dependent on him
for support and maintenance and such trust is the only trust so declared by him.
Where the whole or any part of the relevant income is not exempt under section 11 or section
12 because any income thereof is for the benefit of prohibited persons or the rules with regard
to investment in specified channels have not been followed, tax shall be charged on the
relevant income or part of relevant income at the maximum marginal rate.

(3) Taxation of Oral Trusts [Section 164A]: Oral Trust is a trust which is not declared by a
duly executed instrument in writing. As per section 164A, any income which a trustee receives
or is entitled to receive on behalf of or for the benefit of any person under an oral trust will be
chargeable to income tax at the maximum marginal rate.

However, such trust shall be deemed to be a trust declared by a duly executed instrument in
writing if a statement in writing, signed by the trustee or trustees, setting out the purpose or
purposes of the trust, particulars as to the trustee or trustees, the beneficiary or beneficiaries
and the trust property, is forwarded to the Assessing Officer within three months from the
date of declaration of the trust.

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(4) Case where part of trust income is chargeable [Section 165]: In cases where only some
portion of the trust’s income to which the beneficiary or beneficiaries is/are entitled is taxable
and the other portion is not taxable, the taxable portion of the income received by him from
the trust as a beneficiary shall be only such portion thereof as bears to the whole income of
the trust. In other words, where a part only of the trust income is chargeable to tax under this
Act, the beneficiaries’ share of the income should be taken to be that derived proportionately
from the chargeable and non-chargeable portions of the trust income.

10.4 SPECIAL PROVISIONS RELATING TO INCOME OF

POLITICAL PARTIES [SECTION 13A]
Section 13A of the Income-tax Act, 1961 grants exemption from tax to political parties in respect of
their income specified below:

Exempt Income

Income from house Income from other Voluntary contributions

property Capital Gains received
sources

The aforesaid categories of income would qualify for exemption provided additional conditions for
availing the benefit of the said section which are as under are met :
Maintains such books of account and other documents to enable the A.O. to properly deduce
its income therefrom
Conditions to be satisfied by political

Maintains a record of each such voluntary contribution (other than electoral bonds) in excess
of ` 20,000 and the name and address of the contributor

Audit of accounts of the political party by a chartered accountant

party

No donation exceeding ` 2,000 to be received otherwise than by an A/c payee cheque/bank

draft or use of ECS through a bank account or through such other prescribed electronic mode
or electoral bond
Submission of report u/s 29C(3) of the Representation of the People Act, 1951 for the financial
year

Furnishing of return of income for the P.Y. in accordance with section 139(4B)

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Meaning of “Political Party” and “Electoral bond”:

Political Party A political party registered under section 29A of the Representation of
the People Act, 1951
Electoral Bond A bond issued by a scheduled bank (as authorised by the Central
Government) under a scheme notified by the Central Government.

ILLUSTRATION 16
Explain in the context of provisions of the Act, whether the income derived during the year ended on
31.03.2026 in following case shall be subject to tax in the A.Y. 2026-27:
A political party, duly registered under section 29A of the Representation of the People Act, 1951,
received rent of ` 1,25,000 per month of one of its building let out to a bank from 01.06. 2025.

SOLUTION
Rent received by the political party from the bank is an income chargeable under the head "Income
from house property". However, according to the provisions of section 13A, income from , inter alia,
house property shall not be included in total income of a political party registered under section 29A
of the Representation of the People Act, 1951, provided the political party fulfils the conditions as
specified therein including furnishing a return of income for the previous year in accordance with the
provisions of section 139(4B) on or before the due date under section 139. Therefore, if the stipulated
conditions are fulfilled by the political party, rent of ` 1,25,000 per month received by the registered
political party from letting out of its building to a bank would not be included in its total income .

ILLUSTRATION 17
The books of account maintained by a National Political Party registered with Election Commission
for the year ended on 31.3.2026 discloses the following receipts:
`
(a) Rent of property let out to a departmental store at Chennai 6,00,000
(b) Interest on deposits other than banks 5,00,000
(c) Contribution of ` 21,000 each from 100 persons (who have secreted their 21,00,000
names)
(d) Contribution from 10 persons by way of electoral bonds of ` 25,000 each 2,50,000
(e) Cash contribution @ ` 2,100 each from 1,000 members (recorded in books of 21,00,000
account)
(f) Net profit of cafeteria run in the premises at Delhi 3,00,000

Compute the total income of the political party for the assessment year 2026-27, with reasons for
inclusion or otherwise.

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SOLUTION
The total income of a political party registered with the Election Commission is to be computed as
per section 13A under which the income derived from house property, income from other sources
and income by way of voluntary contributions received from any person, on fulfilling of the conditions
as mentioned thereunder, are exempt from tax. However, in this case, since cash contribution in
excess of ` 2,000 is received from 1000 persons, the political party has violated the condition of
receipt of donation through account payee cheque/draft or prescribed electronic modes. Further, the
political party has also violated the condition of maintenance of records in case of donations
exceeding ` 20,000 received otherwise than by way of electoral bonds. Hence, its total income has
to be computed as under without providing for exemption available under section 13A:
Computation of total income of National Political Party
Particulars `
(a) The rent of the property of ` 6 lacs located at Chennai [assuming the same 4,20,000
to be the Gross Annual Value] less 30% of ` 6 lacs, being deduction u/s 24
(b) Interest received on deposits 5,00,000
(c) Contribution from 100 persons (who have secreted their names) of 21,00,000
` 21,000 each
(d) Contribution from 10 persons by way of electoral bonds of ` 25,000 each 2,50,000
(e) Cash contribution @ ` 2,100 each from 1,000 members (recorded in books 21,00,000
of account)
(f) Net profit of cafeteria at Delhi 3,00,000
Total Income 56,70,000
Note – Alternatively, the political party can contend that only ` 45 lakh is taxable on account of non-
maintenance of records and receipt of cash donations, in which case the total income would be
computed as under:
Computation of total income of National Political Party
Particulars `
(a) Rent of the property of ` 6 lacs located at Chennai Exempt
(b) Interest received on deposits Exempt
(c) Contribution from 100 persons (who have secreted their names) of ` 21,000 each 21,00,000
(d) Contribution from 10 persons by way of electoral bonds of ` 25,000 each Exempt
(e) Cash contribution @ ` 2,100 each from 1,000 members (recorded in books 21,00,000
of account)
(f) Net profit of cafeteria at Delhi 3,00,000
Total Income 45,00,000

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Note: It is presumed that the conditions regarding maintenance of books of account, audit,
submission of report under section 29C of the Representation of the People Act, 1951 and filing of
return of income under section 139(4B) are fulfilled by the political party, and hence it is eligible for
exemption of income under section 13A.

10.5 SPECIAL PROVISIONS RELATING TO VOLUNTARY

CONTRIBUTIONS RECEIVED BY ELECTORAL
TRUSTS [SECTION 13B]
(1) Voluntary contribution treated as income: Any voluntary contribution received by an
electoral trust (as may be approved by the CBDT in accordance with the scheme to be made
by the Central Government) shall be treated as its income under section 2(24).
(2) Conditions for availing exemption under section 13B: Any voluntary contributions
received by an electoral trust would be exempt, if such electoral trust:
(I) distributes to a registered political party during the previous year, 95% of the aggregate
donations received by it during the year along with the surplus if any, brought forward
from any earlier previous year and
(II) function in accordance with the rules made by the Central Government.
(3) Functions of an electoral trust: Accordingly, the Central Government has notified Rule
17CA which provides that the following shall be the functions of an electoral trust referred to
in section 13B –
(i) The electoral trust may receive voluntary contributions from
(a) an individual who is a citizen of India;
(b) a company which is registered in India; and
(c) a firm or Hindu undivided family or an Association of persons or a body of
individuals, resident in India.
(ii) A receipt indicating the following shall be issued by the trust immediately on receipt of
any contribution indicating the following:
(a) name and address of the contributor;
(b) Permanent account number of the contributor or passport number in the case
of a citizen who is not a resident;

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(c) amount and mode of contribution including name and branch of the Bank and
date of receipt of such contribution;
(d) name of the electoral trust;
(e) Permanent account number of the electoral trust;
(f) date and number of approval by the prescribed authority; and
(g) Name and designation of the person issuing the receipt.
(iii) The electoral trust shall not accept contributions-
(a) from an individual who is not a citizen of India or from any foreign entity whether
incorporated or not;
(b) from any other electoral trust which has been registered a company under
section 25 of the Companies Act, 19567 and approved as an electoral trust
under the Electoral Trusts Scheme, 2013;
(c) from a Government company as defined in section 2(45) of the Companies Act,
2013; and

(d) from a foreign source as defined in section 2(j) of the Foreign Contribution
(Regulation) Act, 2010.
(iv) The electoral trust shall accept contributions only by way of an account payee cheque
drawn on a bank or account payee bank draft or by electronic transfer to its bank
account and shall not accept any contribution in cash.
(v) The electoral trust shall not accept any contribution without the PAN of the contributor,
who is a resident and the passport number in the case of a citizen of India, who is not
a resident.
(vi) A political party registered under section 29A of the Representation of the People Act,
1951 shall be an eligible political party and an electoral trust shall distribute funds only
to the eligible political parties.
(vii) (a) The electoral trust may, for the purposes of managing its affairs, spend upto
5% of the total contributions received in a year subject to an aggregate limit of
` 5 lakh in the first year of incorporation and ` 3 lakh in subsequent years;

7Section 8 of the Companies Act, 2013

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(b) the total contributions received in any financial year alongwith the surplus from
any earlier financial year, if any, as reduced by the amount spent on managing
its affairs, shall be the distributable contributions for the financial year;
(c) an electoral trust shall be required to distribute the distributable contributions
received in a financial year, referred to in point (b) above, to the eligible political
parties before 31 st March of the said financial year, subject to the condition that
at least 95% of the total contributions received during the financial year along
with the surplus brought forward from earlier financial year, if any, are
distributed.
(viii) The trust shall obtain a receipt from the eligible political party indicating the name of
the political party, its permanent account number, registration number, amount of fund
received from the trust, date of the receipt and name and designation of person signing
such receipt.
(ix) The electoral trust shall not utilize any contributions for the direct or indirect benefit of
the members or contributors, or for any of the following persons, namely:
(a) the members (including members of its Executive Committee, Governing
Committee or Board of Directors) of the electoral trust;

(b) any relative of such Members;

(c) where such member or contributor is a Hindu undivided family, a member of
that Hindu undivided family;
(d) any person who has made a contribution to the trust;
(e) any person referred in section 13(3); and
(f) any concern in which any of the persons referred to in clauses (a),(b),(c),(d)
and (e) has a substantial interest.
(x) (a) An electoral trust shall keep and maintain such books of account and other
documents in respect of its receipts, distributions and expenditure as may
enable the computation of its total income in accordance with the provisions of
the Act;
(b) The electoral trust shall also maintain a list of persons from whom contributions
have been received and to whom the same have been distributed, containing
the name, address and permanent account number (PAN) of each such person

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along with the details of the amount and mode of its payment including the
name and branch of the bank.
(xi) Every electoral trust shall get its accounts audited by an accountant as defined in the
Explanation below section 288(2) and furnish the audit report in Form No.10BC along
with particulars forming part of its Annexure, to the Commissioner of Income-tax or the
Director of Income-tax, as the case may be, having jurisdiction over the electoral trust,
on or before the due date specified for furnishing the return of income by a company
under section 139.
(xii) An electoral trust shall maintain a regular record of proceedings of all meetings and
decisions taken therein.
(xiii) Every electoral trust shall furnish a certified copy of list of contributors and a list of
political parties, to whom sums were distributed in the manner prescribed in (vii)
above, to the Commissioner of Income-tax or the Director of Income-tax, as the case
may be, every year along with the audit report;

(xiv) Any change in the shareholders, subsequent to the approval granted under the
Electoral Trusts Scheme, 2013 shall be intimated to the Board within thirty days of
such change.

Section 2(22AAA) defines ‘Electoral Trust’ to mean a trust so approved by the CBDT,
in accordance with the scheme made in this regard by the Central Government.
In exercise of the powers conferred by section 2(22AAA), the Central Government, has
through Notification No.9/2013 dated 31.1.2013, notified the Electoral Trusts Scheme, 2013
to lay down the procedure for grant of approval to an electoral trust which will receive
voluntary contributions and distribute the same to political parties.
Eligibility
A company registered for the purposes of section 25 of the Companies Act, 1956 satisfying
all of the following conditions shall be eligible to make an application for approval as an
electoral trust, namely –
1. The company should be registered on or after 1.4.2012 for the purposes of section 25
of the Companies Act, 1956;
2. The name of the company registered for the purposes of section 25 of the Companies
Act, 1956 has to include the phrase “electoral trust”;

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3. The sole object of the electoral trust should be to distribute the contributions received
by it to the political party, registered under section 29A of the Representation of the
People Act, 1951;
4. The electoral trust should have a permanent account number.
Criteria for Approval
An electoral trust shall be considered for approval if it fulfills all of the following conditions,
namely –
1. The company registered for the purposes of section 25 of the Companies Act, 1956,
which satisfies the above conditions;
2. The object of the electoral trust shall not be to earn any profit or pass any direct or
indirect benefit to its members or contributors, or to any person referred to in section
13(3) or any person referred to in Rule 17CA(10) of the Rules;
3. It has made adequate arrangement for recording the receipts from the contributors in
accordance with Rule 17CA;

4. The stipulations contained in Rule 17CA for functioning of the electoral trust are
specifically included in the articles of association of the company registered for the
purposes of section 25 of the Companies Act, 1956.
Renewal of approval
1. The approval shall be valid for the assessment year relevant to the financial year in
which such application has been made and for a further period, not exceeding three
assessment years, as may be specified in the approval.
2. The electoral trust may apply for renewal of approval at any time during the financial
year immediately preceding the last assessment year, for which the approval has been
originally granted, and such renewal of approval may be granted after examining the
application in the same manner as laid out for approval in this scheme.
Withdrawal of approval
1. The CBDT may withdraw the approval granted under this Scheme if it is satisfied that
the electoral trust has ceased its activities or its activities are not genuine or are not
carried out in accordance with all or any of the conditions laid down under this Scheme
or the provisions of Rule 17CA of the Rules, or any other condition imposed in the
approval granted.

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2. In order to ascertain whether an electoral trust, after its approval, is functioning in

accordance with the provisions of Rule 17CA of the Rules, the CBDT may call for
information or documents as it may deem fit from the electoral trust or may get an
enquiry conducted in this regard by an income-tax authority or any other agency.
3. If the Commissioner of Income-tax or the Director of Income-tax is satisfied that an
approved electoral trust is not fulfilling any of the conditions specified under this
Scheme or the conditions subject to which approval was granted to it or does not
function in accordance with Rule 17CA, he may, after making appropriate enquiries,
furnish a report to the CBDT in this regard and the Board may take such action on the
report as it may deem fit.
4. An order for withdrawal of the approval shall be passed after giving the electoral trust
an opportunity of being heard, and shall record the reasons in writing for the withdrawal
of approval.
5. A copy of the order withdrawing the approval shall be sent to the applicant, the
Assessing Officer and the Commissioner of Income-tax or the Director of Income-tax,
as the case may be.

10.6 TAXATION REGIME FOR SECURITIZATION TRUSTS

AND ITS INVESTORS
(1) Meaning of Securitisation Trust [Clause (d) of Explanation below section 115TCA]:
“Securitisation trust” means a trust being a special purpose distinct entity or a special
purpose vehicle (as per the guidelines on securitisation of standard assets issued by RBI) or
a trust setup by a securitisation company or a reconstruction company, which fulfils such
conditions, as may be prescribed.
(2) Exemption of income of securitisation trust from the activity of securitisation:
The income of securitisation trust from the activity of securitisation shall be exempt under
section 10(23DA).
(3) Taxability of income from securitisation trust in the hands of the investor [Section
115TCA(1)]:
Section 115TCA(1) provides that any income accruing or arising to, or received by, a
person, being an investor from the securitisation trust, out of investments made in the
securitisation trust, shall be taxable in the hands of investor in the same manner as if the
investor had made investment directly in the underlying assets and not through the trust.

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(4) Nature of income paid or credited by securitisation trust in the hands of the investor
[Section 115TCA(2)]:
The income paid or credited by the securitisation trust shall be deemed to be of the same
nature and in the same proportion in the hands of the investor of the securitisation trust, as if
it had been received by, or had accrued and arisen to, the securitisation trust during the
previous year.
(5) Deemed credit to investor [Section 115TCA(3)]:
If the income accruing or arising to, or received by, the securitisation trust, during a previous
year has not been paid or credited to the investor, the same shall be deemed to have been
credited to the account of the said person on the last day of the previous year in the same
proportion in which such person would have been entitled to receive the income had it b een
paid in the previous year.

(6) Statement specifying the details of nature of income to be furnished to investor and
prescribed income-tax authority [Section 115TCA(4)]:

The securitisation trust shall provide breakup regarding nature and proportion of its income
and such other relevant details to the investors and also to the prescribed income -tax
authority in the prescribed form and verified in the prescribed manner, within the prescribed
period.

(7) Income taxed in the year of accrual not taxable again in the year of payment [Section
115TCA(5)]:

Where income has been included in the total income of the investor in a previous year, on
account of it having accrued or arisen in the said previous year, the same shall not be included
in the total income of such person in the previous year in which such income is actually paid
to him by the securitisation trust.

(8) Deduction of tax at source in respect of income payable to investor [Section 194LBC]:

Tax deduction at source under section 194LBC shall be effected by the securitisation trust at
the time of payment or credit of income to the account of the investor, whichever is earlier.

S. No Payee Rate of TDS

(i) Resident payees 10%
(ii) Non-corporate non-residents and foreign companies Rates in force

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Where any income as aforesaid is credited to any account in the books of account of the
person liable to pay such income, such crediting is deemed to be credit of such income to the
account of the payee and tax has to be deducted at source. The account to which such income
is credited may be called “Suspense account” or by any other name.

(9) Application for low or nil deduction of tax at source:

The facility for the investors to obtain low or nil deduction of tax certificate would be available;
the investor can make an application to the Assessing Officer, and he can, on an application
made by the assessee in this behalf, issue a certificate under section 197 in this behalf for
no deduction of income-tax or deduction of income-tax at a lower rate.
(10) Meaning of certain terms:
Explanation Term Meaning
(a) Investor A person who is holder of any securitised debt instrument or
securities, or security receipt issued by the securitisation
trust
(b) Securities Debt securities issued by a Special Purpose Vehicle as
referred to in the guidelines on securitisation of standard
assets issued by RBI

10.7 SCHEME FOR TAXATION OF REAL ESTATE

INVESTMENT TRUST (REIT) AND INFRASTRUCTURE
INVESTMENT TRUST (INVIT) [CHAPTER XII-FA –
SECTION 115UA]
(1) The SEBI has notified the regulations relating to two categories of investment vehicles
namely, the Real Estate Investment Trust (REIT) & Infrastructure Investment Trust (Invit).
(2) The SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”) provide a
framework for registration and regulation of Real Estate Investment Trusts (“REIT's”).
Salient features of the REIT Regulations, as approved by the SEBI:
(a) REITs shall be set up as a trust and registered with SEBI. It shall have parties such
as Trustee, Sponsor group, inducted sponsor and Manager.
(b) The trustee of a REIT means a person who holds the REIT assets in trust for the
benefit of the unit holders, in accordance with these regulations. The trustee has to
registered with the Board as Debenture Trustee and should not be an associate of the
sponsor(s) or manager.

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(c) REIT shall invest in commercial real estate assets, on a freehold or leasehold basis,
either directly or through a holdco and/or special purpose vehicles (SPVs). Real estate
for the purpose of REIT Regulations means land and any permanently attached
improvements to it, whether leasehold or freehold and includes buildings, sheds,
garages, fences, fittings, fixtures, warehouses, car parks, etc. and any other assets
incidental to the ownership of real estate but does not include mortgage.
(d) Once registered, the REIT shall raise funds through an initial offer. Subsequent raising
of funds may be through follow-on offer, rights issue, qualified institutional placement,
etc.
(e) Units of REITs shall be mandatorily listed on a recognized Stock Exchange and REIT
shall make continuous disclosures in terms of the listing agreement.
(f) Not less than 80% of the value of the REIT assets shall be invested in completed and
rent and/or income generating properties.
Upto 20% of the value of REIT assets shall be invested in following:
(1) developmental properties, whether directly or through a company or LLP;
(2) mortgage backed securities;
(3) listed/ unlisted debt of companies/body corporates in real estate sector;
(4) equity shares of companies which are listed on a recognized stock exchange
in India which derive not less than 75% of their operating income from Real
Estate activity;
(5) unlisted equity shares of companies which derive not less than 75% of their
operating income from real estate activity
(6) government securities;
(7) unutilized FSI of a project where it has already made investment;
(8) TDR acquired for the purpose of utilization with respect to a project where it
has already made investment;
(9) money market instruments or cash equivalents.
(g) REIT shall distribute not less than 90% of the net distributable cash flows, subject to
applicable laws, to its unitholders, at-least on a half yearly basis.
(h) A REIT shall not invest in units of other REITs.

(3) Likewise, the SEBI (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”)
provide a framework for registration and regulation of Infrastructure Investment Trusts (“InvITs”).

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(4) The Finance (No.2) Act, 2014 had introduced a special taxation regime for providing the
manner of taxability of –
(i) income in the hands of business trusts; and
(ii) income distributed by such business trusts in the hands of the unit holders.

Section 2(13A) of the Income-tax Act, 1961 defines a business trust to mean a trust registered
as an Infrastructure Investment Trust (Invit) under SEBI (Infrastructure Investment Trusts)
Regulations, 2014 or as a Real Estate Investment Trust (REIT) under SEBI (Real Estate
Investment Trusts) Regulations, 2014.

Chapter XII-FA contains the special provisions relating to business trusts. Section 115UA(1)
provides that any income distributed by a business trust to its unit holders shall be deemed
to be of the same nature and in the same proportion in the hands of the unit holder, as it had
been received by, or accrued to the business trust.

However, as per section 115UA(3A), any sum other than the following components of
income–

(i) interest and dividend (received from SPV and distributed to unit holders)

(ii) rental income from directly owned real estate assets distributed to unitholders

(iii) income chargeable to tax in the hands of the business trust under section 115UA(2)

received by a unit holder from a business trust which is chargeable to tax under section
56(2)(xii) in the hands of unitholders under the head “Income from Other Sources” would not
be deemed to be of same nature. Such sum chargeable to tax under section 56(2)(xii) would
include repayment of debt or amount paid against redemption of units to the unit holders.

(5) Exemption of certain income to business trust [Section 10(23FC)]

Section 10(23FC) exempts any income of a business trust by way of-

- interest or dividend received or receivable from a Special Purpose Vehicle (SPV). Thus,
the business trust enjoys a pass-through status in respect of interest or dividend
received or receivable from a SPV.
"SPV" means any Indian company, -
(i) in which the REIT holds or proposes to hold not less than 50% of the equity
share capital or interest;

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(ii) which holds not less than 80% of its assets directly in properties and does not
invest in other special purpose vehicles; and
(iii) which is not engaged in any activity other than holding and developing property
and any other activity incidental to such holding or development;

(6) Exemption of Rental income of REIT from directly owned real estate asset [Section
10(23FCA)]
Any income of a business trust, being a REIT, by way of renting or leasing or letting out any
real estate asset owned directly by such business trust is exempt in the hands of the business
trust.
(7) Any distributed income referred to in section 115UA received by unit holders is exempt
in their hands under section 10(23FD) to the extent it does not comprise of
- interest referred to in sub-clause (a) of section 10(23FC) (interest income from SPV
distributed to unitholders) or
- dividend income referred to in section 10(23FC)(b) from a special purpose vehicle
which has exercised option under section 115BAA and distributed to unit holders or
- rental income referred to in section 10(23FCA) (rental income from directly owned real
estate assets).

(8) Section 115UA(2) provides that subject to the provisions of sections 111A and 112, the total
income of a business trust shall be chargeable to tax at the maximum marginal rate.
(9) Section 56(2)(xii) provides that any specified sum received by a unit holder from a business
trust during the previous year with respect to unit held by him at any time during the previous
year would be chargeable to tax in the hands of unit holder under the head “ Income from
other sources.
Specified sum is to be computed in the following manner:
Specified sum = A (-) B (-) C (which shall be zero if sum of B and C is greater than A)
A aggregate of sum distributed by the business trust with respect to such unit, during the
previous year or during any earlier previous year or years, to such unit holder, who
holds such unit on the date of distribution of sum or to any other unit holder who held
such unit at any time prior to the date of such distribution, which is -
(a) not in the nature of interest and dividend referred to in section 10(23FC) or
rental income referred to in section 10(23FCA); and

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(b) not chargeable to tax in the hands of the business trust under section 115UA(2).
B amount at which such unit was issued by the business trust; and
C amount charged to tax under this clause in any earlier previous year;

(10) Section115UA(3) provides that distributed income or any part thereof, which is in the
nature of
- interest income received by the business trust from the SPV or
- dividend income received or receivable by the business trust from a SPV which has
exercised the option under section 115BAA or
- rental income from real estate assets owned directly by the REIT [referred to in
section 10(23FCA)]
is deemed to be the income of the unit holder in the previous year of distribution and subject
to tax in the hands of the unit holder in that year.
(11) Any person responsible for making payment of income distributed on behalf of the business
trust to a unit holder is required to furnish a statement to the unit holder and the prescribed
authority within the prescribed time.
The statement should be in the prescribed form and manner. It should contain the particulars
of the nature of income paid during the previous year as well as the other details as may be
prescribed [Section 115UA(4)].
(12) Under section 139(4E), a business trust is mandatorily required to furnish a return of its
income or loss in every previous year. All the provisions of the Income-tax Act, 1961 would
apply as if it were a return required to be furnished under section 139(1 ).
(13) The scheme of taxability of income in the hands of the business trust, unit holders, sponsors
etc. is briefed in the table given hereunder –
Transaction Section Tax and TDS implications
(1) Transfer of Tax implications in the hands of unit
listed units of holders:
the business ➢ STT leviable on trading of listed units on a
trust by the unit recognized stock exchange.
holders
2(42A) ➢ The period of holding of units of business
trust to qualify as “long-term capital
assets” is “more than 12 months”.

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POLITICAL PARTIES AND OTHER SPECIAL ENTITIES

112A ➢ Long-term capital gains upto ` 1.25 lakh

would be exempt in the hands of the
unitholders; Long-term capital gain
exceeding ` 1.25 lakh would be taxable
@12.5% plus surcharge, if applicable, and
health and education cess @4%.
111A ➢ Short-term capital gains would be
subject to tax @ 20% (plus surcharge, if
applicable, and cess@4%).
(2) Exchange of Tax implications in the hands of the
shares in SPV 47(xvii) sponsor:
by sponsor for ➢ Such exchange is not treated as a transfer.
units of Hence, taxability of capital gains on such
Business Trust transfer deferred to the time of disposal of
units by the sponsor.
112A & 111A ➢ The sponsor would get the same tax
treatment on offloading of units under an
Initial offer on listing of units as it would
have been available had he offloaded the
underlying shareholding through an IPO.
STT shall be levied on sale of such units
of business trust which are acquired in lieu
of shares of SPV, under an initial offer at
the time of listing of units of business trust
in the like manner as in the case of sale of
unlisted equity shares under an IPO. The
benefit of concessional tax regime of tax
@ 20%, as the case may be, on STCG and
@ 12.5%, as the case may be, on LTCG
exceeding ` 1.25 lakh under section 112A
shall be available to the sponsor on sale of
units received in lieu of shares of SPV
subject to levy of STT.
49(2AC) ➢ For computing capital gains in the hands of
the sponsor, cost of acquisition of units
would be deemed to be the cost of
acquisition of shares to the sponsor;
2(42A) ➢ For computing capital gains in the hands of
the sponsor, the period of holding of units
to include the period of holding of shares
for determining whether the capital gains
are long-term or short-term.

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(3) Interest income Tax implications in the hands of the

of business business trust & unit holders and TDS
trust from SPV implications in the hands of the SPV &
business trust:
➢ Pass-through status for interest received
by business trust from SPV:
10(23FC) ➢ Interest income is not taxable in the hands
of the business trust; and
194A(3)(xi) ➢ SPV is not required to deduct tax at source
on interest paid to business trust.
Tax consequences on distribution of such
income by the business trust to the
unitholders:
115UA(3) The distributed income or any part thereof,
received by a unit holder from the REIT, which
is in the nature of interest received or
receivable from a SPV is deemed as income
of unit holder.
115A(1)(a) ▪ Interest income taxable in the hands of the
(iiac) unit holders –
o @5%, in case of unit holders, being
non-corporate non-residents or foreign
companies; and
o at normal rates of tax, in case of
resident unit holders.
194LBA ▪ Business trust to deduct tax at source on
interest component of income distributed
to unit holders at the time of payment or
credit of income to the account of the unit
holder, whichever is earlier:
o @5%, in case of unit holders, being
non-corporate non-residents or foreign
companies; and
o @10%, in case of resident unit holders.

(4) Interest 194LC TDS implications in the hands of business

payments to trust:
non-resident ➢ An Indian Company or a business trust
lenders on ECBs paying interest income to a non-resident,
by the business not being a company, or to a foreign
trust company is liable to deduct TDS@5%

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[Such interest would attract tax in the
hands of the non-resident lenders @5% as
per section 115A].
▪ The above concessional rate of
TDS@5% is applicable to interest in
respect of money borrowed by the
Indian Company or the business trust
in foreign currency from a source
outside India –
(i) Under a loan agreement between
1st July 2012 and 30 th June, 2023.
(ii) By issuing long term infrastructure
bonds between 1st July 2012 to 1 st
October 2014.
(iii) By issuing long term bond including
long term infrastructure bonds
between 1 st October 2014 and 30 th
June, 2023.
(iv) By way of issue of rupee
denominated bond on or before 30 th
June, 2023.
▪ However, tax is required to be
deducted @4% in respect of monies
borrowed by it from a source outside
India by way of issue of any long-term
bond or rupee denominated bond
between 1st April, 2020 and 30th June,
2023, which is listed only on a
recognised stock exchange located in
any IFSC [Such interest would attract
tax in the hands of the non-resident
lenders @4% as per section 115A].
▪ Further, tax is required to be deducted
@9% in respect of monies borrowed by
it from a source outside India by way of
issue of any long-term bond or rupee
denominated bond on or after 1st July,
2023, which is listed only on a
recognised stock exchange located in
any IFSC [Such interest would attract
tax in the hands of the non-resident
lenders @9% as per section 115A]

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(5) Dividend Tax implications in the hands of the SPVs,

received by the business trust and unit holders and TDS
business trust implications in the hands of the SPV &
from SPV business trust:
10(23FC)(b) ➢ Pass-through status for dividend
received by business trust from SPV:
- Dividend received or receivable from
a special purpose vehicle, by the
business trust would be exempt in its
hands;
- Consequently, SPV is not required to
deduct tax at source on dividend paid
to business trust.
➢ Tax consequences on distribution of
such income by the business trust to
the unitholders:
The distributed income or any part thereof,
115UA(3) received by a unit holder from the REIT,
which is in the nature of dividend received
or receivable from a SPV, which has
exercised option under section 115BAA, is
deemed as income of unit holder.
10(23FD) ▪ Dividend income taxable in the hands
of the unit holders –
o 10%8, in case of unit holders, being
non-corporate non-residents or
foreign companies; and
o at normal rates of tax, in case of
resident unit holders.
(However, in case where SPV has not
exercised option under section
115BAA, dividend income distributed
by the business trust would be exempt
in the hands of the unit-holders)
194LBA ▪ Business trust to deduct tax at source
on dividend component of income
distributed to unit holders at the time of

8 On harmonious interpretation of law and on the principle that in case of non-resident, the TDS rates should not be
less than the tax rates, distributed income, being dividend would be taxable @10%. However, on independent
reading of section 115A, it is possible to take a view that the tax rate for such dividend income is 20%.

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payment or credit of income to the
account of the unit holder, whichever is
earlier, where SPV has exercised
option under section 115BAA:
o @ 10%, in case of unit holders,
being non-corporate non-residents
or foreign companies; and
o @10%, in case of resident unit
holders.
(However, in a case where SPV has not
exercised option under section
115BAA, no tax is required to be
deducted at source by the business
trust on dividend income distributed by
it to the unitholders)
(6) Capital gains Tax implications in the hands of the
on disposal of Business Trust and Unit holders:
assets by the ➢ Capital gains is chargeable at the
Business Trust 115UA(2)
applicable rates in the hands of the
Business Trust:
▪ In case of long-term capital gains, the
provisions of section 112 or 112A, as
the case may be would apply;
▪ In case of short-term capital gains on
sale of listed shares, the provisions of
section 111A would apply;
▪ Short-term capital gains, other than the
gains subject to tax under section
111A, would be subject to maximum
marginal rate.
10(23FD) ➢ If such capital gains are further distributed
to unitholders, the component attributable
to capital gains would be exempt in the
hands of the unit holders.
(7) Rental income 10(23FCA) ➢ Rental income of REIT from directly
arising to REIT owned real estate asset
from real estate Any income of a business trust, being a
property REIT, by way of renting or leasing or letting
directly held by out any real estate asset owned directly by
it such business trust is exempt in the hands
of the business trust

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194-I ➢ Rental income received or credited to a

REIT
Where the income by way of rent is
credited or paid to a business trust, being
a REIT, in respect of any real estate asset,
owned directly by such business trust, tax
is not deductible at source.
115UA(3) ➢ Distributed income received by unit
holder
The distributed income or any part thereof,
received by a unit holder from the REIT,
which is in the nature of income by way of
renting or leasing or letting out any real
estate asset owned directly by such REIT
is deemed as income of unit holder.
194LBA ➢ Distribution by REIT to unit holders of
rental income from real estate assets
directly owned by it
► TDS@10% in case of distribution to a
resident unit holder
► TDS at rates in force in case of
distribution to a non-resident unit
holder.
(8) Repayment of 56(2)(xii) ➢ Any sum other than the following
debt / Amount components of income –
paid against (a) Interest and dividend received from
redemption of SPV and distributed to unitholders
units to
unitholders (b) Rental income from real estate assets
directly owned by it; and
(c) Income chargeable to tax in the hands
of the business trust u/s 115UA(2)
received by a unitholder from a business
trust is chargeable to tax in the hands of
unit holder under the head “Income from
other sources”. It would be computed in the
manner specified under section 56(2)(xii).
(9) Income of Tax implication in the hands of the
business trust Business Trust and Unit holders:
[Other than ➢ Long-term capital gains chargeable to tax
interest and 115UA(2) u/s 112 or u/s 112A

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dividend from ➢ Short-term capital gains chargeable to tax
SPV, rental u/s 111A
income from
➢ Any other income of the trust is chargeable
real estate
to tax at the maximum marginal rate.
property]
10(23FD) ➢ The above income distributed to unit
holders would be exempt in their hands.

ILLUSTRATION 18
A business trust, registered under SEBI (Real Estate Investment Trusts) Regulations, 2014, gives
particulars of its income for the P.Y.2025-26:
(1) Interest income from Beta Ltd. – ` 4 crore;
(2) Dividend income from Beta Ltd. – ` 2 crore;
(3) Short-term capital gains on sale of listed shares of Beta Ltd.– ` 1.5 crore;
(4) Short-term capital gains on sale of developmental properties – ` 1 crore
(5) Interest received from investments in unlisted debentures of real estate companies – ` 10 lakh;
(6) Rental income from directly owned real estate assets – ` 2.50 crore
Beta Ltd. is an Indian company in which the business trust holds 70% of the shareholding.
Discuss the tax consequences of the above income earned by the business trust in the hands of the
business trust and the unit holders, assuming that the business trust has distributed ` 10 crore to
the unit holders in the P.Y.2025-26 (Assume that Beta Ltd. does not opt to pay tax under section
115BAA).

SOLUTION
Tax consequences in the hands of the business trust and its unit holders
(1) Interest income of ` 4 crore from Beta Ltd.: There would be no tax liability in the hands of
business trust due to pass-through status enjoyed by it under sub-clause (a) of section
10(23FC) in respect of interest income from Beta Ltd., being the special purpose vehicle.
Therefore, Beta Ltd. is not required to deduct tax at source on interest payment to the
business trust.
The distributed income or any part thereof, received by a unit holder from the REIT, which is
in the nature of interest income received or receivable from a SPV is deemed income of the
unit holder as per section 115UA(3).

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The business trust has to deduct tax at source under section 194LBA –
- @ 10%, on interest component of income distributed to resident unit holders; and
- @ 5%, on interest component of income distributed to non-corporate non-resident and
foreign companies’ unit holders.
The interest component of income received from the business trust in the hands of each
unitholder would be determined in the proportion of 4/11.1, by virtue of section 115UA(1).
(2) Dividend income of ` 2 crore from Beta Ltd.: The dividend distributed by the SPV to the
business trust is exempt by virtue of section 10(23FC). Any distributed income referred to in
section 115UA, which is in the nature of dividend income received or receivable from SPV, in
a case where the SPV has exercised the option under section 115BAA, is taxable in the hands
of unitholders by virtue of section 10(23FD). However, since Beta Ltd., being a SPV does not
opt for section 115BAA, dividend component is exempt in the hands of the unitholders.
Consequently, business trust is not required to deduct tax at source on the dividend
component distributed to the unitholders.
(3) Short-term capital gains of ` 1.50 crore on sale of listed shares of Beta Ltd.: As per
section 115UA(2), the business trust is liable to pay tax@20% under section 111A in respect
of short-term capital gains on sale of listed shares of special purpose vehicle. There would,
however, be no tax liability on the capital gain component of income distributed to unit
holders, by virtue of the exemption contained in section 10(23FD).
(4) Short-term capital gains of ` 1 crore on sale of developmental properties: It is taxable
at maximum marginal rate in the hands of the business trust as per section 115UA(2). There
would be no tax liability in the hands of the unit holders on the capital gain component of
income distributed to them, by virtue of the exemption contained in section 10(23FD).
(5) Interest of ` 10 lakh received in respect of investment in unlisted debentures of real
estate companies: Such interest is taxable at maximum marginal rate, in the hands of the
business trust, as per section 115UA(2). However, there would be no tax liability in the hands
of the unit holders on the interest component of income distributed to them, by virtue of
section 10(23FD).
(6) Rental income of ` 2.50 crore from directly owned real estate assets: Any income of a
business trust, being a REIT, by way of renting or leasing or letting out any real estate asset owned
directly by such business trust is exempt in the hands of the trust as per section 10(23FCA).
Where the income by way of rent is credited or paid to a business trust, being a REIT, in
respect of any real estate asset held directly by such REIT, no tax is deductible at source
under section 194-I.

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The distributed income or any part thereof, received by a unit holder from the REIT, which is in
the nature of income by way of renting or leasing or letting out any real estate asset owned
directly by such REIT is deemed income of the unit holder as per section 115UA(3). The
business trust has to deduct tax at source@10% under section 194LBA in case of distribution
to a resident unit holder and at rates in force in case of distribution to a non-resident unit holder.
The rental income component received from the business trust in the hands of each unitholder
would be determined in the proportion of 2.5/11.1, by virtue of section 115UA(1).

10.8 SPECIAL TAXATION REGIME FOR INVESTMENT

FUNDS AND INCOME RECEIVED FROM SUCH FUNDS
[CHAPTER XII-FB] [SECTIONS 115UB, 10(23FBA) &
10(23FBB)]
(1) Tax liability of the unit holders:
Any income accruing or arising to, or received by, a person, being a unit holder of an
investment fund, out of investments made in the investment fund shall be chargeable to
income-tax in the same manner as if it were the income accruing or arising to, or received by,
such person had the investments made by the investment fund, been made directly by him
[Section 115UB(1)].

Note – Accordingly, income in the hands of the non-resident investor from offshore
investments routed through Category I or Category II AIFs, being a deemed direct investment
outside India by the non-resident investor, is not taxable in India under section 5(2) of the Act
[Circular No. 14/2019, dated 3.7.2019].
(2) Exemption of income of investment fund other than income under the head profits and
gains from business and profession [Section 10(23FBA)]

The Scheme provides for exemption of income, other than income chargeable under the head
“Profits and gains of business or profession”, in the hands of investment fund. The income in
the nature of profits and gains of business or profession shall be taxable in the hands of the
investment fund.
(3) Exemption to unit holder of income under the head “Profits and gains from business
or profession” of investment fund [Section 10(23FBB)]
Income accruing or arising to, or received by, a unit holder of an investment fund, being that
proportion of income which is of the same nature as income chargeable under the head

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“Profits and gains of business or profession” at investment fund level, shall be exempt under
section 10(23FBB). This implies that all income from investment fund is taxable in the hands
of unit holders except income under the head “PGBP”.
(4) TDS in respect of income of units of investment fund to unit holders [Section 194LBB]
Investment fund to deduct tax at source on any income (other than the proportion of income
which is of the same nature as income chargeable under the head “Profits and gains of
business or profession” which is taxable at investment fund level) payable by the investment
fund to a unit holder

- @10%, in case of payable to a resident unit holder

- at rates in force in case of payable to a non-corporate non-resident or foreign company
unit holder

In case of income payable to a non-corporate non-resident or foreign company unit holder, no

deduction is to be made in respect of any income that is not chargeable to tax under the Act.
Such tax has to be deducted at the time of credit of such income to the account of the payee
or at the time of payment, whichever is earlier.
For this purpose, any such income credited to any account, whether called “suspense
account” or by any other name, in the books of account of the person liable to pay such
income, such crediting shall be deemed to be the credit of such income to the account of the
payee, and the provisions of section 194LBB shall apply accordingly.
(5) Pass - through status for current year losses:
If in any year there is a loss under any head of income at the fund level and such loss cannot
be or is not wholly set-off against income under any other head of income of the said previous
year, then out of such losses,
(i) the loss arising to the Investment Fund under the head “Profits & Gains of Business
or Profession” shall not be allowed to be passed through to the investors but has to be
carried over at fund level to be set off against income of the next year in acco rdance
with the provisions of Chapter VI
(ii) loss other than loss under the head “profits and gains from business or profession”
would not be allowed be passed through to the investors if such loss has arisen in
respect of a unit which has not been held by the unit holder for a period of at leas t 12
months [Section 115UB(2)].

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Note – By implication, losses other than those referred to in (i) and (ii) above, which cannot
be wholly set-off against current year income, would be passed on to the unit holders to be
carry forward and set-off in their individual hands in accordance with the provisions of
Chapter VI.
(6) Pass through status for losses accumulated as on 31.3.2019:
Losses, other than loss under the head “profits and gains from business or profession”, if any,
accumulated at the level of investment fund as on 31.3.2019, shall be
- deemed to be the loss of a unit holder who held the unit as on 31.3.2019 in respect of
the investment made by him in the investment fund in the same manner as it were the
loss incurred by him had he made such investments directly and
- shall be allowed to be passed through to the investors for the remaining period
calculated from the year in which the loss has occurred for the first time taking that
year as the first year and set off against their income in accordance with the provisions
of Chapter VI.

Further, such accumulated losses shall not be available to the investment fund on or after
1.4.2019.
(7) Nature of income in the hands of unitholders:

The income paid or credited by the investment fund shall be deemed to be of the same nature
and in the same proportion in the hands of the unit holder as if it had been received by, or
had accrued or arisen to, the investment fund during the previous year . [Section 115UB(3)].
(8) Tax on total income:
As per section 115UB(4), the total income of the investment fund is chargeable to tax as
follows:
Investment Fund Rate of tax
A company or a firm Rate or rates specified in the Finance Act of the
relevant year (30%/25%, as the case may be, for a
company and 30% for firm for A.Y.2026-27)
Other than a company or a firm Maximum marginal rate

(9) Deemed credit on the last day of the previous year:

If the income accruing or arising to, or received by, an investment fund, during a previous
year is not paid or credited to the unitholders, it shall be deemed to have been credited to the

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account of the unit-holder on the last day of the previous year in the same proportion in which
such person would have been entitled to receive the income had it been paid in the previous
year [Section 115UB(6)].
Income taxed in the year of accrual not taxable again in the year of payment [ Explanation 2
below section 115UB]:
It has been clarified that any income which has been included in the total income of the unit
holder of an investment fund in a previous year, on account of it having accrued or arisen in
the said previous year, would not be included in his total income in the previous year in which
such income is actually paid to him by the investment fund.
(10) Summary:
The following table gives a summary of the above provisions:
Particulars Investment Fund Unit holder
(i) Income under the head Taxable Exempt
“Profits and gains of
business or profession” of
the Investment Fund
(ii) Income, other than profits Exempt. Taxable, as if he had
and gains of business or Tax to be deducted on directly made the
profession such income distributed investment.
to unitholders
- @10%, in case of
resident payee
- at rates in force in
case of non-resident
payee
(iii) Loss under the head To be carried forward for Not passed on to
“Profits and gains of set-off as per Chapter VI investors
business or profession” at the Fund level
incurred by the investment
fund
(iv) Loss (other than loss The Act is silent relating Not allowed to be
referred to in (iii) above) to the permissibility or carried forward by the
where such loss has arisen otherwise of carry unitholder. He cannot
in respect of unit which has forward of these losses in set-off such losses
not been held by the unit the hands of investment against his income.
holder for a period of at- funds.
least 12 months

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(v) Losses (other than losses Not allowed to be carried Unit-holder can carry
referred to in (iii) and (iv) forward for set-off by the forward and set-off
above) remaining after set- Investment Fund such losses against his
off against current year income as per Chapter
income. VI

Note – Losses, other than business losses, accumulated at the level of the investment fund
as on 31.3.2019 would be deemed to be the loss of the unit holder who held the unit as on
31.3.2019 in respect of the investments made by him in the investment fund, in the same
manner as it were the loss incurred by him had he made such investments directly. Such
loss can be carried forward by the unitholder for the remaining period calculated from the
year in which the loss had occurred for the first time taking that year as the first year.
Accordingly, he can set-off such loss in accordance with the provisions of Chapter VI. The
loss so deemed to be the loss of the unitholder shall not be available to the investment fund
on or after 1.4.2019.
(11) Statement to be furnished:
The person responsible for crediting or making payment of the income on behalf of an
investment fund and the investment fund are required to furnish, within the prescribed time,
to the person who is liable to tax in respect of such income and to the presc ribed income-tax
authority, a statement in the prescribed form and verified in the prescribed manner. Such
statement should give details of the nature of the income paid or credited during the previous
year and such other relevant details as may be prescribed [Section 115UA(7)].
(12) Every investment fund has to compulsorily file its return of income or loss under section
139(4F), if it is not required to do so under any other provision of section 139. The provisions
of the Act would apply as if such return of income or loss were a re turn required to be
furnished under section 139(1).
(13) Meaning of certain terms:
Term Meaning
(a) Investment fund Any fund established or incorporated in India in the form of a
trust or a company or a limited liability partnership or a body
corporate which has been granted a certificate of registration
as a Category I or a Category II Alternative Investment Fund
and is regulated under the Securities and Exchange Board of
India (Alternative Investment Fund) Regulations, 2012, made
under the Securities and Exchange Board of India Act, 1992 or
regulated under the International Financial Services Centers
Authority (Fund Management) Regulations, 2022 made

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under the International Financial Services Center Authority

Act, 2019;
(b) Trust A trust established under the Indian Trusts Act, 1882 or under
any other law for the time being in force.
(c) Unit Beneficial interest of an investor in the investment fund or a
scheme of the investment fund and shall include shares or
partnership interests.

ILLUSTRATION 19

The following are the particulars of income of four investment funds for P.Y.2025-26:
Particulars A B C D
` in lakh
Business Income 2 (2) 5
Capital Gains 16 14 (6) 20
Income from other sources 4 4 8 (2)

Compute the total income of the investment funds and each unitholder for A.Y. 2026-27, assuming
that:
(1) each investment fund has 20 unitholders each having one unit held by them for a period
exceeding 24 months; and
(2) income from investment in the investment fund is the only income of the unitholder.
If Investment Fund C has the following income components for A.Y.2027-28, what would be the total
income of the fund and the unit holder for that year?
Business Income ` 2 lakh
Capital Gains ` 9 lakh
Income from Other Sources ` 8 lakh.

SOLUTION
Computation of total income of the investment fund for A.Y. 2026-27
Particulars A B C D
`
Business Income Nil 2,00,000 Nil 3,00,000
Total Income Nil 2,00,000 Nil 3,00,000

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Computation of total income of a unit holder of the following Investment

funds for A.Y. 2026-27
Particulars A B C D
`
Capital Gains 80,000 70,000 - 1,00,000
Income from other sources 20,000 20,000 30,000 -
Total Income 1,00,000 90,000 30,000 1,00,000

Notes:
(i) The total income of Investment Fund B would be chargeable to tax @30% if the fund is a firm
and @30%/25%, as the case may, if the fund is a company and at the maximum marginal
rate, in any other case.
(ii) In case of Investment Fund D, the loss from other sources ` 2 lakh is set-off against business
income of ` 5 lakh.
(iii) In case of Investment Fund C, the business loss of ` 2 lakh is set-off against income from
other sources of ` 8 lakh. Loss of ` 6 lakh under the head “Capital gains” cannot be set-off
against income under any other head. The same can be carried forward by the Unitholder for
set-off in the subsequent years since, the units are held for a period of 12 months or more.
For A.Y. 2027-28, brought forward capital loss of ` 30,000 [` 6 lakh/20] can be set-off against
capital gains of ` 45,000 [` 9 lakh/20] by the unit-holder since, the period of holding of units
is 24 months or more. Business income of ` 2 lakh would be taxable in the hands of the
Investment Fund. Income from other sources of ` 40,000 (` 8 lakh/20) would be taxable in
the hands of the unitholders.

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SIGNIFICANT SELECT CASES

1 New Noble Educational Society v. CCIT (2022) 448 ITR 594 (SC)

Issue Analysis & Decision

Does the requirement under Relevant provision of law: Under section
section 10(23)(vi) to solely 10(23C)(vi), income of a university or educational
engage itself in education institution existing solely for educational purposes
mean that such institution and not for the purposes of profit, approved by the
cannot have objects not Principal Commissioner or Commissioner would be
related to education? Also, is exempt.
it necessary that the profits of As per the second proviso to section 10(23C), the
business referred to in the Principal Commissioner or Commissioner, on receipt
seventh proviso to section of application from an institution under clause (ii) or
10(23C) be the profits of such clause (iii) of the first proviso thereof, shall call for
business incidental to documents or information from it or make such
educational activity and not enquiries to satisfy himself about the genuineness of
any other activity? the activities of the institution and compliance of such
requirements of any other law for the time being in
force by it as are material for the purpose of
achieving its objects.
As per the seventh proviso to section 10(23C), the
exemption provisions under section 10(23C)(vi) would
not apply in relation to income of the educational
institution, being profits and gains of business, unless
the business is incidental to the attainment of its
objectives and separate books of account are
maintained by it in respect of such business.
Issue under consideration: The issue under
consideration is whether the requirement under section
10(23)(vi) to solely engage itself in education mean that
such institution cannot have objects not related to
education. Also, is it necessary that profits of business
referred to in the seventh proviso to section 10(23C) be
the profits of such business incidental to educational
activity and not any other activity.
Analysis and Conclusion:
The Supreme Court, made the following
observations and conclusions:
(a) The requirement of the charitable institution,
society or trust, etc., to "solely" engage itself in

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education or educational activities, and not
engage in any activity of profit, means that such
institutions cannot have objects which are
unrelated to education. In other words, all
objects of the society, trust, etc., must relate to
imparting education or be in relation to
educational activities.
The term "solely" is not the same as
"predominant/mainly". The term "solely" means
to the exclusion of all others.
(b) Where the objective of the institution appears to
be profit-oriented, such institutions would not be
entitled to approval under section 10(23C). At
the same time, where surplus accrues in a given
year or set of years per se, it is not a bar,
provided such surplus is generated in the
course of providing education or educational
activities.
(c) The seventh proviso to section 10(23C), as well
as section 11(4A) refer to profits which may be
"incidentally" generated or earned by the
charitable institution. In the present case, the
same is applicable only to those institutions
which impart education or are engaged in
activities connected to education.
(d) The reference to "business" and "profits" in the
seventh proviso to section 10(23C) and section
11(4A) merely means that the profits of
business which is "incidental" to educational
activity—i.e., relating to education such as sale
of text books, providing school bus facilities,
hostel facilities, etc.
However, where institutions provide their
premises or infrastructure to other entities,
trusts, societies, etc., for the purposes of
conducting workshops, seminars or even
educational courses (which the concerned trust
is not actually imparting) and outsiders are
permitted to enrol in such seminars, workshops,
courses, etc., then the income derived from
such activity cannot be characterised as part of
education or "incidental" to the imparting
education.

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Additionally, the Supreme Court also held that

wherever registration of trust or charities is obligatory
under State or local laws, the concerned trust,
society, other institution, etc., seeking approval
under section 10(23C) should also comply with
provisions of such State laws. This would enable the
Commissioner or concerned authority to ascertain
the genuineness of the trust, society, etc. This
reasoning is reinforced by the recent insertion of
another proviso of section 10(23C) with effect from
April 1, 2021.

2. ACIT (Exemptions) v. Ahmedabad Urban Development Authority (and other

appeals) (2022) 449 ITR 1 (SC)
Issue Analysis & Decision

When can an activity be Relevant provision of law: As per section 2(15),

considered as trade, ‘charitable purpose’ includes relief of the poor,
commerce or business for education, yoga, medical relief, preservation of
attracting the provisions of the environment (including watersheds, forests and
proviso to section 2(15)? wildlife) and preservation of monuments or places or
objects of artistic or historic interest and the
advancement of any other object of general public
utility.
However, as per the proviso to section 2(15),
“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, or any activity of rendering
any service in relation to any trade, commerce or
business, for a cess or fee or any other
consideration, irrespective of the nature of use or
application, or retention, of the income from such
activity, unless,-
(1) such activity is undertaken in the course of
actual carrying out of such advancement of any
other object of general public utility; and
(2) the aggregate receipts from such activity or
activities, during the previous year, does not
exceed 20% of the total receipts, of the trust or
institution undertaking such activity or activities,
for the previous year.

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As per section 11(4A), for the purpose of availing the

beneficial provisions of section 11(1)/(2)/(3) and
(3A), the business must be incidental to the
objectives of the trust and the trust has to maintain
separate books of account in respect of such
business. Likewise, the seventh proviso to section
10(23C) provides that for the purpose of availing
exemption under section 10(23C)(iv)/(v)/(vi)/(via),
the business should be incidental to the attainment
of its objectives and separate books of accounts are
maintained by the trust in respect of such business.
Issue under consideration: The issue under
consideration is when an activity can be considered
as trade, commerce or business for attracting the
provisions of the proviso to section 2(15).
Analysis: The first consideration would be whether
the activity concerned was or is in any manner
covered by the objects clause. Thereafter, if the
accounts disclose that the amounts paid are nominal
mark-up over and above the cost incurred towards
supplying the services, the activity may fall within the
description of one advancing the general public
utility. If on the other hand, there is a significant
mark-up over the actual cost of service, the next step
would be ascertain whether the quantitative limit in
the proviso to section 2(15) is adhered to. It is only
in the event of the trust actually carrying on an
activity in the course of achieving one of its
objects, and earning income which should not
exceed the quantitative limit prescribed at the
relevant time, that it can be said to be driven by
charitable purpose.
Section 11(4A) [and Seventh proviso to section
10(23C)] must be interpreted harmoniously with
section 2(15), with which there is no conflict.
Carrying out activity in the nature of trade,
commerce or business, or service in relation to
such activities, should be conducted in the
course of achieving the object of general public
utility, and the income, profits or surplus or gains
must, therefore, be incidental. The requirement in
section 11(4A) [and Seventh proviso to section
10(23C)] of maintaining separate books of account is

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also in line with the necessity of demonstrating that

the quantitative limit prescribed in the proviso to
section 2(15), has not been breached.
Conclusion: The conclusions arrived at by way of
this judgment, neither precludes any assessee
(whether statutory or non-statutory) advancing
objects of general public utility, from claiming
exemption, nor the taxing authorities from denying
exemption, in the future, if the receipts of the relevant
year exceed the quantitative limit. The assessing
authorities must on a yearly basis, scrutinize the
record to discern whether the nature of the
assessee's activities amount to "trade, commerce or
business" based on its receipts and income (i. e.,
whether the amounts charged are on cost-basis, or
significantly higher). If it is found that they are in the
nature of "trade, commerce or business", then it must
be examined whether the quantified limit (as
amended from time to time) in proviso to section
2(15), has been breached, thus disentitling them to
exemption.

3. CIT v. St. Peter’s Educational Society (2016) 385 ITR 66 (SC)

Issue Analysis & Decision

Would imparting Institutions engaged in providing specialized training

education/training in in certain fields and awarding diplomas and
specialized field like certificates are also eligible for tax exemption in
communication, advertising terms of section 10(23C)(vi). It is not mandatory for
etc. and awarding diplomas/ such institutions to impart education in formalized
certificates constitute an manner or conduct only recognized educational
“educational purpose” for courses. Further, when corporates depute
grant of exemption u/s employees for gaining specialized knowledge, such
10(23C)(vi)? imparting of knowledge by the institution would not
mean that the institution is engaged in the activity of
general public. Making of profit incidentally will not
make the institution as existing for making profit.

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TEST YOUR KNOWLEDGE

Questions
1. A trust, unless created for "charitable purpose", does not qualify to claim exemption under
Chapter III of the Act. In this context, explain the meaning of "charitable purpose" and
examine whether the following objects constitute part of it:
(i) Rural reconstruction and upliftment of the masses through Cottage Industry.
(ii) Welfare of industrial workers with a stipulation that the workers of settlor of trust have
got preference over others.
2. Ramji Charitable Trust has filed return of income for the Assessment Year 2026-27 in
December 2026 and applied only 50% of its income for specified purposes. It intends to
accumulate the balance 35% of income to be spent in future years. Accordingly, it filed its
Statement in Form 10 in August, 2026 and deposited the money so accumulated in post office
savings bank account. While completing the assessment, the Assessing Officer disallowed
the accumulated income of 35% and taxed the same on the ground that the trust has filed its
return of income after the due date for filing return of income. Discuss the validity of the action
of the Assessing Officer in this case.
3. An institution operating for promotion of education claiming exemption under section 11 since
1994 furnishes the following data for the assessment year 2026-27:
S. No. Particulars ` in crores
(i) Fees collected from students 14
(ii) Construction of a new computer science laboratory 0.50
(iii) Land acquired to be used as a cricket field for the students 2
(iv) Amount earmarked and set apart for construction of an arts 4
block within the next 4 years.

Compute the total income of the institution for the A.Y.2026-27.

4. A public charitable trust registered under section 12AB, for the previous year ending
31.3.2026, derived gross income of ` 21 lakhs, which consists of the following:
(` in Lacs)
(a) Income from properties held by trust (net) 10
(b) Income (net) from business (incidental to main objects) 4
(c) Voluntary contributions from public 7

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The trust applied a sum of ` 11.60 lacs towards charitable purposes during the year which
includes repayment of loan taken for construction of orphanage ` 3.60 lacs. The entire
expenditure incurred on construction of orphanage was allowed as application of income in
the P.Y. 2020-21.
Determine the taxable income of the trust for the assessment year 2026-27.
5. Work out, from the following particulars, the amount of capital gain which shall be deemed to
have been applied for charitable or religious purpose arising out of sale of a capital asset
utilized for the purposes of trust to the extent of 60%:
Particulars `
Cost of transferred asset 2,40,000
Sale consideration 3,60,000
Cost of new asset purchased 3,00,000

6. An electoral trust approved by the CBDT is not liable to income-tax in respect of voluntary
contribution received and other income - Examine the correctness of the statement.
7. Helpage is a charitable trust set up on 1.4.2010 with the object of providing relief to the poor.
Later on, in April, 2012, it changed its object to medical relief. It applied for registration on
the basis of its new object, i.e., medical relief, on 1.9.2012 and was granted registration under
Section 12AA on 1.2.2013.
On 1.4.2025, Helpage got merged with Poor Aid, is not eligible for registration under section
12AB or approval under section 10(23C). All the assets and liabilities of the erstwhile trust
became the assets and liabilities of Poor Aid. The trust appointed a registered valuer for the
valuation of its assets and liabilities. From the following particulars (including the valuation
report), calculate the tax liability in the hands of the trust arising as a result of such merger:
(i) Land
Location Date of Stamp Value which the land Book
purchase duty value would fetch, if sold in Value on
on the open market on 1.4.2025
1.4.2025 1.4.2025
` ` `
Noida 1.9.2010 55 lakhs 58 lakhs 50 lakhs
Gurgaon 1.9.2013 100 lakhs 120 lakhs 110 lakhs

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(ii) Shares
Type of shares Date of Face Purchase Price at which Open
purchase value of price of each share is market
each each quoted on BSE as value as
share share on 1.4.2025 on
Highest Lowest 1.4.2025#
price price
` ` ` ` `
5000 Quoted 1.5.2014 100 110 320 300
equity shares of A
Ltd.
2000 Preference 1.9.2015 100 100 - - 180
shares of B Ltd.
# on the basis of report of Merchant Banker
(iii) Liabilities
Book value of liabilities on 1.4.2025 = ` 120 lakhs. This includes –
(a) Corpus fund ` 12 Lakhs.
(b) Provision for taxation ` 8 lakhs; and
(c) Reserves and Surplus ` 18 lakhs
8. “Serving the poor”, a charitable trust, is registered under section 12AB of the Act. On
1.4.2025, it got merged with another entity not eligible for registration under section 12AB or
approval under section 10(23C).
All the assets and liabilities of the erstwhile trust became the assets and liabilities of the
merged entity.
The trust appointed a registered valuer for the valuation of its assets and liabilities. From the
following particulars (including the valuation report), calculate the tax liability in the hands of
the trust arising as a result of such merger:
(i) Stamp duty value of land held ` 15 lakhs. However, if this land is sold in the open
market, it would ordinarily fetch ` 17 lakhs. The book value of the land is ` 20 lakhs.
(ii) 75,000 equity shares in Ink Ltd. traded in Delhi Stock Exchange. The lowest price per
share on 1.4.2025 was ` 75 and the highest price on that day was ` 85. The book
value was ` 67 lakhs.

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(iii) 55,000 preference shares held in N Ltd. The shares will fetch ` 44 lakhs, if they are
sold in the open market on 1.4.2025 Book value was ` 25 Lakhs.
(iv) Corpus fund as on 1.4.2025 ` 15 Lakhs.
(v) Outside liabilities ` 90 lakhs
(vi) Provision for taxation ` 5 lakhs.
(vii) Liabilities in respect of payment of various utility bills ` 6 lakhs.

Answers
1. Section 2(15) defines “charitable purpose” to include relief of the poor, education, medical
relief, yoga, preservation of environment (including watersheds, forests and wildlife) and
preservation of monuments or places or objects of artistic or historic interest and the
advancement of any other object of general public utility. However, “advancement of any
other object of general public utility” would not be a charitable purpose, if it involves carrying
on of any activity in the nature of trade, commerce or business or, any activity of rendering of
any service in relation to any trade, commerce or business, for a fee or cess or any other
consideration, irrespective of the nature of use or application of the income from such activity
or the retention of such income, by the concerned entity.

“Advancement of any other object of general public utility” would continue to be a “charitable
purpose”, if the total receipt from any activity in the nature of trade, commerce or business,
or any activity of rendering any service in relation to any trade, commerce or business does
not exceed 20% of the total receipts of the trust in the previous year, and such activity is
undertaken in the course of actual carrying out of such advancement of any other object of
general public utility.

(i) The Supreme Court has, in Thiagarajar Charities vs. Addl. CIT (1997) 225 ITR 1010,
observed that “cottage industry” is associated with the idea of a small, simple
enterprise or industry in which employees work in their own houses or in a small place,
gathered together for the purpose, using their own equipments and is usually found in
rural areas or so carried on, by the poorer section of the society. In substance, the
activity of rural reconstruction and upliftment of masses through cottage industry is to
afford relief to the poor and consequently, it is for charitable purpose.
(ii) The welfare of industrial workers with a stipulation that the workers of settl or of trust
have preference over others would also constitute “charitable purpose” within the

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meaning of section 2(15). The Patna High Court has, in CIT v. Tata Steel Charitable
Trust (1993) 203 ITR 764, observed that exemption under section 11(1) can be availed
only if the following conditions are satisfied –
(1) the trust is created for a charitable purpose; and
(2) no part of the income of such trust enures or has been used or applied directly
or indirectly for the benefit of any person referred to in section 13(3).
The list of persons contained in section 13(3) does not include employees of the settlor
of the trust. Section 13(3)(d), which includes any relative of the author, can have no
application because “relative” means a person connected by birth or marriage wit h
another person. A person having relationship pursuant to a contract like that of an
employer and an employee cannot be said to be a relative. The High Court concluded
that it was immaterial that any employee of the settler of the trust had acquired any
benefit out of the income of the trust as an ordinary member of the community.
Therefore, the application of part of the income of the trust for the benefit of the
employees of the settler cannot disentitle the trust from claiming exemption under
section 11.
2. Section 11(2) provides that a charitable trust has to apply 85% of its income to charitable
purposes and where 85% of its income is not applied for such purposes, the trust may
accumulate or set apart either the whole or part of its income for future application for such
purposes in India. The requirement of the Act is that the trust has to make an
application/intimation in the prescribed form, for accumulation of income, specifying the
purpose and the period (not exceeding 5 years). The application should be filed or furnished
before the assessing authority two months prior to the due date specified under section
139(1). Further, the money so set apart or accumulated should be invested/deposited in any
one or more of these modes or forms specified under section 11(5).
In case the statement in Form 10 is submitted in August, 2026 and the amount accumulated
was deposited in post office savings bank account, which is a mode specified in section 11(5).
However, the benefit of accumulation would not be available if the return of income is not
furnished on or before the due date of filing of return of income under section 139(1). In this
case, trust has not filed its return on or before the due date under section 139(1). The return
of income was filed only in December, 2026. Therefore, the action of the Assessing Officer,
in this case, is valid.

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3. Computation of total income of the institution for the A.Y. 2026-27

Particulars ` (in crores)
Fees received 14.00
Less : 15% (exempt even if not spent for the objects of the institution) 2.10
11.90
Less: Amount applied for charitable purposes
Actual amount spent on construction of computer science lab 0.50
(See Note 1)
Actual amount spent on purchase of land for cricket field (See Note 1) 2.00
2.50
9.40
Less : Accumulated for specified purpose (See Note 2) 4.00
Total Income 5.40

Notes:
(1) The institution must utilise 85% of its income within the previous year for the objects
of the institution. The institution can apply its income either for revenue expenditure or
for capital expenditure provided the expenditure is incurred for promoting the objects
of the institution. Land acquired and meant for use as cricket field for students is a
capital expenditure incurred for promoting the objects of the institution and hence ,
eligible for deduction. Likewise, the amount spent on construction of computer science
laboratory is also eligible for deduction.
(2) Section 11(2) provides that a trust/institution can accumulate or set apart its income
for a specified purpose by furnishing statement in prescribed format to the concerned
Assessing Officer. However, the period for which the funds can be accumulated cannot
exceed 5 years. The amount so accumulated should be invested in the forms and
modes specified in section 11(5). In this case, the institution has to furnish statement
in Form 10 two months prior to the due date of filing return of income to the Assessing
Officer, stating the purpose for which the income is being accumulated or set apart
and the period for which the income is being accumulated or set apart, which shall, in
no case, exceed five years. Further, the institution has to invest ` 4 crore in the
specified forms and modes.

Note – Section 11(2) stipulates the conditions for accumulation, on fulfillment of which the
income so accumulated or set apart would not be included in the total income of the
previous year of the trust. The condition stipulated in clause (c) of Section 11(2) is that

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the statement in Form 10 has to be furnished at least 2 months prior to the due date of
filing of return of income u/s 139(1). However, as per section 13(9), the income
accumulated would not be excluded from total income if Form 10 is not submitted on or
before the due date under section 139(1). Section 13(9) permits exclusion of accumulated
income from total income of the previous year, if Form 10 is filed on or before the due date
under section 139(1). CBDT Circular No.6/2023 dated 24.5.2023 clarifies that the
statement of accumulation in Form No. 10 is required to be furnished at least two months
prior to the due date of furnishing return of income so that it may be taken into account
while auditing the books of account. However, the accumulation/deemed application shall
not be denied to a trust as long as the statement of accumulation/deemed application is
furnished on or before the due date of furnishing the return as provided in section 139(1).
4. Computation of taxable income of public charitable trust
Particulars `
(i) Income from property held under trust (net) 10,00,000
(ii) Income (net) from business (incidental to main objects) 4,00,000
(iii) Voluntary contributions from public 7,00,000
Voluntary contribution made with a specific direction towards corpus
are alone to be excluded under section 11(1)(d). In this case, there is
no such direction and hence, included.
21,00,000
Less: 15% of the income eligible for retention / accumulation without 3,15,000
any conditions
17,85,000
Less: Amount applied for the objects of the trust
(i) Amount spent for charitable purposes (` 11,60,000 - 8,00,000
` 3,60,000)
(ii) Repayment of loan for construction of orphan home (See Note -
below)
Taxable Income 9,85,000
Note - As per Explanation 4(ii) to section 11(1), any application for charitable or religious
purposes, from any loan or borrowing in the concerned year, shall not be treated as
application of income for charitable or religious purposes. However, the amount not so treated
as application, shall be treated as application in the year in which the loan is repaid. The
Fourth proviso to Explanation 4(ii) to section 11(1) clarifies that this provision will, however,
not apply where application is from loan or borrowing made on or before 31.3.2021.

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Since the amount spent on construction of orphanage was allowed as deduction in the P.Y.
2020-21, repayment of loan taken for such purposes will not be allowed as application as it
would tantamount to double deduction.
5. In this case, since the asset which is transferred is utilized for the purposes of the trust only
to the extent of 60%, only the proportionate amount (i.e., 60%) of the capital gain would be
regarded as having been applied for charitable or religious purposes.
As per section 11(1A), where a capital asset held under trust is transferred, and only a part
of the net consideration is utilized for acquiring a new capital asset, only so much of the
capital gain as is equal to the amount, if any, by which the amount so utilized exceeds the
cost of the transferred asset shall be considered to have been applied for the objects of the
trust.
In this case, only a part of the net consideration of ` 3,60,000 is utilized for acquiring the new
capital asset costing ` 3,00,000. The amount utilized in acquiring the new asset
(i.e., ` 3,00,000) exceeds the cost of the transferred asset (i.e., ` 2,40,000) by ` 60,000.
Therefore, only 60% of (` 3,00,000 – ` 2,40,000) = 60% of ` 60,000 = ` 36,000 is deemed
to be applied for the objects of the trust.
6. Section 13B provides exemption in respect of voluntary contribution received by an electoral
trust approved by the CBDT in accordance with the scheme to be made by the Central
Government.
Voluntary contribution received by an electoral trust would be treated as its income under
section 2(24), but shall be exempt under section 13B if the trust distributes to a registered
political party during the year, 95% of the aggregate donations receive d by it during the year
along with surplus brought forward from any earlier years. Another condition for availing the
benefit under this section is that the electoral trust should function in accordance with the
rules framed by the Central Government.
It may be noted that the exemption under section 13B will be available only in respect of
voluntary contribution received by an electoral trust. The exemption cannot be claimed in
respect of any other income of the electoral trust.
Therefore, the given statement is not correct.
7. As per section 115TD, the accreted income of “Helpage”, a charitable trust, registered under
section 12AA which is merged with Poor Aid, an entity not entitled for registration under
section 12AB or approval under section 10(23C), would be chargeable to tax at the rate of
34.944% [30% plus surcharge @12% plus cess@4%].

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Computation of accreted income and tax liability in the hands of the Helpage trust
arising as a result of merger with Poor Aid
Particulars Amount (`)
Aggregate FMV of total assets as on 1.4.2025, being the specified date 1,39,10,000
(date of merger) [See Working Note 1]
Less: Total liability computed in accordance with the prescribed method of
valuation [See Working Note 2] 82,00,000
Accreted Income 57,10,000
Tax Liability @ 34.944% of ` 57,10,000 (rounded off) 19,95,300
Working Notes:
(1) Aggregate fair market value of total assets on the date of merger
- Land at Noida, being immovable property, purchased on 1.9.2010 -
Since the trust was registered only on 1.2.2013 and benefit of section
11 and 12 was available to the trust only from A.Y.2013-14, relevant
to P.Y.2012-13, being the previous year in which the application for
registration is made, the value of land purchased in P.Y.2010-11, in
respect of which benefit under sections 11 and 12 was not availed,
has to be ignored for computing accreted income.
- Land at Gurgaon, being an immovable property, purchased on 1,20,00,000
1.9.2013
[The fair market value of land would be higher of ` 120 lakhs i.e.,
price that the land would ordinarily fetch if sold in the open market
and ` 100 lakhs, being stamp duty value as on the specified date,
i.e., 1.4.2025]
- Quoted equity shares of A Ltd. [5,000 x ` 310 per share] 15,50,000
[` 310 per share, being the average of the lowest (` 300) and highest
price (` 320) of such shares on the specified date]
- Preference shares of B Ltd. [2,000 x ` 180 per share]
[The fair market value which it would fetch if sold in the open market
on the specified date i.e., FMV on 1.4.2025] 3,60,000
1,39,10,000
(2) Total liability
- Reserves and Surplus ` 18 lakhs [not includible] -
- Corpus Fund of ` 12 lakhs [not includible] -
- Provision for taxation ` 8 lakhs [not includible] -
- Other Liabilities
[` 120 lakhs - ` 18 lakhs - ` 12 lakhs - ` 8 lakhs] 82,00,000
82,00,000

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8. As per section 115TD, the accreted income of “Serving the poor”, a charitable trust, registered
under section 12AA which merged with an entity not entitled for registration under section
12AB or approval under section 10(23C), would be chargeable to tax at maximum marginal
rate @ 34.944% [30% plus surcharge @12% plus cess@4%].

Computation of accreted income and tax liability in the hands of the trust arising as a
result of merger with the “not eligible” entity for A.Y. 2026-27
Particulars Amount (`)
Aggregate FMV of total assets as on 1.4.2025, being the specified date 1,21,00,000
(date of merger) [See Working Note 1]
Less: Total liability computed in accordance with the prescribed method
of valuation [See Working Note 2] 96,00,000
Accreted Income 25,00,000
Tax Liability @ 34.944% of ` 25,00,000 8,73,600
Working Notes:
(1) Aggregate fair market value of total assets on the date of
merger
- Land, being an immovable property 17,00,000
[The fair market value of land would be higher of ` 17 lakhs i.e.,
price that the land would ordinarily fetch if sold in the open market
and ` 15 lakhs, being stamp duty value as on the specified date]
- Quoted equity shares in Ink Ltd. [75,000 x ` 80 per share] 60,00,000
[` 80 per share, being the average of the lowest (` 75) and highest
price (` 85) of such shares on the date of merger]
- 55,000 preference shares of N Ltd.
[The fair market value which it would fetch if sold in the open market
on the date of merger i.e., FMV on 1.4.2025] 44,00,000
1,21,00,000
(2) Total liability
- Outside liabilities 90,00,000
- Corpus Fund of ` 15 lakhs [not includible] -
- Provision for taxation ` 5 lakhs [not includible] -
- Liabilities in respect of payment of various utility bills [since this
liability is an ascertained liability] 6,00,000
96,00,000

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CHAPTER a
11

TAX PLANNING,
TAX AVOIDANCE
AND TAX EVASION

LEARNING OUTCOMES
After studying this chapter, you would be able to -

❑ distinguish between tax planning, tax avoidance and tax evasion;

❑ analyse whether a specified activity resulting in reduction of tax liability

would be considered as tax planning, tax avoidance or tax evasion;

❑ examine the doctrine of form and substance in the context of tax planning;
❑ analyse the provisions of General Anti-avoidance Rules (GAAR)
❑ examine the applicability of General Anti-avoidance Rules (GAAR) vis-a-
vis Specific Anti-avoidance Rules (SAAR)

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CHAPTER OVERVIEW

Tax Planning, Tax Avoidance General Anti-Avoidance Rules

and Tax Evasion (GAAR)

11.1 TAX PLANNING, TAX AVOIDANCE AND TAX EVASION

– AN OVERVIEW
Tax planning involves an intelligent application of the various provisions of the direct tax laws to
practical situations in such a manner as to reduce the tax impact on the assessee to the minimum.
A thorough understanding of the principles, practices and procedures of tax laws and the ability to
apply such knowledge to various practical situations is expected at the final level.
A thorough up-to-date knowledge of tax laws is a pre-requisite for a successful study of tax planning
techniques. Not only an up-to-date knowledge of the statute is necessary, but one must also be
aware of the contents of the various circulars issued by the CBDT and also of case laws in the form
of various decisions of the Courts. One of the best methods to study tax planning in action is to
analyze the case laws. In view of this position, students should realise the importance and
usefulness of keeping track of the judgments of the Supreme Court and of various High Courts
reported in tax law journals from time to time. Students should make it a point to go through the
relevant cases and understand the issues involved and the rationale of the judgments. Of course,
tax planning in any particular case would depend on the facts and circumstances of that particular
case.
Apart from the above, students are advised to go through the articles on tax laws published in tax
journals and financial papers. With this brief introduction, let us go into the basic concepts of tax
planning.
(1) Concept of tax planning : Before entering into a transaction or before starting a business,
one normally considers its profitability and other aspects. Amongst other aspects, the tax
implications of the transactions of the business have to be thought out before actually embarking o n

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.3

the deal. Otherwise, one may be caught unwittingly in huge tax liability. Planning from the point of
view of taxation helps in generating greater savings of investible surplus.
Tax planning may be defined as an arrangement of one’s financial affairs in such a way that, without
violating in any way the legal provisions, full advantage is taken of all tax exemptions, deductions,
concessions, rebates, allowances and other reliefs or benefits permitted under the Act so that the
burden of taxation on the assessee is reduced to the minimum.
It involves arranging one’s financial affairs by intelligently anticipating the effects which the tax laws
will have on the arrangements now being adopted. As such it is a very stimulating intellectual
exercise.
Any tax planning scheme should be a natural one and should not give an appearance of an artificial
arrangement on the face of it. The tax planner or the tax adviser should exercise great care and
caution in designing any tax planning scheme as its failure will result in great difficulties and heavy
burden of tax on the assessee for whom the scheme is evolved.
In relation to income-tax, the following may be noted as illustrative instances of tax-planning
measures:
(a) Varying the residential status taking into consideration the number of days of stay in India to
be a resident, in case of an individual.

(b) Choosing the suitable form of assessable entity (Individual, HUF, Firm, Co-operative society,
Association of persons, Company, Trust, etc. to obtain optimal tax concessions) .
(c) Exercising the option to shift out of default regime under section 115BAC and paying tax as
per the normal provisions of Income-tax law in case of Individual, HUF, AOPs or BOI.
(d) Exercising the option to pay tax as per concessional tax regimes under section 115BAA or
115BAB in case of corporate assessee subject to satisfaction of certain conditions and
non-allowability of certain exemptions or deductions.
(c) Choosing suitable forms of investment (share capital, loan capital, lease, mortgages, tax
exempt investments, priority sector, etc.), considering deductions available in respect of
interest or dividend etc.
(d) Programmed replacement of assets to take advantage of the provisions governing
depreciation.

(e) Programmed sale of capital assets depending upon the period of holding and deductions
specifically available for assets held for long term.

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(f) Diversification of the business activities (hotel industry, agro-based industry etc.) considering
the various profit-linked and investment-linked benefits available under the provisions of the
Act.
(g) The use of the concept of commercial expediency to claim deduction in respect of
expenditure, in computing business income.
(2) Tax planning, tax evasion and tax avoidance: Three methods of reducing taxes have
been developed in most countries of the world over a period of time.

• Tax planning
Methods of reducing taxes • Tax evasion
• Tax avoidance

The dividing line between tax evasion and tax avoidance is very thin. The Direct Taxes Enquiry
Committee (Wanchoo Committee) has tried to draw a distinction between the two items in the
following words.
“The distinction between ‘evasion’ and ‘avoidance’, therefore, is largely dependent on the difference
in methods of escape resorted to.

Tax avoidance
• Between two extremes
i.e., tax planning and tax
Tax evasion evasion, a vast domain
• Manoeuvre involving an for selecting a variety of
element of deceit, methods which, though
Tax Planning misrepresentation of technically satisfying the
• Availing tax exemptions facts, falsification of requirements of law, in
or tax privileges offered accounting calculations fact, circumvent it with a
by the Government, or downright fraud. In view to eliminate or
strictly in accordance simple terms, tax evasion reduce tax burden.
with law. refers to any attempt to
avoid payment of taxes
by using illegal means.

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.5

• Misrepresentation or suppression of facts;

• Failure to record investments in books of account;
• Claim of expenditure not substantiated by any evidence;
Common • Recording of any false entry in books of account;
forms of tax • Failure to record any receipt in books of account having a
evasion bearing on total income; and
• Failure to report any international transaction or deemed
international transaction or specified domestic transaction
under Chapter X.

These constitute misreporting of income attracting penalty@200% under section 270A.

(3) Judicial thinking—A brief study: The judicial attitude towards tax avoidance schemes is
very strict and the landmark judgment of the Supreme Court in M/s. Mc Dowell and Co. Ltd. vs.
Commercial Tax Officer (1985) 154 ITR.148 (SC) is proof of the same. Though this decision was
rendered in the context of A.P. General Sales Tax Act, the principles emerging out of this decision
will have relevance to direct taxes also.
Before discussing the relevant observations of the Supreme Court in relation to tax avoidance
scheme it will be instructive to have an idea of the development in judicial thinking in England since
our own judicial thinking on the subject has been largely derived from English thinking.
English Scene: In Inland Revenue Commissioner vs. Duke of Westminster 1936 AC 1 it was held
“Every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate
Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result,
then, however unappreciative the Commissioners of Inland revenue or his fellow taxpayers may be
of his ingenuity, he cannot be compelled to pay an increased tax.”
After the World War II and the consequent huge profiteering and racketeering the attitude of the
courts towards the avoidance of tax perceptibly changed and hardened. Commenting on a tax
avoidance scheme, the court observed that it scarcely lies in the mouth of the taxpayer who plays
with fire to complain of burnt fingers.
It was felt that there must be some limit to the devices which courts can put up with in order to defeat
the fiscal intentions of the legislature. A very significant departure from the Westminster Principle
was made in Ramsay vs. Inland Revenue Commissioners (1982) AC 300. It was felt in that case that
even though the doctrine that courts could not go behind a given genuine document or transaction
to some supposed underlying substance was a cardinal principle, it must not be overstated or
over-extended. While obliging the courts to accept documents or transactions, found to be genuine,

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as such, the doctrine did not compel the court to look at the document or transaction in blinkers
isolated from any context to which it properly belonged. If it could be seen that a document or
transaction was intended to have effect as a part of a nexus or series of transactions or as an
ingredient of a wider transaction intended as a whole, there was nothing in the doctrine to prevent it
being so regarded. To do so was not to prefer form to substance or substance to form. It was the
task of the court to ascertain the legal nature of any transaction to which it was sought to attach a
tax consequence and if that emerged from a series or combination of transactions, intended, apart
as such, as was that series or combination which might be regarded.
Thus, two points were established. The first was a significant change in the approach adopted by
the court with regard to its judicial role towards tax avoidance scheme. The second was that it was
crucial when considering any such scheme to take the analysis far enough to determine where the
profit, gain or loss was really to be found. It was also stated that the fact that the court accepted
that each step in a transaction was a genuine step producing its intended legal results did not confine
the court to consider each step in isolation for the purpose of assessing the fiscal results. Thus, we
can say that the true principle of the decision in Ramsey was that the fiscal consequence of a
preordained series of transactions intended to operate as such, are generally to be ascertained by
considering the result of the series as a whole and not by dissecting the scheme and considering
each transaction separately.
In I.R.C. vs. Burmah Shell Co. Ltd. (1982) STC 30 (Burmah) and Furniss (Inspector of Taxes) vs.
Dawson (1984) 1 All E.R.530, it was held that where tax avoidance was targeted through a series
of transactions with no commercial or substantial value but with the only aim of avoiding tax, the
Courts have to ignore the transactions and the tax liability has to be determined as if these
transactions never took place.
Indian Scenario: In CIT vs. A. Raman & Co. 1 SCR 10, the Supreme Court followed the dictum of
the Westminster’s case. It observed that avoidance of tax liability by so arranging commercial affairs
that charge of tax is distributed is not prohibited. The taxpayer may resort to a device to divert the
income before it accrues or arises to him. Effectiveness of the device depends not upon
consideration of morality but on the operation of the Income-tax Act, 1961. Legislative injunction in
taxing statutes may not, except on pain of penalty, be violated but it may lawfully be circumvented.
The same view was expressed in CIT vs. Kharwar (1969) 72 ITR 603 (SC) as follows:
“The taxing authority is entitled and is indeed bound to determine the true legal relation resulting
from a transaction, if the parties have chosen to conceal by a device the legal relation, it is open for
the taxing authorities to unravel the device and to determine the true character of relationship. The
legal effect of a transaction, however, cannot be displaced by probing into the substance of the
transaction.”

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.7

However, the Supreme Court in Mc Dowell’s case clearly departed from the above views and
expressly disassociated itself with the earlier observations of the Supreme Court echoing the
sentiments of Westminster principle. The court enumerated the evil consequences of tax avoidance
as follows:
(1) Substantial loss of much needed public revenue.
(2) Serious disturbance caused to the economy of the country by the piling up mountains of black
money, directly causing inflation.
(3) Large hidden loss to the community by some of the best brains of the country involved in
perpetual litigation.
(4) Sense of injustice and inequality which tax avoidance arouses in the minds of those who are
unwilling or unable to profit from it.

(5) The unethical practice of transferring the burden of tax liability to the shoulders of the
guileless, good citizens from those of the ‘artful dodgers’.
The court felt that there was as much moral sanction behind taxation laws as behind any other
welfare legislation and avoidance of taxation was not ethical.
In the view of the Court, the proper way to construe a taxing statute while considering a device to
avoid tax was not to ask whether the provisions should be construed literally or liberally, nor whether
the transaction was not unreal and not prohibited by the statute, but whether the transaction was as
device to avoid tax and whether the transaction was such that the judicial process might record its
approval to it.
The court felt that it was neither fair nor desirable to expect the legislature to intervene and take
care of every device to avoid taxation. It was up to the court to take stock to determine the nature of
the new and sophisticated legal devices to avoid tax and consider whether the situation created by
the devices could be related to the existing legislation with the aid of emerging techniques of
interpretation as was done in Ramsey’s case to expose the devices for what they are really worth
and to refuse to give judicial benediction.
The Supreme Court emphasised that tax planning may be legitimate provided it is within the
framework of law and colorable devices cannot be part of tax planning. It is wrong to encourage or
entertain the belief that it is honourable to avoid the
payment of tax by resorting to dubious methods. The Tax planning may be
Supreme Court also recommended that it is the legitimate provided it is within
obligation of every citizen to pay the taxes honestly the framework of law
without resorting to subterfuge.

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Another significant case decided by the Supreme Court, though involving a dispute relating to
payment of bonus, is worthy of reference at this stage as it also reflects the same thinking as in
Mc Dowell’s case. In Associated Rubber Industries case (1986) 157 ITR 77(SC), a new wholly owned
subsidiary company was created with no asset of its own except investments transferred by the
holding company with no business income, except receiving dividend from the transferred
investments. The Supreme Court held that on facts, the purpose of such a transfer of investments
was nothing but to reduce the gross profits of the holding company and thereby to reduce the
payment of bonus. There was no direct evidence that the subsidiary was formed as a device to
reduce the gross profits of the principal company for whatever purpose. But Justice Chinnappa
Reddy in passing his judgment was following the principles earlier laid down by him in Mc Dowell’s
case and was of the opinion that the transfer of shares was nothing but a device like tax evasion to
avoid a welfare legislation like the Payment of Bonus Act. It was observed that it is the duty of the
Court in every case where ingenuity is expended to avoid liability to taxation and welfare legislation,
to get behind the smoke screen and discover the true state of affairs.

The above decision seems to have introduced a new doctrine that it is upto the court to take stock,
weigh out sophisticated legal devices and expose the devices for what they really are. The fact that
this new doctrine has started gaining ground very fast is seen from a quick succession of decisions,
after Mc Dowell in Kartikeya vs. Sarabhai and in Associated Rubber’s case. The above change in
the trend of judicial thinking clearly shows that the line of demarcation between Tax Planning and
Tax avoidance.

In order to curb tax avoidance, provisions such as

- applicability of transfer pricing provisions in respect of specified domestic transactions,

- treating any transaction with the person located in the notified jurisdiction areas to be treated
as international transaction,

- General Anti-avoidance Rules,

- provisions relating to furnishing of Tax Residency Certificate for claiming benefit of double
tax avoidance agreements

have been introduced.

The decision in Mc Dowell’s case and the subsequent developments have evoked lot of debate in
all legal and tax circles.

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.9

The Gujarat High Court in CIT vs. Smt. Minal Rameshchandra (1987) 61 CTR (Guj) 80 had occasion
to consider the impact of Mc Dowell’s case. The following propositions appear to emerge from the
same.
(i) Mc Dowell’s case and observations therein cannot be ignored and these are binding on all
courts.
(ii) Mc Dowell’s case and observation therein should be understood in the context of questioning
the legitimacy of the use of artificial and transparent device and sham practices to circumvent
the law.

(iii) Where the arrangement cannot be dismissed as an artificial tax device (and not as a
legitimate transaction), the subject can be taxed only having “regard to strict letter of the law
and not merely to the spirit of the statute or the substance of the law” and had been
consistently laid down earlier. In this sense there is no radical departure from law, prior to Mc
Dowell case.
In CWT. vs. Arvind Narottam [1988] 173 ITR 479 (SC) Judge Sabyasachi Mukharji J. made the
following significant observations:
(i) Where the language of the deed of settlement is plain and admits no ambiguity there is no
scope for considerations of tax avoidance.

(ii) One would wish as noted by Chinnappa Reddy in Mc Dowell’s case that one could get the
enthusiasm of Justice Holmes that taxes are the price of civilization and one would like to pay
that price to buy civilization. But the question which many ordinary taxpayers very often in a
country of shortages (with ostentatious consumption and deprivation for the large masses)
ask is does he with taxes buy civilization or does he facilitate the waste and ostentation of
the few. Unless waste and ostentation in government spending are avoided or eschewed no
amount of moral sermons would change people’s attitude to tax avoidance.
(iii) Where the true effect on the construction of the deeds is clear, appeal to discourage tax
avoidance is not a relevant consideration”.

In the light of the above development, we have to ascribe a proper meaning to the concept of tax-
planning. We can take a cue from the structure of our tax laws.
Our tax laws tend to serve a dual purpose of collecting revenue and of achieving certain social
objectives. There are in-built tax incentives which promote savings and investments in new
enterprises and facilitate the development of backward areas. A lot of exemptions and incentives
are provided in all the direct taxes. If an assessee takes maximum advantage of these incentives,

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exemptions etc. and enlarges the scope of his disposable resources, there can be no objection
because the legislature wants the optimum utilisation of these incentives to promote economic
activity in the country. The complexity of our tax-laws makes it impossible for even an intelligent
assessee to comprehend them properly and avail all the reliefs which may be genuinely provided by
such laws. Moreover, the interaction of other laws such as MRTP Act, FERA, Companies Act etc.
make the exercise much more complicated. It requires, therefore, meticulous planning to bring down
the tax commitments keeping in view not only the statutes but also the judge -made law. We may
say that the above area properly belongs to tax-planning. In this sense there is nothing unethical
about tax-planning.
Due to constant changes in the law and new court decisions, it is always necessary to have a
continuous review in relation to all matters of tax planning so that appropriate changes are
introduced without delay.
(4) Doctrine of form and substance : One of the reasons which prompts a taxpayer to resort
to tax planning is the existence of the doctrine of form and substance. The principle involved in this
doctrine is simple. How far Court may stretch the wording of a Statute to cover a particular set of
facts, where those facts have clearly been created by a tax payer in order to avoid or minimise his
tax and the literal interpretation of the Statute is not, at first sight apt to cover them? Is it possible to
ignore the form of a transaction and determine the substance thereof?
Landmark Judgments wherein the doctrine of form and substance played a major role in
decision making:
(i) In Commissioner of Income tax vs. Motor and General Stores (P) Ltd. (1967) 66 ITR 692 , the
Supreme Court had observed that in the absence of any suggestion of bad faith or fraud the
true principle is that the taxing statute has to be applied in accordance with the legal rights of
the parties to the transaction. According to the court, when the transaction is embodied in a
document the liability to tax depends upon the meaning and content of the language used in
accordance with the ordinary rules of construction. The House of Lords in Duke of
Westminster vs. ICR (1936) 19 ATC 498 held that in considering the substance of the
transaction, the legal form cannot be disregarded.
(ii) It was held in CIT vs. B.M. Kharwar (1969) 72 ITR 603 (SC) that the taxing authority is entitled
and is indeed bound to determine the true legal relation resulting from a transaction. If the
parties have chosen to conceal by device the legal relation, it is open to the taxing authority
to unravel the device and to determine the true character of the relationship. However, the
legal effect of a transaction cannot be displaced by probing into ‘the substance of the
transaction’. This principle applies alike to cases in which the legal relation is recorded in a

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.11

formal document and to cases where it has to be gathered from the evidence - oral and
documentary - and the conduct of the parties to the transaction. However, this view of the
Supreme Court has now been expressly disapproved by the Supreme Court in Mc Dowell &
Co. Ltd.’s case.
(iii) Justice Shah, in Ram Laxman Sugar Mills vs. CIT (1967) 66 ITR 613, 617 (SC), has stated
that to ascertain the legal effect of a transaction, the court seeks, in the first instance, to
determine the intention of the parties and if ambiguous expressions are used, the court may
normally adopt such interpretation consistent with the parties thereto having acted on the
assumption of its validity. Thus, any claim made by a taxpayer will be scrutinized from the
point of view of his intention and if there was any intention to defraud the revenue, the court
will consider the transaction or the claim as fraud.

Thus, we can say that unless there is clear evidence of malafide intention resulting in a form
which is a “colorable device” or “mere legal facade” or “non-genuine” form the tax authorities
are not justified in disregarding the legal form and probing into the substance of the
transaction.
Principles governing the form and substance: Theory of interpretation of a taxing statute:
(i) It is well settled that when a transaction is arranged in one form known to law, it will attract
tax liability while, if it is entered into in another form which is equally lawful, it may not. In
considering, whether a transaction attracts tax or not, the form of the transaction put through
by the assessee is to be considered and not the substance thereof.
(ii) The above rule cannot naturally apply where the transaction, as put through by the assessee,
is not genuine but colourable or is a mere device. For here, the question is not one between
‘form’ and ‘substance’ but between appearance and truth.
(iii) In deciding whether the transaction is a genuine or colourable one, it will be open to the
authorities to pierce the corporate veil and look behind the legal facade at the reality of the
transaction.
(iv) Where the authorities are charged under the Act with the duty of determining the nature or
purpose of and payment or receipt on the facts of a case, it is open to them to work at the
substance of the matter and the formal aspect may be ignored.

(v) Where the terms of a transaction are embodied in a document, it should not be construed
only in its formal or technical aspect. While the words used should be looked at, too much
importance should not be attached to the name or label given by the parties and the document

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should be interpreted so as to accord with the real intention of the parties as appearing from
the instrument.
As noted earlier, the decisions of the Supreme Court in the cases of Mc Dowell, Karthikeya Sarabhai
and Associated Rubber Industries, clearly show a preference for the ‘substance’ over the ‘form’, if
the circumstances of the case warrant such a preference. Where the transactions are genuine,
perfectly authentic and not sham, the mere fact that the transaction results in less liability or no
liability to tax should not put the transaction to a legal scrutiny questioning the substance of the
transaction, attributing a motive behind it. It is up to the Court to take stock of the situation, weigh
out sophisticated legal devices and expose the devices for what they really are.
(5) Doctrine of Precedence : Doctrine of Precedence would be applicable in case of tax laws.
The following principles which govern the rule of precedence may be noted.

 Supreme Court:
(i) The Supreme Court judgments are absolutely binding on all the courts, Tribunals and
authorities.

(ii) Not only the ratio decidendi1, but also obiter dicta2 of the Supreme Court are binding
on all the Courts.
(iii) When there are two irreconcilable decisions of the Supreme Court on some point of
law, the decision of a larger Bench shall prevail.
(iv) When there are two irreconcilable decisions of two Benches of similar strength, the
decision later in time will have to be followed by the lower courts.
(v) The Supreme Court judgments cannot be ignored by the lower courts though such
judgments are per incuriam.
(vi) The Supreme Court, though expected to follow its own judgments, is not bound to
follow them and in appropriate cases it can review its earlier judgment .
 High Courts:
(i) A Division Bench of a High Court is generally bound by its earlier decision, but it may
refuse to follow the same if the earlier judgment is per incuriam3.

1 the rationale for deciding a case

2 things said by the way (additional observations, remarks, and opinions given while deciding a case)
3 Without referring to the statutory provision

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.13

(ii) If the Division Bench of a High Court does not agree with its earlier judgment it will
have to either follow the same or refer the issue to a Full Bench.
(iii) A Division Bench of High Court is bound to follow a decision of the Full Bench of the
same High Court.
(iv) A single judge of a High Court is bound by a decision of a Division Bench or of the Full
Bench of the same High Court.
(v) A single judge of a High Court is not bound to follow the decision of another single
judge, though he is expected to follow the same.

(vi) All the lower authorities, Commissioner (Appeals) and Tribunals are absolutely bound
to follow the decision of a High Court within whose jurisdiction they function. Here, the
High Court decisions include decision of a single judge.

(vii) The lower authorities and courts can ignore a decision of a High Court only if it is
overruled by a larger Bench of the same High Court, or by the Supreme Court or by a
later enactment.

 Others:
(i) The Assessing Officer and the Commissioner, while acting under section 263, cannot
refuse to follow the decision of the High Court. They cannot pass orders which are
inconsistent with the decisions of the High Court within whose jurisdiction they
function, even for the purpose of keeping the issue alive.
(ii) In all Indian Acts like the Income-tax Act, 1961, to keep the uniformity of law, a High
Court should normally follow the decision of another High Court, unless it finds an
overriding reason not to follow the same.
(iii) The lower appellate authorities are bound to follow the decision of another High Court,
though they do not function within the jurisdiction of the said High Court, if there is no
contrary decision of any other High Court.
(iv) The Assessing Officer or the Commissioner need not follow the decision of another
High Court if the department has not accepted the said decision and has taken the
matter to Supreme Court.
(v) The Bench of the Appellate Tribunal, should generally follow the orders of other
Benches of the Tribunal, unless those orders of the Tribunal are per incuriam.
(vi) An order of a Full Bench of a Tribunal is binding on the ordinary Bench of the Tribunal.

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(vii) If an ordinary bench of a Tribunal does not agree with an order of another Bench of
the Tribunal, and that order of another Bench of the Tribunal is not per incuriam, the
Bench cannot differ from the view taken by the other Bench. It can only get the matter
referred to a larger Bench. But this is subject to the general rule that as far as possible,
the Bench should try to follow the orders of the Benches.
(viii) The Tribunal orders are binding on the Commissioner (Appeals) falling within the
territorial jurisdiction of the Tribunal passing the order in question.
(ix) The Assessing Officer and the Commissioner are bound by the order of the Tribunal
(falling within the jurisdiction of the Tribunal unless the Department has not accepted
the decision of the Tribunal.)
Summary for Quick Reference of Doctrine of Precedence:
Decision of Will precede over the decision of
Supreme Court
Supreme Court All the Courts, Tribunals and authorities
Larger Bench of Supreme Court Smaller Bench of Supreme Court
Supreme Court at a later point in time Supreme Court at an earlier point in time
(if same strength)
High Court
High Court (even if single judge All the lower authorities, Commissioner
decision) (Appeals), Joint Commissioner (Appeals) and
Tribunals functioning within the jurisdiction of
the High Court
Full Bench of High Court Division Bench of same High Court and single
judge of same High Court
Division Bench of High Court Single Judge of same High Court
Appellate Tribunal
Full Bench of a Tribunal Ordinary Bench of the Tribunal
Tribunal Assessing Officer, Commissioner and
Commissioner (Appeals)

11.2 GENERAL ANTI-AVOIDANCE RULES

There is a growing concern amongst the revenue in many countries that taxpayers structure
transactions to reduce the tax costs. The Base Erosion and Profits Shifting (BEPS) project of the

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Organization for Economic Cooperation and Development ("OECD") along with G-20 countries sort
to tackle this issue. The BEPS Action plans have come out with various recommendations on the
issue, both to address it within the international treaty framework (for example, introducing the
principle purpose test, limitation of benefits clause, amending the permanent establishment clause,
etc.) and in the domestic tax law context (for example, controlled foreign corporation rules,
equalization levy, etc.).
Tax avoidance is not defined in taxing statutes. Tax avoidance is, nevertheless, the outcome of
actions taken by the assessee, none of which or no combination of which is illegal or forbidden by
the law as such. International literature on the subject tends to describe it in the following ways:
 Tax avoidance involves the legal exploitation of tax laws to one’s own advantage.
 Every attempt by legal means to prevent or reduce tax liability which would otherwise be
incurred, by taking advantage of some provisions or lack of provisions in the law.
 An arrangement entered into solely or primarily for the purpose of obtaining a tax advantage.
Taxpayers consider it their legitimate right to arrange their affairs in a manner as to pay the least tax
possible. However, tax authorities internationally consider aggressive tax planning schemes by
taxpayers to erode the tax base unnaturally, particularly when effective rates of tax diminish
significantly. Several countries have, therefore, legislated to prevent tax avoidance in various ways

The General Anti-Avoidance Rules (GAAR) provisions aim at combating 'impermissible tax
avoidance'. Many countries, like the United Kingdom, China, South Africa, Australia, Canada and
Brazil have incorporated General Anti-Avoidance Rules in their domestic tax laws to deal with
aggressive tax planning.

The Indian GAAR

In India, the GAAR concept was initially introduced in the Direct Taxes Code Bill, 2009 [DTC Bill,
2009]. Later, a Revised Discussion Paper was released. The Direct Taxes Code Bill, 2010 [DTC Bill,
2010] proposed to introduce GAAR from 1st April 2012 onwards. The GAAR provisions were
introduced in the Income-tax Act, 1961 vide the Finance Act, 2012 by insertion of new Chapter X-A.
Chapter X-A was substituted by the Finance Act, 2013.
The Government subsequently set up a panel under Parthasarathy Shome to review the proposals.
The Committee suggested that the rules be deferred by three years to 2016 -17, arguing that more
time is needed to create administrative machinery for its implementation and called for intensive
training of officials.

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The Shome Committee Report explains the need for and rationale of GAAR as under :
(i) GAAR has been enacted as a codification of the proposition that, while interpreting the tax
legislation, substance should be selected over a legal form.
(ii) Transactions have to be real and are not to be looked at in isolation.
(iii) The fact that the transactions are legal, does not imply that they are acceptable with reference
to the underlying meaning embedded in the fiscal statute.
(iv) Thus, where there is no business purpose except to obtain a tax benefit, the GAAR provisions
would not allow such a tax benefit to be availed through the tax statute. These propositions
have comprised part of jurisprudence in direct tax laws as reflected in various judicial
decisions.
The GAAR provisions codify this ‘substance over form’ basis of the tax law.

The CBDT, vide Press Release dated January 27, 2017, clarified that the GAAR provisions shall be
effective from A.Y.2018-19 onwards, i.e., financial year 2017-18 onwards. The provisions of GAAR
are contained in Chapter X-A of the Income-tax Act, 1961. The necessary procedures for application
of GAAR and conditions under which it shall not apply, have been enumerated in Rules 10U to 10UC
of the Income-tax Rules, 1962.
Prior to A.Y. 2018-19, the Act contained only Specific Anti-Avoidance Rules (SAARs) to prevent tax
avoidance. SAAR targets known tax planning schemes which are commonly used by taxpayers but
are not acceptable owing to misuse or abuse of tax laws, or they result in a consequence unintended
in the law. In the Act, the following may, inter alia, be considered specific examples of SAAR -
(i) Section 40A(2) on excessive or unreasonable payments to related parties not deductible
(ii) Section 80-IA(8) on transactions with tax exempt entities to be valued at market value.
(iii) Sections 92 to 92F on transfer pricing regulations applicable to international transactions.
These provisions are also made applicable to specified domestic transactions by the Finance
Act, 2012.
(iv) Section 93 on avoidance of tax by transfer of income to non-residents through transfer of
assets, rights or interest.
(v) Section 94 on avoidance of tax by certain transactions in securities.
(vi) Section 94A on transactions with persons located in notified jurisdictions.
(vii) Section 2(22)(e) on deemed dividend.

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(viii) Section 40(a)(i) and (ia) on the disallowance of expenses for non-deduction of tax at source.
(ix) Section 9 on scope of 'income deemed to accrue or arise in India'. The Finance Act, 2012 had
widened its scope to overcome the Supreme Court's ruling in Vodafone and some other cases.
(x) Explanations 1 to 13 to section 43(1) on determination of actual cost of assets ignoring
agreements, etc., in certain cases.
Tax treaties also provide certain anti-avoidance rules for instance, the Limitation of Benefit (LOB)
Clause and concept of Beneficial Ownership.
The above list of provisions relating to SAAR other than section 94 are discussed in the respective
chapters of the Study Material. Before moving to the discussion on provisions of GAAR, let’s
understand section 94.
Special provisions for avoidance of tax by certain transactions in securities [Section 94]

Section 94 aims at preventing avoidance of tax by an assessee by sale or purchase of securities

under different circumstances.

Dividend and Income Stripping transactions [Section 94(7)]

(a) If any person buys or acquires any securities or unit within a period of three months prior to
the record date and

(b) such person sells or transfers –

(i) such securities within a period of three months after such date, or
(ii) such unit within a period of nine months after such date and
(c) the dividend or income on such securities or unit received or receivable by such person is
exempted,
then, the loss, if any, arising therefrom shall be ignored for the purposes of computing his income
chargeable to tax. Such loss would be ignored to the extent of the amount of dividend or income
received or receivable on such securities or unit.
Buying units Dividend declared (Record date) Selling units

Within 3 months Within 9 months

Note – Since dividend and income from units of mutual fund specified under section 10(23D) and
UTI is taxable in the hands of shareholders/unitholders, the provisions of section 94(7) are currently
not relevant in relation to such income.

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In case of dividend from units of business trust, the same would be taxable in the hands of
unitholders, if the Special Purpose Vehicle (SPV) exercises the option under section 115BAA, in
which case the provisions of section 94(7) would not be attracted. However, if the SPV does not
exercise option under section 115BAA, dividend component of income distributed to unit -holders
would be exempt in the hands of unit-holders, in which case the provisions of section 94(7) would
be attracted if the person buys and sells or transfers units within the specif ied period mentioned
above.

Bonus Stripping Transactions [Section 94(8)]

According to section 94(8), where

(a) any person buys or acquires any securities or units within a period of three months prior to
the record date;
(b) such person is allotted additional securities or units without any payment on the basis of
holding such securities or units on such date;
(c) such person sells or transfers all or any of the securities or units referred to in (a) above
within a period of nine months after such date, while continuing to hold all or any of the
additional securities or units referred to in (b), then –
(i) the loss on sale of original securities or units sold within a period of 9 months after the
record date will be ignored for the purpose of computing his income chargeable to tax
and
(ii) the amount of such loss so ignored will be deemed to be the cost of purchase or
acquisition of the bonus securities or units referred to in (b) above, held by him on the
date of such sale or transfer.
Buying securities or units Bonus issued (Record date) Selling original securities
or original units

Within 3 months Within 9 months

Meaning of certain terms
Term Meaning
(i) Record date Such date as may be fixed by -
(i) a company; or

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(ii) a mutual fund or the Administrator of the specified undertaking or

the specified company as referred to in the Explanation to section
10(35);
(iii) A business trust
(iv) An Alternative Investment Fund defined under regulation 2(1)(b) of
the SEBI (AIF) Regulations, 2012 made under the SEBI Act, 1992
for the purposes of entitlement of the holder of the securities or units, as the
case may be, to receive dividend, income, or additional securities or unit
without any consideration, as the case may be.
(iii) Securities The term includes stocks and shares.
(iv) Unit It means
(i) unit of a business trust
(ii) unit of a mutual fund specified in section 10(23D) or unit of the Unit
Trust of India.
(iii) beneficial interest of an investor in an Alternative Investment Fund ,
and shall include shares or partnership interests.

Applicability of General Anti-Avoidance Rule [Section 95]

(i) Section 95 of the Act with regard to the applicability of GAAR provides that an arrangement
entered into by an assessee may be declared to be an impermissible avoidance arrangement
and the consequence in relation to tax arising there from may be determined subject to the
provisions of this Chapter.
(ii) The section further clarifies that the provisions of this Chapter may be applied to any step in,
or a part of, the arrangement as they are applicable to the arrangement .
(iii) The section starts with a non-obstante clause which means, if there is a conflict with
provisions in other sections, then this section shall prevail over other conflicting provisions .
(iv) The term arrangement referred to in section 95 of the Act, has been defined in section 102(1)
and means any step in, or a part or whole of, any transaction, operation, scheme, agreement
or understanding, whether enforceable or not, and includes the alienation of any property in
such transaction, operation, scheme, agreement or understanding;
The term ‘Step’ has been defined in section 102(9) to include a measure or an action,
particularly one of a series taken in order to deal with or achieve a particular thing or object
in the arrangement.

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Example 1
Facts:
M/s India Chem Ltd. is a company incorporated in India. It sets up a unit in a Special Economic Zone
(SEZ) in F.Y. 2019-20 for manufacturing of chemicals. It claims 50% deduction of profits earned
from that unit in F.Y. 2025-26 and subsequent years as per section 10AA of the Act. Is GAAR
applicable in such a case?
Interpretation:
There is an arrangement of setting up of a unit in SEZ which results in a tax benefit. However, this
is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to
him by complying with the conditions imposed and economic consequences of the provisions in the
legislation e.g., setting up the business unit in SEZ area. Hence, the Revenue would not invoke
GAAR as regards this arrangement.
Example 1A
Facts:
In the above example 1, let us presume M/s India Chem Ltd. has another unit for manufacturing
chemicals in a non-SEZ area. It then diverts its production from such manufacturing unit and shows
the same as manufactured in the tax exempt SEZ unit, while doing only the process of packaging
there. Is GAAR applicable in such a case?
Interpretation:
This is a case of misrepresentation of facts by showing production of non -SEZ unit as production of
SEZ unit. Hence, this is an arrangement of tax evasion and not tax avoidance.
Tax evasion, being unlawful, can be dealt with directly by establishing correct facts. GAAR provisions
will not be invoked in such a case.
Example 1B
Facts:
In the above example 1A, let us presume that M/s India Chem Ltd. does not show production of non-
SEZ unit as a production of SEZ unit but transfers the product of non -SEZ unit at a price lower than
the fair market value to SEZ unit and does only some insignificant activity in SEZ unit. Thus, it is
able to show higher profits in SEZ unit than in non-SEZ unit, and consequently claims higher
deduction in computation of income. Can GAAR be invoked to deny the tax benefit?

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Interpretation:

As there is no misrepresentation of facts or false submissions, it is not a case of tax evasion. The
company has tried to take advantage of tax provisions by diverting profits from non -SEZ unit to SEZ
unit. This is not the intention of the SEZ legislation. However, such tax avoidance is specifically dealt
with through the provisions contained in section 10AA(9), as per which provisions of section 80 -IA(8)
would get attracted in such a case. Further, if the aggregate of such transactions entered into in the
relevant previous year exceed the threshold of ` 20 crore, domestic transfer pricing regulations
under section 92BA would be attracted. Hence, the Revenue need not invoke GAAR in such a case,
though GAAR and SAAR can co-exist as per clarification given in the CBDT Circular.

Example 1C

Facts:

In the above example 1B, let us presume, that both units in SEZ area (say A) and non -SEZ area
(say B) work independently. M/s India Chem Ltd. started taking new export orders from existing as
well as new clients for unit A and gradually, the export from unit B declined. The com pany offered
lower profits from unit B in computation of income. Can GAAR be invoked on the ground that there
has been shifting or reconstruction of business from unit B to unit A for the main purpose of obtaining
tax benefit?

Interpretation:

The issue of tax avoidance through shifting/reconstruction of existing business from one unit to
another has been specifically dealt with in section 10AA of the Act. Hence, the Revenue need not
invoke GAAR in such a case, though GAAR and SAAR can co-exist as per clarification given in the
CBDT Circular.

Impermissible Avoidance Agreement [Section 96]

(1) An impermissible avoidance arrangement (IAA) means an arrangement, the main purpose or
one of the main purposes of which is to obtain a tax benefit and also any of the following tests
is satisfied:

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(c) lacks
(a) creates rights, commercial (d) is entered into,
or obligations, (b) results, directly substance or is or carried out, by
which are not or indirectly, in the deemed to lack means, or in a
ordinarily created misuse, or abuse, commercial manner, which are
between persons of the provisions of substance under not ordinarily
dealing at arm's this Act; section 97, in whole employed for bona
length; or in part; or fide purposes

(2) The purpose test of obtaining tax benefit and tainted element test as under clauses (a)
to (d) above are twin conditions that satisfy an impermissible avoidance arrangement. The
purpose test requires that the main purpose or one of the main purposes is to obtain tax
benefit. The term “tax benefit” has been defined in section 102 clause (10) as under -
(a) a reduction or avoidance or deferral of tax or other amount payable under this Act; or

(b) an increase in a refund of tax or other amount under this Act; or

(c) a reduction or avoidance or deferral of tax or other amount that would be payable
under this Act, as a result of a tax treaty; or
(d) an increase in a refund of tax or other amount under this Act as a result of a tax treaty;
or
(e) a reduction in total income or

(f) an increase in loss,

in the relevant previous year or any other previous year.
(3) The first tainted element refers to non-arm’s length dealings where an arrangement creates
rights and obligations, which are not normally created between parties dealing at arm‘s
length. As there are specific transfer pricing regulations (SAAR) applicable to international
transactions and certain specified domestic transactions, this tainted element is to be

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examined only in those transactions which are not covered by Transfer Pricing regulations
and where the main purpose of the arrangement is to obtain tax benefit.
(4) The second tainted element refers to an arrangement which results in misuse or abuse of
the provisions of the Act. It implies cases where the law is followed in letter or form but not in
spirit or substance, or where the arrangement results in consequences which are not intended
by the legislation, revealing an intent to misuse or abuse the law.
Example 2
Facts:

A LTD

K LTD L LTD
Country F4

India 9.95% 9.95%

Ind Co

Under the provisions of a tax treaty between India and country F4, any capital gains arising
from the sale of shares of Indco, an Indian company, would be taxable only in F4 if the
transferor is a resident of F4 except where the transferor holds more than 10% interest in
the capital stock of Indco. A company, A Ltd., being resident in F4, makes an investment
in Indco through two wholly owned subsidiaries (K Ltd. and L Ltd.) located in F4. Each
subsidiary holds 9.95% shareholding in the Indian Company, the total adding to 19.9% of
equity of Indco. The subsidiaries sell the shares of Indco and claim exemption as each is
holding less than 10% equity shares in the Indian company. Can GAAR be invoked to deny
treaty benefit?
Interpretation:
The above arrangement of splitting the investment through two subsidiaries appears to be
with the intention of obtaining tax benefit under the treaty. Further, there appears to be no
commercial substance in creating two subsidiaries as they do not change t he economic
condition of investor A Ltd. in any manner (i.e. on business risks or cash flow), and reveals
a tainted element of abuse of tax laws. Hence, the arrangement can be treated as an
impermissible avoidance arrangement by invoking GAAR. Consequently , treaty benefit

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would be denied by ignoring K and L, the two subsidiaries, or by treating K and L as one
and the same company for tax computation purposes.

(5) The third tainted element refers to an arrangement which lacks commercial substance or is
deemed to lack commercial substance.
(6) The fourth element refers to an arrangement which is entered into, or carried out, by means
of, or in a manner which is normally not employed for a bona fide purpose. In other words, it
means an arrangement that possesses abnormal features. This is not a purpose test but a
manner test.
Arrangement to lack commercial substance [Section 97]

Another alternate condition of an impermissible avoidance arrangement is that the arrangement

lacks commercial substance or is deemed to lack commercial substance in whole or in part.
(1) Under section 97, certain arrangements have been deemed to lack commercial substance as
under –
(a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs
significantly from, the form of its individual steps or a part; or

(b) it involves or includes—

(i) round trip financing;
(ii) an accommodating party;
(iii) elements that have effect of offsetting or cancelling each other; or
(iv) a transaction which is conducted through one or more persons and disguises
the value, location, source, ownership or control of funds which is the subject
matter of such transaction; or
(c) it involves the location of an asset or of a transaction or of the place of residence of
any party which is without any substantial commercial purpose other than obtaining a
tax benefit (but for the provisions of this Chapter) for a party.
(d) it does not have a significant effect upon the business risks or net cash flows of any
party to the arrangement apart from any effect attributable to the tax benefit that would
be obtained (but for the provisions of this Chapter)
(2) Clause (a) is the codification of substance v. form doctrine. It implies that where the
substance of an arrangement is different from what is intended to be shown by the form of

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the arrangement, then the tax consequence of a particular arrangement should be assessed
based on the ―substance of what took place. In other words, it reflects the inherent ability of
the law to remove the corporate veil and look beyond form.
(3) Sub-clause (i) of clause (b) deems an arrangement, which includes round tripping of funds,
to lack commercial substance. For this purpose, the phrase round trip financing has been
further defined. Round trip financing includes any arrangement in which, through a series of
transactions—
(a) funds are transferred among the parties to the arrangement; and

(b) such transactions do not have any substantial commercial purpose other than
obtaining the tax benefit (but for the provisions of this Chapter),
without having any regard to—

(A) whether or not the funds involved in the round trip financing can be traced to any funds
transferred to, or received by, any party in connection with the arrangement;
(B) the time, or sequence, in which the funds involved in the round trip financing are
transferred or received; or
(C) the means by, or manner in, or mode through, which funds involved in the round trip
financing are transferred or received.

Example 3
Facts:

Indco incorporates a Subco in a LTJ (Low Tax Jurisdiction) with equity of US $100. Subco
gives a loan of US $ 100 to another Indian company (X Ltd.) at the rate of 10% p.a. X Ltd.
claims deduction of interest payable to Subco from the profit of business. There is no other
activity in Subco. Can GAAR be invoked in such a case?

Subco
Debt
NTJ

India
Indco X Ltd

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Interpretation:
The arrangement appears to avoid payment of tax on interest income by Indco in case
loan is directly provided by Indco to X Ltd. The arrangement involves round tripping of
funds even though the funds emanating from Indco are not traced back to Indco in this
case. Hence, the arrangement may be deemed to lack commercial substance.
Consequently, in the case of Indco, Subco may be disregarded and the interest income
may be taxed in the hands of Indco.

(4) Sub-clause (ii) of clause (b) deems an arrangement which includes an accommodating party
to lack commercial substance. For this, the phrase “accommodating party ” has been further
defined. A party to an arrangement shall be an accommodating party, if the main purpose of
the direct or indirect participation of that party in the arrangement, in whole or in part, is to
obtain, directly or indirectly, a tax benefit (but for the provisions of this Chapter) for the
assessee whether or not the party is a connected person in relation to any party to the
arrangement.

It means that where a party is included in an arrangement mainly for obtaining tax benefit to
the taxpayer, then such party may be treated as an accommodating party and consequently
the arrangement shall be deemed to lack commercial substance. Also, it is not necessary that
such party should be connected to the taxpayer.

(5) Sub-clause (iii) of clause (b) deems an arrangement, which includes elements that have effect
of offsetting or cancelling each other to lack commercial substance.

(6) Sub-clause (iv) of clause (b) deems an arrangement, which disguises value, source or
location etc. of funds, to lack commercial substance. In other words, such arrangements have
an element of deceit as regards funds.

(7) Clause (c) deems an arrangement to lack commercial substance where it involves the location
of an asset or of a transaction or of the place of residence of any party and such location is
without any substantial commercial purpose. It means if a particular location is selected for
an asset or transaction or residence, and such selection has no substantial commercial
purpose, then such arrangement shall be deemed to lack commercial substance .

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Example 4
Facts:

Country F1 LTJ
100%
Y Ltd A Ltd
Country C1 Debt
49%
India
Z Ltd X Ltd
51%

(i) Y Ltd. is a company incorporated in country C1. It is a non-resident in India.

(ii) Z Ltd. is a company resident in India.
(iii) A Ltd. is a company incorporated in country F1 and it is a 100% subsidiary of Y Ltd.
(iv) A Ltd. and Z Ltd. form a joint venture company X Ltd. in India after the date of
commencement of GAAR provisions. There is no other activity in A Ltd.
(v) The India-F1 tax treaty provides for non-taxation of capital gains in the source
country and country F1 charges no capital gains tax in its domestic law.
(vi) A Ltd. is also designated as a permitted transferee of Y Ltd. Permitted transferee
means that though shares are held by A Ltd, all rights of voting, management, right
to sell etc., are vested in Y Ltd.
(vii) As per the joint venture agreement, 49% of X Ltd’s equity is allotted to A Ltd. and
51% is allotted to Z Ltd.
(viii) Thereafter, the shares of X Ltd. held by A Ltd. are sold to C Ltd., a company
connected to the Z Ltd. group.
As per the tax treaty with country F1, capital gains arising to A Ltd. are not taxable in India.
As per the India – Country C1 tax treaty, capital gains is chargeable to tax in the
source country. Can GAAR be invoked to deny the treaty benefit?
Interpretation:
The arrangement of routing investment through country F1 results in a tax benefit. Since
there is no business purpose in incorporating company A Ltd. in country F1 which is an
LTJ, it can be said that the main purpose of the arrangement is to obtain a tax benefit. The
alternate course available in this case is direct investment in X Ltd. joint venture by Y Ltd.
The tax benefit would be the difference in tax liabilities between the two available courses.

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The next question is, does the arrangement have any tainted element? It is evident that
there is no commercial substance in incorporating A Ltd. as it does not have any effect on
the business risk of Y Ltd. or cash flow of Y Ltd. As the twin conditions of main purpose
being tax benefit and the existence of a tainted element are satisfied, GAAR may be
invoked.
Additionally, as all rights of shareholders of X Ltd. are being exercised by Y Ltd instead of
A Ltd, it again shows that A Ltd lacks commercial substance.
Hence, it is possible to invoke GAAR in this case.

(8) In section 97(4), the following factors are considered relevant but not sufficient for
determining whether an arrangement lacks commercial substance or not, namely —

(i) the period or time for which the arrangement (including operations therein) exists;

(ii) the fact of payment of taxes, directly or indirectly, under the arrangement;

(iii) the fact that an exit route (including transfer of any activity or business or operations)
is provided by the arrangement.

Consequence of impermissible avoidance arrangement [Section 98]

(1) If an arrangement is declared to be an impermissible avoidance arrangement, then the

consequences may include denial of tax benefit or a benefit under a tax treaty. The
consequence may be determined in such manner as is deemed appropriate in the
circumstances of the case. Certain illustrations of the manner have been provided, namely:—

(a) disregarding, combining or re-characterizing any step in, or a part or whole of, the
impermissible avoidance arrangement;

(b) treating the impermissible avoidance arrangement as if it had not been entered into or
carried out;

(c) disregarding any accommodating party or treating any accommodating party and any
other party as one and the same person;

(d) deeming persons who are connected persons in relation to each other to be one and
the same person for the purposes of determining tax treatment of any amount;

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(e) reallocating amongst the parties to the arrangement—

(i) any accrual, or receipt, of a capital or revenue nature; or
(ii) any expenditure, deduction, relief or rebate;
(f) treating—
(i) the place of residence of any party to the arrangement; or
(ii) the situs of an asset or of a transaction,
at a place other than the place of residence, location of the asset or location of the
transaction as provided under the arrangement; or

(g) considering or looking through any arrangement by disregarding any corporate

structure.
(2) It has also been provided that –

(i) any equity may be treated as debt or vice versa;

(ii) any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice
versa; or

(iii) any expenditure, deduction, relief or rebate may be recharacterised.

Treatment of connected persons and accommodating party [Section 99]
(1) As per section 99, for the purposes of Chapter X-A, in determining whether a tax benefit
exists—
(i) the parties who are connected persons in relation to each other may be treated as one
and the same person;
(ii) any accommodating party may be disregarded;
(iii) such accommodating party and any other party may be treated as one and the same
person;

(iv) the arrangement may be considered or looked through by disregarding any corporate
structure.
(2) The term ‘connected person’ is defined in section 102(4). Connected person means any
person who is connected directly or indirectly to another person and includes –

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If Connected Person is an A A Any person who

Company/Fir Company/Firm/ carries on
Individual: Company: Firm/ AOP/ HUF:
m/AOP/BOI/H AOP/BOI/HUF business
any relative any BOI: Any member UF having whose – being an
or who has director or any or relative of substantial director/partner individual or
substantial relative of partner/ such interest in the /member has any relative of
interest in such member or member business of substantial such person
the business director relative of the person or interest in the has substantial
of the such any business of the interest in the
person or partner/me director/partn person or business of that
any relative mber er/member or family or any other person
of such any relative of relative of such
individual – being a
such director/partner company/
director/partn /member Firm/AOP/BO
er/member I/HUF or any
director
/partner/mem
ber or any
relative of
such
director/partn
er/member
has
substantial
interest in the
business of
that other
person

Framing of guidelines under Income-tax Rules [Section 101]

The provisions of Chapter XA have to be applied in accordance with such guidelines and subject to
such conditions as may be prescribed. These guidelines are contained in Rules 10U to 10UC.
(1) As per Rule 10U, the provisions of General Anti Avoidance Rule are not applicable to
(a) an arrangement where the tax benefit in the relevant assessment year arising, in
aggregate, to all the parties to the arrangement does not exceed a sum of rupees three
crores.
(b) a Foreign Institutional Investor -
(i) who is an assessee under the Act;
(ii) who has not taken benefit of an agreement referred to in section 90 or section
90A as the case may be; and
(iii) who has invested in listed securities, or unlisted securities, with the prior
permission of the competent authority, in accordance with the Securities and
Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and
such other regulations as may be applicable, in relation to such investments.

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.31

(c) a person, being a non-resident, in relation to investment made by him by way of

offshore derivative instruments or otherwise, directly or indirectly, in a Foreign
Institutional Investor.
(d) any income accruing or arising to, or deemed to accrue or arise to, or received or
deemed to be received by, any person from transfer of investments made before the
1st day of April, 2017 by such person.
However, the provisions of GAAR shall apply to any arrangement [other than specified in (d)
above], irrespective of the date on which it has been entered into, in respect of the tax benefit
obtained from the arrangement on or after the 1st day of April, 2017.
(2) Where a part of an arrangement is declared to be an impermissible avoidance arrangement, the
consequences in relation to tax shall be determined with reference to such part only [Rule 10UA].
(3) The Assessing Officer shall, before making a reference to the Commissioner under section
144BA(1), issue a notice in writing to the assessee seeking objections, if any, to the
applicability of provisions of GAAR in his case [Rule 10UB(1)].

Implementation of GAAR Provisions under the Income-tax Act, 1961

Clarifications on certain queries about implementation of GAAR [Circular No.7 of 2017 dated
27-1-2017]
The provisions of Chapter X-A of the Income-tax Act, 1961 relating to General Anti-Avoidance Rule
came into force from 1st April, 2017. Certain queries were received by the Board about
implementation of GAAR provisions. The Board constituted a Working Group in June, 2016 for this
purpose. The Board has considered the comments of the Working Group and the following
clarifications were issued:
Question no. 1: Will GAAR be invoked if SAAR applies?
Answer: It is internationally accepted that specific anti avoidance provisions may not address all
situations of abuse and there is need for general anti-abuse provisions in the domestic legislation.
The provisions of GAAR and SAAR can coexist and are applicable, as may be necessary, in the
facts and circumstances of the case.
Question no. 2: Will GAAR be applied to deny treaty eligibility in a case where there is compliance
with LOB test of the treaty?
Answer: Adoption of anti-abuse rules in tax treaties may not be sufficient to address all tax
avoidance strategies and the same are required to be tackled through domestic anti -avoidance rules.
If a case of avoidance is sufficiently addressed by LOB in the treaty, there shall not be an occasion
to invoke GAAR.

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Question no. 3: Will GAAR interplay with the right of the taxpayer to select or choose method of
implementing a transaction?
Answer: GAAR will not interplay with the right of the taxpayer to select or choose method of
implementing a transaction.
Question no. 4: Will GAAR provisions apply where the jurisdiction of the FPI is finalised based on
non-tax commercial considerations and such FPI has issued P-notes referencing Indian securities?
Further, will GAAR be invoked with a view to denying treaty eligibility to a Special Purpose Vehicle
(SPV), either on the ground that it is located in a tax friendly jurisdiction or on the ground that it does
not have its own premises or skilled professional on its own roll as employees.
Answer: For GAAR application, the issue, as may be arising regarding the choice of entity, location
etc., has to be resolved on the basis of the main purpose and other conditions provided under section
96 of the Act. GAAR shall not be invoked merely on the ground that the entity is located in a tax
efficient jurisdiction. If the jurisdiction of FPI is finalized based on non-tax commercial considerations
and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply.

Question no. 5: Will GAAR provisions apply to (i) any securities issued by way of bonus issuances
so long as the original securities are acquired prior to 01 April, 2017 (ii) shares issued post 31 March,
2017, on conversion of Compulsorily Convertible Debentures, Compulsorily Convertible Preference
Shares (CCPS), Foreign Currency Convertible Bonds (FCCBs), Global Depository Receipts (GDRs),
acquired prior to 01 April, 2017; (iii) shares which are issued consequent to split up or consolidation
of such grandfathered shareholding?
Answer: Grandfathering under Rule 10U(1)(d) will be available to investments made before 1st April
2017 in respect of instruments compulsorily convertible from one form to another, at terms finalized
at the time of issue of such instruments. Shares brought into existence by way of split or
consolidation of holdings, or by bonus issuances in respect of shares acquired prior to 1st April 2017
in the hands of the same investor would also be eligible for grandfathering under Rule 10U(1)(d) of
the Income-tax Rules, 1962.
Question no. 6: The expression "investments" can cover investment in all forms of instrument -
whether in an Indian Company or in a foreign company, so long as the disposal thereof may give
rise to income chargeable to tax. Grandfathering should extend to all forms of investments including
lease contracts (say, aircraft leases) and loan arrangements, etc.
Answer: Grandfathering is available in respect of income from transfer of investments made before
1st April, 2017. As per Accounting Standards, 'investments' are assets held by an enterprise for
earning income by way of dividends, interest, rentals and for capital appreciation. Lease contracts

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.33

and loan arrangements are, by themselves, not 'investments' and hence grandfathering is not
available.
Question no. 7: Will GAAR be invoked if arrangement is sanctioned by an authority such as the
Court, National Company Law Tribunal or is in accordance with judicial precedents etc.?
Answer: Where the Court has explicitly and adequately considered the tax implication while
sanctioning an arrangement, GAAR will not apply to such arrangement.
Question no. 8: Will a Fund claiming tax treaty benefits in one year and opting to be governed by
the provisions of the Act in another year attract GAAR provisions? An example would be where a
Fund claims treaty benefits in respect of gains from derivatives in one year and in another year set-
off losses from derivatives transactions against gains from shares under the Act.
Answer: GAAR provisions are applicable to impermissible avoidance arrangements as under
section 96. In so far as the admissibility of claim under treaty or domestic law in different years is
concerned, it is not a matter to be decided through GAAR provisions.
Question no. 9: How will it be ensured that GAAR will be invoked in rare cases to deal with highly
aggressive and artificially pre-ordained schemes and based on cogent evidence and not on the basis
of interpretation difference?
Answer: The proposal to declare an arrangement as an impermissible avoidance arrangement
under GAAR will be vetted first by the Principal Commissioner / Commissioner and at the second
stage by an Approving Panel, headed by judge of a High Court. Thus, adequate sa feguards are in
place to ensure that GAAR is invoked only in deserving cases.
Question no. 10: Can GAAR lead to assessment of notional income or disallowance of real
expenditure? Will GAAR provisions expand the scope of charging provisions or scope of taxable
base and/or disallow the expenditure which is actually incurred and which otherwise is admi ssible
having regard to diverse provisions of the Act?
Answer: If the arrangement is covered under section 96, then the arrangement will be disregarded
by application of GAAR and necessary consequences will follow.

Question no. 11: A definite timeline may be provided such as 5 to 10 years of existence of the
arrangement where GAAR provisions will not apply in terms of the provisions in this regard in section
97(4).

Answer: Period of time for which an arrangement exists is only a relevant factor and not a sufficient
factor under section 97(4) to determine whether an arrangement lacks commercial substance.

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Question no. 12: It may be ensured that in practice, the consequences of a transaction being treated
as an 'impermissible avoidance arrangement' are determined in a uniform, fair and rational basis.
Compensating adjustments under section 98 of the Act should be done in a c onsistent and fair
manner. It should be clarified that if a particular consequence is applied in the hands of one of the
participants, there would be corresponding adjustment in the hands of another participant.
Answer: Adequate procedural safeguards are in place to ensure that GAAR is invoked in a uniform,
fair and rational manner. In the event of a particular consequence being applied in the hands of one
of the participants as a result of GAAR, corresponding adjustment in the hands of another participant
will not be made. GAAR is an anti-avoidance provision with deterrent consequences and
corresponding tax adjustments across different taxpayers could militate against deterrence.
Question no. 13: Tax benefit of INR 3 crores as defined in section 102(10) may be calculated in
respect of each arrangement and each taxpayer and for each relevant assessment year separately.
For evaluating the main purpose to be obtaining of tax benefit, the review shoul d extend to tax
consequences across territories. The tax impact of INR 3 crores should be considered after taking
into account impact to all the parties to the arrangement i.e. on a net basis and not on a gross basis
(i.e. impact in the hands of one or few parties selectively).
Answer: The application of the tax laws is jurisdiction specific and hence what can be seen and
examined is the Tax Benefit' enjoyed in Indian jurisdiction due to the 'arrangement or part of the
arrangement'. Further, such benefit is assessment year specific. Fur ther, GAAR is with respect to
an arrangement or part of the arrangement and therefore limit of INR 3 crores cannot be read in
respect of a single taxpayer only.
Question no. 14: Will a contrary view be taken in subsequent years if arrangement held to be
permissible in an earlier year?
Answer: If the PCIT/Approving Panel has held the arrangement to be permissible in one year and
facts and circumstances remain the same, as per the principle of consistency, GAAR will not be
invoked for that arrangement in a subsequent year.
Question no. 15: No penalty proceedings should be initiated pursuant to additions made under
GAAR at least for the initial 5 years.
Answer: Levy of penalty depends on facts and circumstances of the case and is not automatic. No
blanket exemption for a period of five years from penalty provisions is available under law. The
assessee, may at his option, apply for benefit u/s 273A if he satisfies conditions prescribed therein.

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.35

TEST YOUR KNOWLEDGE

Questions
1. Distinguish between Tax planning and Tax Evasion.
2. Specify with reason, whether the following acts can be considered as (i) Tax planning; or (ii)
Tax management; or (iii) Tax evasion.
(i) Mr. P deposits ` 1,00,000 in PPF account so as to reduce his total income from
` 5,90,000 to ` 4,90,000.
(ii) SQL Ltd. maintains a register of tax deduction at source effected by it to enable timely
compliance.
(iii) An individual tax payer making tax saver deposit of ` 1,00,000 in a nationalised bank.
(iv) A partnership firm obtaining declaration from lenders/depositors in Form No. 15G/15H
and forwarding the same to income-tax authorities.
(v) A company installed an air-conditioner costing ` 75,000 at the residence of a director
as per terms of his appointment but treats it as fitted in quality control section in the
factory. This is with the objective to treat it as plant for the purpose of computing
depreciation.
(vi) RR Ltd. issued a credit note for ` 80,000 as brokerage payable to Mr. Ramana who
is the son of the managing director of the company. The purpose is to increase the
total income of Mr. Ramana (paying tax as per default tax regime u/s 115BAC) from
` 11,20,000 to ` 12,00,000 and reduce the income of RR Ltd. correspondingly.
(vii) A company remitted provident fund contribution of both its own contribution and
employees' contribution on monthly basis before due date.
3. Examine the doctrine of form and substance in the context of tax planning.
4. The merger of a loss making company with a profit making one results in losses setting off
profits, a lower net profit and lower tax liability for the merged company. Would the losses be
disallowed by applying GAAR?
5. A choice is made by a company by acquiring an asset on lease over outright purchase. The
company claims deduction for lease rentals in case of acquisition through lease rather than
depreciation as in the case of purchase of the asset. Would the lease rent payment, being
higher than the depreciation, be disallowed as expense under GAAR?

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6. M/s Global Architects Inc is a company incorporated in country F1. It is engaged in the business
of providing architectural design services all over the world. It receives an offer from Lovely
Resorts Pvt Ltd, an Indian company, for design and development of resorts all over India.
India-F1 tax treaty provides that architectural services are technical services and payment for
the same to a company may be taxed in India. However, if such professional services are
provided by a firm or individual, then payment for such services are taxable only if the firm
has a fixed base in India or stay of partners/ employees in India exceed 180 days. Limitation
of benefit clause does not exist in tax treaty between India-F1.
M/s Global Architects Inc forms a partnership firm with a third party (director of the company)
having only a nominal share in the F1. The firm enters into an agreement to carry out the
services in India. The company seconded its trained manpower to the fi rm.
Thus, the partnership firm claimed the treaty benefit and no tax was paid in India. Can such
an arrangement be examined under GAAR?

Answers
1. Tax planning is carried out within the framework of law by availing the deductions and
exemptions permitted by law and thereby minimizing tax liability. Tax planning is an
arrangement by which full advantage is taken of the concessions and benefits conferr ed by
the statute, without violation of legal provisions. Tax evasion on the other hand is an attempt
to reduce tax liability by dubious or artificial methods or downright fraud. It is illegal and denies
the State its legitimate share of tax.
2. Tax Planning / Tax Management / Tax Evasion
Answer Reason
1. Tax planning Depositing money in PPF and claiming deduction under section 80C
is as per the provisions of law.
2. Tax Maintaining a register of payments subject to TDS helps in
management complying with the obligations under the Income-tax Act, 1961.
3. Tax planning Making a tax saver deposit of ` 1,00,000 in a nationalized bank for
claiming deduction under section 80C by an individual is a permitted
tax planning measure under the provisions of income-tax law.
4. Tax Obtaining declaration from lenders/depositors in Form No. 15G/15H
management by a partnership firm and forwarding the same to Income-tax
authorities is in the nature of compliance with statutory obligation
under the Income-tax Act, 1961.

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TAX PLANNING, TAX AVOIDANCE AND TAX EVASION 11.37

5. Tax evasion An air conditioner fitted at the residence of a director as per the
terms of his appointment would be a furniture qualifying for
depreciation @10%, whereas an air conditioner fitted in a factory
would be a plant qualifying for a higher depreciation @15%. The
wrong treatment unjustifiably increases the amount of depreciation
and consequently, reduces profit and consequent tax liability.
Treatment of air-conditioner fitted at the residence of a director as a
plant fitted at the factory would tantamount to furnishing of false
particulars in an attempt to evade tax.
6. Tax evasion Issuance of a credit note for ` 80,000 by RR Ltd. as brokerage
payable to Mr. Ramana, the son of the Managing Director, to
increase his total income from ` 11.2 lakh to ` 12.00 lakh and to
correspondingly reduce the company’s total income is a method of
reducing the tax liability of the company by recording a fictitious
transaction.
The company is liable to tax at a flat rate of 30%/25%/22%, as the
case may be, whereas Mr. Ramana would not be liable to pay any
tax as per the default regime under section 115BAC, since his total
income does not exceed ` 12,00,000, consequent to which he would
be eligible for tax rebate of entire tax amount under section 87A.
Reducing tax liability by recording a fictitious transaction would
tantamount to tax evasion.
7. Tax Remitting of own contribution to provident fund and employees
management contribution to provident fund on a monthly basis before the due date
is proper compliance with the statutory obligations.

3. The following are certain principles enunciated by the Courts on the question as to whether
it is the form or substance of a transaction, which will prevail in income-tax matters:
(i) Form of transaction is to be considered in case of genuine transactions - It is
well settled that when a transaction is arranged in one form known to law, it will attract
tax liability whereas, if it is entered into in another form which is equally lawful, it may
not. Therefore, in considering whether a transaction attracts tax or not, the form of the
transaction put through is to be considered and not the substance. However, this rule
applies only to genuine transactions. [CIT v. Motor and General Stores (P) Ltd. v. CIT
(1967) 66 ITR 692(SC).
(ii) True legal relation is the crucial element for taxability - It is open for the authorities
to pierce the corporate veil and look behind the legal facade at the reality of the
transaction. The taxing authority is entitled as well as bound to determine the true
legal relation resulting from a transaction. The true legal relation arising from a

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transaction alone determines the taxability of a receipt arising from the transaction
[CIT v. B.M. Kharwar (1969) 72 ITR 603 (SC)]
(iii) Substance (i.e. actual nature of expense) is relevant and not the form – Under
section 97, an arrangement shall be deemed to lack commercial substance if the
substance or effect of the arrangement as a whole, is inconsistent with or differs
significantly from, the form of its individual steps or a part. Accordingly, such
arrangement would be impermissible avoidance arrangement and be subject to GAAR.
However, GAAR provisions will be applicable only to an arrangement where the tax
benefit in the relevant A.Y. arising, in aggregate to all parties to the arrangement
exceeds ` 3 crores. The Income-tax Act, 1961 also contains Specific Anti-avoidance
provisions to address the concern of tax avoidance.
Some examples where Supreme Court has upheld substance over form are -
(a) In case of an expenditure, the mere fact that the payment is made under an
agreement does not preclude the department from enquiring into the actual nature
of the payment [Swadeshi Cotton Mills Co. Ltd. v. CIT (1967) 63 ITR 57(SC)].
(b) In order to determine whether a particular item of expenditure is of revenue or
capital nature, the substance and not merely the form should be looked into.
[Assam Bengal Cement Co. Ltd. v. CIT (1955) 27 ITR 34 (SC)].
4. As regards setting off of losses, the provisions relating to merger and amalgamation already
contain specific anti-avoidance safeguards. Therefore, GAAR need not be invoked when SAAR
is applicable, though as per CBDT Circular No. 7/2017 dated 27.01.2017, GAAR and SAAR can
co-exist. Further, since merger and amalgamation would be carried out under the order of the
National Company Law Tribunal (NCLT), GAAR need not be invoked if the NCLT has explicitly
and adequately considered the tax implication while sanctioning the merger scheme.
5. GAAR provisions would not apply in this case as the taxpayer merely makes a selection out
of the options available to him under the provisions of the Act for which he is eligible and
satisfies the stipulated conditions, if any. Even if choice of such option results in lower tax
liability, the same is a result of tax planning.
6. It is obvious that there was no commercial necessity to create a separate firm except to obtain
the tax benefit. The firm was only on paper as the manpower was drawn from the company.
The firm did not have any commercial substance. Moreover, it is a case of treaty abuse.
Hence, GAAR may be invoked to disregard the firm and tax payment for architectural services
as fee for technical services. However, the rate of tax on such payment shall be as applicable
under the treaty, if more beneficial.

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CHAPTER a
12

TAXATION OF DIGITAL
TRANSACTIONS

LEARNING OUTCOMES

After studying this chapter, you would be able to -

❑ appreciate the meaning of e-commerce and how business is transacted
through E-commerce;
❑ identify the issues and problems in taxing e-commerce transactions;
❑ comprehend the OECD recommendations for taxing e-commerce
transactions under Action Plan 1 of Base Erosion and Profit Shifting
(BEPS) project;
❑ determine the income arising on transfer of virtual digital asset and
taxability thereof;
❑ examine the applicability of the provisions of tax deducted at source on
transfer of virtual digital asset by a resident assessee.

1
 12.2 DIRECT TAX LAWS

CHAPTER OVERVIEW

E-commerce
• Meaning
• How e-commerce transactions takes
place Taxation of Virtual Digital Assets

12.1 INTRODUCTION
The rapid growth of information and communication technology has resulted in substantial expansion
of the supply and procurement of digital goods and services globally, including India. The digital
economy is growing at a faster pace than the global economy as a whole.

At present, in the digital domain, business may be conducted without regard to national boundaries
and may dissolve the link between an income-producing activity and a specific location. Hence,
business in digital domain doesn’t actually occur in any physical location but instead takes place in
"cyberspace." Persons carrying business in digital domain could be located anywhere in the world.
Entrepreneurs across the world have been quick to evolve their business to take advantage of these
changes. It has also made it possible for the businesses to conduct themselves in ways that did not
exist earlier, and given rise to new business models that rely more on digital and telecommunication
network, do not require physical presence, and derives substantial value from data collected and
transmitted from such networks.

The growth of e-commerce economy has revolutionised the concept of brick and mortar to click and
order. The need for physical presence in a jurisdiction is consequently getting diminished. Therefore,
due to transformed business models, communication with suppliers and customers take place
virtually and digitally. Emergence of new age technologies such as 3D printing, sharing economy,
internet of things etc. has revolutionised new business models in line with the digital epoch making
it difficult to identify the location of source or origin point of a business transaction.

The expansion of business in digital form, give rise to certain tax challenges in relation to nexus,
data and characterization of digital transactions. Over the years, to address these tax challenges
certain developments are taking place to tax digital transactions which are carried out either by a
non-resident non-corporate/ a foreign company or by a resident assessee. This chapter
 TAXATION OF DIGITAL TRANSACTIONS 12.3
a

encompasses these developments introduced in the form of taxation of gains arising on transfer of
virtual digital assets by a resident assessee.

12.2 WHAT IS E-COMMERCE?

Clause (a) of Explanation to Section 194O defines “electronic commerce” to mean the supply of
goods or services or both, including digital products over digital or electronic network.

E-commerce or electronic commerce is one of the main components of the Digital Economy. In its
widest sense, it encompasses consumer and business transactions conducted over a network, with
the help of computers and telecommunications. In other words, e-commerce refers to the exchange
of goods or services for value on the internet. E-commerce, inter-alia, includes, online shopping,
online trading of goods and services, electronic fund transfers, electronic data exchanges and online
trading of financial instruments.
1OECD defines e-commerce as the sale or purchase of goods or services, conducted over computer
networks by methods specifically designed for the purpose of receiving or placing orders.
Accordingly, whether a commercial transaction qualifies as e-commerce is determined by the
ordering method rather than the characteristics of the product purchased, the parties involved, the
mode of payment or the delivery channel. The ordering process is considered as a crucial
determinant of an e-commerce transaction in the OECD definition.

E-commerce facilitates trade across borders, increases convenience for consumers, and enables
firms to reach new markets. E-commerce reforms have rapidly evolved through the development of
new business models, which often integrate new and emerging digital technologies as well as new
online payment mechanisms. Many e-commerce business models use online platforms, facilitating
purchases between often unknown and dispersed buyers and sellers. Another emerging trend is the
growth of subscription e-commerce business models, whereby users access goods and services in
a continuous, recurring stream. E-commerce business models integrate digital ordering mechanisms
alongside physical infrastructures, including within brick-and-mortar stores.

1 OECD (2019), Unpacking E-commerce: Business Models, Trends and Policies, OECD Publishing, Paris,
[Link]
 12.4 DIRECT TAX LAWS

12.3 CONDUCT OF BUSINESS IN DIGITAL ECONOMY

E-commerce is a method of conducting business transactions and not a business transaction by
itself. Therefore, the contents of a business transaction done through e-commerce means is no
different from that of a business transaction carried out through traditional means.
New business models expand the e-commerce frontier in two ways. First, new business models can
enable more transactions to move online in a given market or for a given set of participants. Second,
new business models can enable whole new markets to emerge for goods and services that
previously could not have been bought or sold online, or allow new participants to enter the market .
Digital technologies enable e-commerce innovations and often serve as the backbone of business
model developments. Some of these technologies, like smart assistants enabled by artificial
intelligence (AI), constitute new channels for selling or purchasing products over electronic networks.
Similarly, online payment innovations can help to unlock e-commerce potential by promoting trusted
online transactions between unknown parties.
Classification of E-commerce based on parties involved in transactions. Major types are
mentioned below:

(i) Business to Customers (B2C): In this type of e-commerce, transactions take place between
businesses and consumers. In B2C e-commerce, products or services are sold to end-users
(i.e. consumers).
Examples: [Link], [Link], [Link], [Link] etc. are the examples of
B2C e-commerce businesses, where consumers can find almost anything be it books,
electronic products like washing machines, USB storage devices, clothes, shoes or personal
care etc.
 TAXATION OF DIGITAL TRANSACTIONS 12.5
a

(ii) Business to Business (B2B): In B2B e-commerce, transactions take place between two
businesses.
Example: IndiaMART, TradeIndia, Alibaba, [Link] (an online B2B
marketplace for global exporters and importers), Amazon, the US-based ecommerce giant
etc. are the example of B2B online platforms.
(iii) Government to Customers (G2C): The online platform between a government and its
citizens or consumers for paying taxes, registering vehicles, and providing information and
services such as filing of income-tax return etc.

(iv) Government to Business (G2B)/ Business to Government (B2G): In G2B/ B2G

e-commerce, an electronic exchange of any information between businesses and the
government, usually using internet so the cooperation or communication takes place on the
internet. In G2B, government agencies and business use websites, procurement
marketplaces, applications, web services.
Example: Government e-Marketplace (GeM), a one stop portal to facilitate online
procurement of common use Goods & Services required by various Government
Departments/Organizations / PSUs.
INAM-Pro is a web based application, designed by National Highways and Infrastructure
Development Corporation Ltd (NHIDCL) and launched by the Ministry as a common platform
to bring cement buyers and sellers together.
(v) Customer to Customer (C2C): When goods or services are bought and sold between two
consumers, C2C e-commerce business takes place.
Example: Olx, a C2C e-commerce online platform where customer sells his used goods to
other customer; eBay, an online marketplace in which an individual sells a product or service
to another.
E-Commerce Business Models
With the advancement of digitalization and emergence of new technologies, new forms of
e-commerce business models have evolved. Some of such ways of transacting e -commerce
business are discussed here below:
Online platform e-commerce business model:

In the context of e-commerce, online platforms act as intermediaries between buyers and sellers to
facilitate the exchange of goods and services over the Internet. Buyers benefit due to the presence
 12.6 DIRECT TAX LAWS

of variety of products available with diverse sellers. Likewise, sellers discover many buyers to whom
they can sell their products. As compared to the physical stores, digital marketplace deliver variety
of goods and service.
Meaning of Marketplace based model and Inventory based model of e-commerce2:

Marketplace based model of e-commerce means providing an information technology platform by

an e-commerce entity on a digital & electronic network to act as a facilitator between buyer and
seller.
Inventory based model of e-commerce means an e-commerce activity where inventory of goods
and services is owned by e-commerce entity and is sold to the consumers directly.

Subscription e-commerce business model: Subscription business model is characterised by

regular and recurring payments for the repeated provision of a good or a service. The subscription
business model can relate to recurring purchases of digital goods and services, or a combination of
both digital and tangible products (such as a newspaper subscription that includes access to digital
content). Some current e-commerce subscription business models, such as Spotify or Netflix etc.

Digital identity and its potential for e-commerce: Digital identity refers to the set of information
used by a computer to authenticate an identity. For example, India’s Aadhaar programme issues a
unique number to every Indian citizen which is a valid means of identification vis-à-vis the
government as well as private Internet sites including Airbnb, Uber and digital wallet services.
Subscription access to tangible and bundled goods and services: A recent e-commerce trend
has been the growth of subscription business models for tangible goods, including in categories like
beauty supplies (Birchbox), minerals (Celestial Minerals), groceries (Blue Apron, Hello Fresh), snack
foods (Nature Box), cosmetics and self-care products (Dollar Shave Club, Harry’s), and many more.
Online-offline e-commerce business models: These business models serve as extensions of
e-commerce, pushing the edges of online purchases into physical stores. Some business models
combine online ordering with offline distribution, which may be useful to enable the online purchase
of products whose quality may not be assessed from a distance, such as perishable goods like
groceries. Many businesses have taken advantage of the ubiquity of digital technologies to grow
business models based on a combination of both online and offline features. Other online businesses
are moving offline by adding brick-and-mortar elements to enable the online sale of other goods, like
clothing, where fit may be difficult to assess from a distance.

2 Consolidated FDI Policy Circular of 2017, dated 28.8.2017 read with Press Note dated 26.12.2018
 TAXATION OF DIGITAL TRANSACTIONS 12.7
a

Mobile technologies - Helping e-commerce to flourish in brick-and-mortar stores: Mobile

technologies empower consumers to perform a range of digital activities, including online shopping.
Consumers use digital technologies throughout the commercial process, but smartphones enable
buyers to compare prices, to do research and finally make transactions from any networked location.
Online groceries – e-commerce frontier: Many businesses are successfully selling perishable
food and groceries online. Some online business models offer direct shipping of purchased groceries
alongside guarantees related to quality and customer satisfaction to give consumers confidence in
the purchase of perishable goods and services.
Innovative payment mechanisms: Safely and remotely exchanging money online, including across
borders, is fundamental to e-commerce. Safe and effective online payment mechanisms facilitate
trusted online transactions, boosting the growth of e-commerce between unknown buyers and
sellers. Many online payment mechanisms are closely associated with the rise of e -commerce. In
fact, one of the earliest online payment models is “Paypal”, which is emerged in combination with
the pioneering online auction house and e-commerce platform eBay, to enable safe online payments
between the parties involved.
Digital wallets: An online payment can be broadly considered to be a “purchase order placed using
devices connected to the Internet”, a definition that is relevant to many forms of e -commerce. One
mechanism of enabling online payments includes the use of digital wallets, also known as “e-wallets”
or “electronic wallets”.
Digital wallets allow e-commerce by enabling trusted transactions online, without which most
e-commerce purchases would not be possible. Consumers may be more willing to do a transaction
online using a digital wallet as opposed to directly sharing financial information with online retailers.
Mobile money - Extending e-commerce to the unbanked: Another form of payment innovation
that enables e-commerce is the rise of a specific form of mobile payment, also known as “mobile
money”, particularly for unbanked people (i.e. those without access to financial services). Mobile
money differs from digital wallets insofar that the mechanism for payment is conducted via mobile
communication networks, and does not necessarily require an existing relationship with a financial
services provider.
Mobile money is facilitated by mobile network operators who use a system of agents to accept
regular currency in the form of cash and store an equivalent value in a digital wallet, which can then
be transferred to other users or can be withdrawn later. Mobile money is connected with a mobile
phone number and often uses two-factor authentication through a personal identification number
issued at the point of registration. Mobile money can be transferred to others who are also registered
 12.8 DIRECT TAX LAWS

with the same mobile money system, exchanged with merchants for goods and services, or can be
withdrawn as cash from a mobile money agent. Mobile money can therefore act as a means of
storing and transferring value in a secure and convenient way for unbanked people.

Resources: The discussion on E-commerce Business Models in this chapter is essentially based
on the text published in “Unpacking E-commerce: Business Models, Trends and Policies, OECD
Publishing, Paris” available at [Link]

12.4 TAXATION ISSUES RELATING TO DIGITAL

ECONOMY
These new business models have created new tax challenges. The typical taxation issues relating
to digital economy are:
(i) the difficulty in characterizing the nature of payment and establishing a nexus or link between
taxable transaction, activity and a taxing jurisdiction,
(ii) the difficulty of locating the transaction, activity and identifying the taxpayer for income tax
purposes.
The digital business, thus, challenges physical presence-based permanent establishment rules. If
permanent establishment principles are to remain effective in the new economy, the fundamental
PE components developed for the old economy i.e. place of business, location, and permanency
must be reconciled with the new digital reality. Further, characterizing the income as technical
services becomes difficult since the technical services rendered digitally does not involve human
intervention, as the digital platforms operate on sophisticated artificial intelligence mechanism.
Hence the new digital business models gives rise to ‘stateless income’ and thereby going completely
tax free.

12.5 OECD RECOMMENDATIONS UNDER ACTION PLAN 1

OF THE BEPS PROJECT
Due to the tax challenges arising from digitalization, the G20-OECD BEPS Action Plan Committee
as part of its 2015 Action 1 Report identified a number of broader tax challenges raised by
digitalisation, notably in relation to nexus, data and characterisation.
 TAXATION OF DIGITAL TRANSACTIONS 12.9
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The Action Report 1 analysed the following three options, namely -

(i) a new nexus rule in the form of a “significant economic presence” test,
(ii) a withholding tax which could be applied to certain types of digital transactions, and
(iii) an equalisation levy, intended to address a disparity in tax treatment between foreign and
domestic businesses where the foreign business had a sufficient economic presence in the
jurisdiction
The OECD has recommended several options to tackle the direct tax challenges which include:
(1) Modifying the existing definition of permanent establishment to provide for whether an
enterprise engaged in fully de-materialized digital activities would constitute a PE, if it
maintained a significant digital presence in another country's economy.
(2) Introducing the concept of a virtual fixed place of business in the concept of permanent
establishments i.e., creation of a permanent establishments when the enterprise maintains a
website on a server of another enterprise located in a jurisdiction and carries on business
through that website.

(3) Imposition of a final withholding tax on gross basis in case of certain payments made for digital
goods or services provided by a foreign e-commerce provider or imposition of a equalisation levy
on consideration for certain digital transactions received by a non-resident from a resident or from
a non-resident having permanent establishment in other contracting state.
It was concluded that countries could introduce any of these options in their domestic laws as
additional safeguards against BEPS, provided they respect existing treaty obligations, or in their
bilateral tax treaties. The above options can be resorted to as an interim measure until a clear
solution emerges on taxing digital economy.
Taking into consideration the potential of new digital economy and the rapidly evolving nature of
business operations, it becomes necessary to address the challenges in terms of taxation of such
digital transactions. In order to arrive at a long term solution, the OECD along with the BEPS
Inclusive Framework is working on arriving at a consensus based solution to tackle the tax
challenges arising out of the digital economy as part of a ‘Unified Approach’ under Pillar O ne.
Consequent to the BEPS Action Report 1, a committee was constituted by the CBDT to evaluate the
alternatives suggested in the BEPS Action Report 1 for addressing the challenges arising on taxing
the digital economy. Pursuant to the recommendations of the Committee, Chapter VIII of the Finance
Act, 2016, titled "Equalisation Levy" was introduced. It provides for an equalisation levy
@6% of the amount of consideration for specified services received or receivable by a non -resident
 12.10 DIRECT TAX LAWS

not having PE in India, from a resident in India who carries out business or profession, or from a
non-resident having PE in India.
In order to widen and deepen the equalisation levy net beyond online advertisement, its scope ha d
been extended by the Finance Act, 2020 to consideration received or receivable for e-commerce
supply or services made or provided or facilitated on or after 1.4.2020.
However, some stakeholders have raised concerns that the scope of equalisation levy on
e-commerce supply or services made or provided or facilitated is ambiguous and as a result it leads
to compliance burden. In view of this it is proposed that this equalisation levy shall not be applicable
to consideration received or receivable for e-commerce supply or services, on or after the 1st day
of August 2024. Further, vide Finance Act, 2025 the equalisation levy on specified s ervices also
abolished.

12.6 TAXATION OF VIRTUAL DIGITAL ASSETS

There has been a phenomenal increase in transactions in virtual digital assets. Further, a market is
emerging where payment for the transfer of a virtual digital asset can be made through another such
asset. Accordingly, for the taxation of virtual digital assets, a scheme has been introduced by the
Finance Act, 2022.
Meaning of virtual digital asset [Section 2(47A)]
It means -
(a) any information or code or number or token (not being Indian currency or foreign currency),
- generated through cryptographic means or otherwise, by whatever name called,
- providing a digital representation of value exchanged with or without consideration,
- with the promise or representation of having inherent value, or
- functions as a store of value or a unit of account including its use in any financial
transaction or investment, but not limited to investment scheme; and
- can be transferred, stored or traded electronically;
(b) a non-fungible token or any other token of similar nature, by whatever name called;
The non-fungible token means such digital asset as may be notified by the Central
Government.
 TAXATION OF DIGITAL TRANSACTIONS 12.11
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Accordingly, the Central Government has, vide notification no. 75/2022 dated 30.6.2022,
specified a token which qualifies to be a virtual digital asset as non-fungible token. However,
it shall not include a non-fungible token whose transfer results in transfer of ownership of
underlying tangible asset and the transfer of ownership of such underlying tangible asset is
legally enforceable.
(c) any other digital asset, as may be notified by the Central Government.
(d) any crypto-asset being a digital representation of value that relies on a cryptographically
secured distributed ledger or a similar technology to validate and secure transactions,
whether or not such asset is included in point (a) or (b) or (c) above.
However, the Central Government may, by notification, exclude any digital asset from the definition
of virtual digital asset subject to specified conditions.
Accordingly, the Central Government has, vide notification no. 74/2022 dated 30.6.2022, notified
that the following virtual digital assets would be excluded from the definition of virtual digital asset –
(i) Gift card or vouchers, being a record that may be used to obtain goods or services or a
discount on goods or services;
(ii) Mileage points, reward points or loyalty card, being a record given without direct monetary
consideration under an award, reward, benefit, loyalty, incentive, rebate or promotional
program that may be used or redeemed only to obtain goods or services or a discount on
goods or services;
(iii) Subscription to websites or platforms or application
Taxability of income from transfer of virtual digital assets [Section 115BBH]
(1) Tax rate on transfer of virtual digital asset – Where the total income of an assessee
includes any income from the transfer of any virtual digital asset, such income would be taxed
@30% under section 115BBH.
(2) No deduction allowed – In computing the income from transfer of virtual digital asset, no
deduction would be allowed under any provisions of the Act in respect of any expenditure or
allowance except cost of acquisition, if any. Further, no set off of any loss is allowed to the
assessee from such income.
(3) Set off or carry forward of loss from transfer of virtual digital asset not allowed – Loss
from transfer of virtual digital asset would not be allowed to be set off against income
computed under any provision of this Act to the assessee and such loss would not be allowed
to be carried forward to succeeding assessment years.
(4) Virtual digital asset need not to be a capital asset - The definition of “transfer” under
section 2(47) would apply to any virtual digital asset, whether it is a capital asset or not.
 12.12 DIRECT TAX LAWS

Taxability of receipt of virtual digital asset as gift or for inadequate consideration

[Section 56(2)(x)]
In order to tax gift of virtual digital asset in the hands of the recipient, section 56 has been amended
to include virtual digital asset within the definition of “property”.
Accordingly, if virtual digital asset is received by any person from any person
(i) Without consideration: The aggregate fair market value of such virtual digital asset on the
date of receipt would be taxed as the income of the recipient, if it exceeds ` 50,000.
(ii) For inadequate consideration: If the difference between the aggregate fair market value
and such consideration exceeds ` 50,000, such difference would be taxed as the income of
the recipient.
However, the exclusions from the applicability of section 56(2)(x) will apply to gift virtual digital asset
also. For example, if virtual digital asset is received as a gift by an individual from his relative, the
value of the same would not be treated as income.
TDS on payment on transfer of virtual digital asset [Section 194S]
(1) Applicability and rate of TDS – Section 194S requires any person who is responsible for
paying to any resident any sum by way of consideration for transfer of a virtual digital asset
to deduct tax @1% of such sum.
(2) Time of deduction – The deduction is to be made at the time of credit of consideration to the
account of the resident or at the time of payment of such sum by any mode, whichever is earlier.
Where consideration is credited to any account in the books of account of the person liable
to pay such sum, such credit of the sum is deemed to be the credit of such sum to the account
of the payee and tax has to be deducted at source. The account to which such sum is credited
may be called “Suspense Account” or by any other name.
(3) Cases where the consideration for transfer of virtual digital asset is wholly in kind or
partly in kind and partly in cash – In a case where the consideration for transfer of virtual
digital asset is
- wholly in kind or in exchange of another virtual digital asset, where there is no part in
cash; or
- partly in cash and partly in kind but the part in cash is not sufficient to meet the liability
of deduction of tax in respect of whole of such transfer,
the person responsible for paying such consideration has to, before releasing the
consideration, ensure that tax required to be deducted has been paid in respect of such
consideration for the transfer of virtual digital asset.
 TAXATION OF DIGITAL TRANSACTIONS 12.13
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(4) Non applicability of TDS under section 194S – No tax is required to be deducted under
section 194S, where the consideration is payable by the person referred to in column (2) of
the table below and aggregate value of such consideration during the financial year does not
exceed the threshold limit in the corresponding row of column (3) of the table below:
(1) Consideration is payable by Threshold limit
(2) (3)
(i) Specified person, being an individual or a Hindu undivided ≤ ` 50,000
family
- whose total sales, gross receipts or turnover from his
business or profession does not exceed ` 1 crore in case
of business or ` 50 lakhs in case of profession, during the
financial year immediately preceding the financial year in
which such virtual digital asset is transferred; or
- not having any income under the head “Profits and gains of
business or profession”.
(ii) Other than specified person mentioned in (i) above ≤ ` 10,000

(5) Due date of remittance to Government Account [Rule 30] and Furnishing statement and
certificate of TDS u/s 194S [Rules 31A and 31]
Sl. (1) (2) (3) (4)
No. Particulars Specified Person Exchange Any other person
(i) Rule 30 – Time of 30 days from the In case of tax deducted in March, on
payment to end of the month of or before 30 th April.
Government deduction In any other case, on or before 7 days
Account from the end of the month of
deduction.
(ii) Rule 31A –
Furnishing of
Statement of TDS
u/s 200(3)
Form Form 26QE Form 26QF Form 26Q
Time Within 30 days from Common for Exchange and any other
the end of the person
month of deduction Qtr ending Due date
30th June 31st July
30th Sep 31st Oct
31st Dec 31st Jan
31st March 31st May
 12.14 DIRECT TAX LAWS

(iii) Rule 31 – TDS Form 16E to be Form 16A to be furnished within 15

Certificate furnished within 15 days from the due date of furnishing
days from the due TDS statement in Form 26QF/Form
date of furnishing 26Q.
TDS statement in
Form 26QE.

ILLUSTRATION 1
Compute the net income-tax payable by Mr. Abhinav, aged 32 years, who has the following
income for the A.Y.2026-27:
(i) Interest on fixed deposits with SBI (Gross) ` 1,10,000
(ii) Interest on savings bank account with SBI ` 35,000
(iii) Consideration for transfer of VDA ` 4,62,000
(iv) Cost of acquisition ` 21,000
(v) Expenses on transfer of VDA ` 1,000
Mr. Abhinav has exercised option to shift out of section 115BAC.
SOLUTION

Total income (excluding Income from transfer of VDA) is below the basic exemption limit of
` 2,50,000. Therefore, tax on income, other than income from VDA, is Nil. Income of
` 4,41,000 (` 4,62,000 – ` 21,000) from transfer of VDA would be taxable@30% (plus cess
of 4%). The tax on income from transfer of VDA would be ` 1,37,592, being 31.2% of
` 4,41,000. The expenses on transfer of VDA is not allowable as deduction.

Section 194S provides for deduction of tax on payment on transfer of virtual digital asset to
a resident at the rate of 1% of consideration. Hence, the transferee would have deducted tax
of ` 4,620, being 1% of ` 4,62,000.

Tax@10% under section 194A would have been deducted by SBI from ` 1,10,000. TDS
u/s 194A = ` 11,000

Net tax payable by Mr. Abhinav would be ` 1,21,972 [` 1,37,592 – ` 11,000 (TDS u/s 194A)
– ` 4,620 (TDS u/s 194S)].
 TAXATION OF DIGITAL TRANSACTIONS 12.15
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ILLUSTRATION 2
Compute the net income-tax payable by Mr. Siddhanth, aged 24 years, who has the following
income for the A.Y.2026-27
(i) Income from Salaries (computed) ` 8,40,000
(ii) Interest on savings bank account with Axis Bank ` 12,000
(iii) Consideration on transfer of VDA to Mr. Harsh ` 50,000
(iv) Cost of acquisition of VDA transferred ` 5,000
Mr. Harsh is employed with ABC Ltd. on a monthly salary of ` 50,000. In addition, he has
interest on savings bank account with Bank of India.
Mr. Siddhanth has not exercised option to shift out of section 115BAC. Ignore TDS on income
other than VDA.
SOLUTION
Tax payable by Mr. Siddhanth for A.Y. 2026-27
Particulars Amount in `
Total income (excluding income from transfer of VDA) [` 8,40,000 + 8,52,000
` 12,000]
Income from VDA (` 50,000 – ` 5,000) 45,000
Total Income 8,97,000
Tax on income other than VDA
Upto ` 4,00,000 Nil
` 4,00,001 to ` 8,00,000 @5% ` 20,000
` 8,00,001 to ` 8,52,000 @10% ` 5,200 25,200
Tax on income from VDA @30% 13,500
38,700
Less: Rebate u/s 87A 25,200
13,500
Add: Health and education cess @ 4% 540
14,040
Less: TDS under section 194S [Mr. Harsh is a specified person since he
does not have income under the head “Profits and gains of business and
profession” and the consideration payable by him does not exceed
` 50,000. Accordingly, Mr. Harsh need not deduct tax u/s 194S on
Nil
consideration payable to Siddhanth]
Net tax payable 14,040
 12.16 DIRECT TAX LAWS

ILLUSTRATION 3
Compute the net income-tax payable by Mr. Raj, aged 32 years, who has the following income
for the A.Y.2026-27
(i) Business loss (` 3,18,000)
(ii) Interest on fixed deposits with HDFC Bank ` 18,000
(iii) Consideration on transfer of VDA ` 6,20,000
(iv) Cost of acquisition of VDA transferred ` 20,000
SOLUTION

As per section 71, business loss of the current year can be set off against income from other
sources of that year. Therefore, business loss of ` 3,18,000 can be set off against interest of
` 18,000 from fixed deposits.

As per section 115BBH, business loss cannot be set off against income from transfer of VDA.
Therefore, balance business loss of ` 3,00,000 cannot be set off against Income from VDA
of ` 6,00,000 (` 6,20,000 – ` 20,000). The same has to be carried forward to A.Y.2027-28
for set-off against business income of that year.

Tax on Income from VDA would be ` 1,87,200 (i.e., 31.2% of ` 6 lakh).

Section 194S provides for deduction of tax on payment on transfer of virtual digital asset to
a resident at the rate of 1% of consideration. Hence, the transferee would have deducted tax
of ` 6,200, being 1% of ` 6,20,000.

Net tax payable by Mr. Raj = ` 1,87,200 – ` 6,200 = ` 1,81,000.

(6) Non-applicability of section 203A - The provisions of section 203A containing the requirement
of obtaining TAN would not be applicable in case of specified person referred in 4(1).

(7) Cross application of section 194-O and section 194S - In case of a transaction where tax
is deductible under section 194-O along with the section 194S, then, the tax shall be deducted
under section 194S and not section 194-O.

(8) Power of the CBDT to issue guidelines – In case any difficulty arises in giving effect to the
provisions of this section, the CBDT is empowered to issue guidelines, with the prior approval
of the Central Government, for the purposes of removing the difficulty.
 TAXATION OF DIGITAL TRANSACTIONS 12.17
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Every guideline issued by the CBDT shall be laid before each House of Parliament and
shall be binding on the income-tax authorities and on the person responsible for paying the
consideration on transfer of such virtual digital asset.
Accordingly, the CBDT has, with the prior approval of the Central Government, vide Circular
no. 13/2022 dated 22.6.2022, issued the following guidelines. These guidelines would apply
only in cases where transfer of virtual digital asset is taking place on or through an
Exchange. In other cases (like peer to peer and others) provisions of section 194S would
apply.
Question 1: Who is required to deduct tax when the transfer of virtual digital asset is
taking place on or through an Exchange and payment is made by the purchaser to
the Exchange (directly or through broker) and then from the Exchange it goes to
seller directly or through the broker?
Answer: According to section 194S, any person who is responsible for paying to any
resident any sum by way of consideration for transfer of virtual digital asset is required to
deduct tax.
Thus, in a peer to peer (i.e., direct buyer to seller) transaction, the buyer (i.e., person paying
the consideration) is required to deduct tax under section 194S. The tax so deducted is
required to be deposited with Government in accordance with the time and procedure
prescribed in the Act read with the relevant provisions of the Income -tax Rules, 1962.
After deduction, the deductor is required to furnish a quarterly statement (in Form No. 26Q)
for all such transactions of the quarter on or before the due date prescribed in the Income -
tax Rules, 1962. For specified person Form 26QE has been introduced.
It may be clarified that the TDS shall be on consideration for transfer of virtual digital asset
less GST. [Clarified by the CBDT vide circular no. 14/2022 dated 28.6.2022 for all other
transactions not conducted on or through Exchange]
However, if the transaction is taking place on or through an Exchange, there is a possibility
of tax deduction requirement under section 194S at multiple stages. Hence, in order to
remove difficulties for transactions taking place on or through an Exchang e, the following
clarifications have been issued by CBDT:-

(i) In a case where the transfer of virtual digital asset takes place on or through
an Exchange and the virtual digital asset being transferred is owned by a
person other than the Exchange: In this case, buyer would be crediting or making
payment to the Exchange (directly or through a broker). The Exchange, then, would
 12.18 DIRECT TAX LAWS

be required to credit or make payment to the owner of virtual digital asset being
transferred, either directly or through a broker. Since there are multiple players, to
remove difficulty it has been clarified that:
1. Tax may be deducted under section 194S only by the Exchange which is
crediting or making payment to the seller (owner of the virtual digital asset
being transferred). In a case where broker owns the virtual digital asset, it is
the broker who is the seller. Hence, the amount of consideration being
credited or paid to the broker by the Exchange is also subject to tax deduction
under section 194S.
2. In a case where the credit/ payment between Exchange and the seller is
through a broker (and the broker is not seller), the responsibility to deduct tax
under section 194S shall be on both the Exchange and the broker. However, if
there is a written agreement between the Exchange and the broker that broker
shall be deducting tax on such credit/ payment, then broker alone may deduct
the tax under section 194S. The Exchange would be required to furnish a
quarterly statement (in Form 26QF) for all such transactions of the quarter on
or before the due date prescribed in the Income-tax Rules, 1962.
(ii) In a case where the transfer of virtual digital asset takes place on or through an
Exchange and the virtual digital asset being transferred is owned by such
Exchange: In this case, there are no multiple players. The buyer is required to deduct
tax under section 194S. However, there may be a practical issue as the buyer may not
know whether the virtual digital asset being transferred is owned by the Exchange or
not. Hence, there may be genuine doubt in the mind of buyer with regard to its
responsibility to deduct tax under section 194S. This difficulty would also be there if
the buyer is buying virtual digital asset from an Exchange through a broker.
To remove this difficulty, it has been clarified that while the primary responsibility to
deduct tax under section 194S, in this case, remains with the buyer or his broker, as
an alternative the Exchange may enter into a written agreement with the buyer o r his
broker that in regard to all such transactions, the Exchange would be paying the tax
on or before the due date for that quarter. The Exchange would be required to furnish
a quarterly statement (in Form 26QF) for all such transactions of the quarter o n or
before the due date prescribed in the Income-tax Rules, 1962. The Exchange would
also be required to furnish its income tax return and all these transactions must be
included in such return. If these conditions are complied with, the buyer or his brok er
would not be held as assessee in default under section 201 for these transactions.
 TAXATION OF DIGITAL TRANSACTIONS 12.19
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Meaning of certain terms:

(i) The term “Exchange” means any person that operates an application or
platform for transferring of virtual digital assets, which matches buy and sell
trades and executes the same on its application or platform.
(ii) The term “Broker” means any person that operates an application or platform
for transferring of virtual digital assets and holds brokerage account/accounts
with an Exchange for execution of such trades.
Question 2: Question no 1 was with respect to transactions where the consideration
for transfer of virtual digital asset is not in kind. How will this operate in a situation
where it is in kind or in exchange of another virtual digital asset?
Answer: In the above situation, the buyer will release the consideration in kind after seller
provides proof of payment of such tax (e.g., Challan details etc.). In a situation where virtual
digital asset “A” is being exchanged with another virtual digital asset “B”, both the persons
are buyer as well as seller. One is buyer for “A” and seller for “B” and another is buyer for “B”
and seller for “A”. Thus, both need to pay tax with respect to transfer of virtual digital asset
and show the evidence to other so that virtual digital assets can then be exchanged. This
would then be required to be reported in TDS statement along with challan number. Form
26Q has included provisions for reporting such transactions. For specified persons, Form
26QE has been introduced. [Also clarified by the CBDT vide circular no. 14/2022 dated
28.6.2022 for all other transactions not conducted on or through Exchange]
However, if the transaction is through an Exchange there is practical issue in implementing
this provision. In order to address this practical issue and to remove difficulty, it is clarified
that in such a situation, as an alternative, tax may be deducted by the Exchange. Such an
alternative mechanism can be exercised by the Exchange based on written contractual
agreement with the buyers/sellers.
If such an alternative mechanism is exercised,
(i) the Exchange would be required to deduct tax for both legs of the transactions and
pay to the Government. In the Form 26Q it will need to report it as tax deducted on
both legs of the transaction.
(ii) the buyer and seller would not be independently required to follow the procedure
prescribed under proviso to section 194S(1) i.e., to ensure that the tax required to be
deducted has been paid by the other person, before releasing the consideration.
 12.20 DIRECT TAX LAWS

(iii) The tax withheld in kind under section 194S and converted into INR shall be deposited
in the Government Account as per the time line and process given in the Income -tax
Rules 1962.
It has been clarified that there would not be any further TDS for converting the tax withheld
in kind in the form of virtual digital asset into INR or from one virtual digital asset to another
virtual digital asset and then into INR.
Question 3: Whether the provision of section 194Q is also applicable on transfer of
virtual digital asset?

Answer: Without going into the merit whether virtual digital asset is goods or not, it is
clarified that once tax is deducted under section 194S, tax would not be required to be
deducted under section 194Q. [Also clarified by the CBDT vide circular no. 14/2022
dated 28.6.2022 for all other transactions also not conducted on or through
Exchange]
Question 4: Whether the consideration for transfer of virtual digital asset shall be on
Gross basis after including GST/commission or it shall be on “net basis” after
exclusion of these items.
Answer: In order to remove difficulty, it is clarified that the tax required to be withheld under
section 194S shall be on the “net” consideration after excluding GST/charges levied by the
deductor for rendering service.
Question 5: In transactions where payment is being carried out through payment
gateways, there may be tax deduction twice. To illustrate that a person “XYZ” is
required to make payment to the seller for transfer of virtual digital asset. He makes
payment of ` 1,00,000 through digital platform of “ABC”. On these facts liability to
deduct tax under section 194S may fall on both “XYZ” and “ABC”. Is tax required to
be deducted by both?
Answer: In order to remove this difficulty, it is provided that in the above example, the
payment gateway will not be required to deduct tax under section 194S on a transaction, if
the tax has been deducted by the person (“XYZ”) required to make deduction under se ction
194S. Hence, in the above example, if “XYZ” has deducted tax under section 194S on
` 1,00,000, “ABC” will not be required to deduct tax under section 194S on the same
transaction. To facilitate proper implementation, “ABC” may take an undertaking from “XYZ”
regarding deduction of tax.
 TAXATION OF DIGITAL TRANSACTIONS 12.21
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TEST YOUR KNOWLEDGE

Questions
1. Explain the core reasons for difference between the e-commerce transactions and the
traditional business transactions causing difficulty to tax the income of e -commerce
transactions.
2. E-commerce transactions have replaced concepts generally associated with international
transactions traditionally. Discuss briefly the taxation issues involving such transactions.

3. From the following details compute the taxable income of Mr. Mohan for the sale and
purchase of Bitcoins and NFT made during the year:
Date Particulars Units Amount (`)
June 15, 2025 Purchase (Bitcoin) 5000 50,000
July 15, 2025 Sale (Bitcoin) 2500 25,500
July 20, 2025 Sale (Bitcoin) 2500 28,750
Expenses Incurred on Sale of Bitcoin 15,000
August 1, 2025 Purchase (NFT) 10000 1,50,000
August 16, 2025 Sale (NFT) 6000 89,000
August 31, 2025 Sale (NFT) 4000 56,000
Expenses Incurred on Sale of NFT 18,000

Answers
1. The core reasons for difference between e-commerce transactions and traditional business
transactions causing difficulty to tax the income from e-commerce transactions under the
Income-tax Act, 1961 are absence of national boundaries, no requirement of phy sical
presence of goods and no requirement of physical delivery (in certain cases). Since e -
commerce transactions are completed in cyberspace, it is often not clear as to the place
where the transaction is effected, thereby causing difficulty in implementing source rule
taxation.
 12.22 DIRECT TAX LAWS

2. The typical taxation issues relating to e-commerce are:

(1) the difficulty in characterizing the nature of payment and establishing a nexus or link
between taxable transaction, activity and a taxing jurisdiction,
(2) the difficulty of locating the transaction, activity and identifying the taxpayer for income
tax purposes.
3. Computation of Taxable Income of Mr. Mohan
`
Sale of 2500 Bitcoin 15.07.2025
Sale Consideration 25,500
Less: Cost of Acquisition (2500 x 50000/5000) 25,000
Gain 500
Sale of 2500 Bitcoin 20.07.2025
Sale Consideration 28,750
Less: Cost of Acquisition (2500 x 50000/5000) 25,000
Gain 3,750
Sale of 6000 NFT 16.08.2025
Sale Consideration 89,000
Less: Cost of Acquisition (6000 x 150000/10000) 90,000
Loss on Sale of NFT [Neither setoff of loss nor carry forward of loss 1,000
allowed]
Sale of 4000 NFT 31.08.2025
Sale Consideration 56,000
Less: Cost of Acquisition (4000 x 150000/10000) 60,000
Loss on Sale of NFT [Neither setoff of loss nor carry forward of loss 4,000
allowed]
Taxable income 4250

Note: VDA income would be taxed @30% under section 115BBH without any deduction of
expenses.