growth in the economy and fuels industrial activity.

In a Welfare State, the Government takes

primary responsibility for the welfare of its citizens, as in matters of health care, education,
employment, infrastructure, social security and other development needs. To facilitate these,
Government needs revenue. The taxation is the primary source of revenue to the
Government for incurring such public welfare expenditure. In other words, Government is
taking taxes from public through its one hand and through another hand; it incurs welfare
expenditure for public at large. However, no one enjoys handing over his hard-earned money
to the government to pay taxes. Thus, taxes are compulsory or enforced contribution to the
Government revenue by public. Government may levy taxes on income, business profits or
wealth or add it to the cost of some goods, services, and transactions.
Objective of taxation
primary purpose of taxation is to raise revenue to meet huge expenditure as most of
governmental expenditure is financed by taxation however Taxation policy has some non-
revenue objective as well. Since taxation is used as an instrument of economic policy it
affects total volume of production consumption, investment, BOP , distribution of income.
Following are the objectives of taxation
1. Economic development
2. Full employment
3. Price stability
4. Control of cyclical fluctuations
5. Reduction of BOP
6. Non-revenue objective
Income tax is a tax on a year i.e. taxable income of a person levied by central govt at
prescribed rate, the taxpayers are individuals, firms, company, HUF association of person,
trust.
Taxable income means income calculated under provisions of income tax act 1961
section 2(24)
1. Profits and gains.
2. Dividends
3. Voluntary contributions received by a charitable trust
4. The value of any perquisite or profit in lieu of salary.
5. Any capital gains.
6. Any winnings from lotteries,
B. ASSESSMENT YEAR (A.Y.) [SEC. 2(9)]
Assessment year means the period of 12 months commencing on the 1st day of April every
year. It is the year (just after the previous year) in which income earned in the previous year
is charged to tax. E.g., A.Y.2019-20 is a year, which commences on April 1, 2019 and ends on
March 31, 2020. Income of an assessee earned in the previous year 2018-2019 is assessed in
the A.Y. 2019-20.
Taxpoint:
 Duration: Period of 12 months starting from 1st April.
 Relation with Previous Year: It falls immediately after the Previous Year
 Purpose: Income of a previous year is assessed and taxable in the immediately
following Assessment Year.
PREVIOUS YEAR [SEC.3]
Previous Year means the financial year immediately preceding the Assessment Year.
Income earned in a year is assessed in the next year. The year in which income is earned
is known as Previous Year and the next year in which income is assessed is known as
Assessment Year. It is mandatory for all assesses to follow financial year (from 1st April
to 31st March) as previous year for Income-Tax purpose.
Financial Year According to sec. 2(21) of the General Clauses Act, 1897, a Financial Year
means the year commencing on the 1st day of April. Hence, it is a period of 12 months
starting from 1st April and ending on 31st March of the next year. It plays a dual role i.e.
Assessment Year as well as Previous Year. Example: Financial year 2018-19 is - •
Assessment year for the Previous Year 2017-18; and • Previous Year for the Assessment
Year 2019-20
Exceptions to the general rule that income of a Previous Year is taxed in its Assessment
Year
This is the general rule that income of the previous year of an assessee is charged to tax in
the immediately following assessment year. However, in the following cases, income of
the previous year is assessed in the same year in order to ensure smooth collection of
income tax from the taxpayer who may not be traceable, if assessment is postponed till
the commencement of the Assessment Year: 1. Income of a non-resident assessee from
shipping business (Sec. 172) 2. Income of a person who is leaving India either
permanently or for a long period (Sec. 174) 3. Income of bodies, formed for a short
duration (Sec. 174A) 4. Income of a person who is likely to transfer property to avoid tax
(Sec. 175) 5. Income of a discontinued business (Sec. 176). In this case, the Assessing
Officer has the discretionary power i.e. he may assess the income in the same previous
year or may wait till the Assessment year.

C. Definition of certain terms

A. Who is a ‘Person’ under the Income Tax Act?
The 7 categories of “persons” mentioned under the Income Tax Act:
 Individual
 Hindu Undivided Family
 Partnership Firm
  Company
 Association of Persons (AOP) or Body of Individuals (BOI) whether
incorporated or not
 Local Authority panchayat, municipalities, cantonment board, port and trusts.
 Artificial Judicial Body eg life insurance university, corporation.
B.Income – Section 2(24)
Even though income tax is a tax on earnings, the act does not establish a comprehensive
definition of “income.” Instead, the term “income” has been defined broadly by
providing an inclusive meaning. It comprises not only income in its broadest meaning,
but also income mentioned in Section 2(24).

In general, the term “income” refers to the following:

 Any illicit money earned by the assessee;

 Any income earned at sporadic periods;
 Any taxable income obtained from a source outside of India;
 Any advantage that may be quantified in monetary terms;
 Any type of assistance, aid, or reimbursement;
 An individual or HUF makes a gift worth more than INR 50,000 without any
consideration.;
 Any kind of award;
 Causal earnings include winnings from lotteries and horse racing betting, among
other things.
The individuals referred to in this section must have received a benefit in order for this
section to apply; if no benefit has been obtained, the situation is not covered by that
clause. All benefits obtained by the referred individuals are taxed, regardless of whether
they are capital or revenue in origin. A director doesn’t have to be an employee in order
to tax the benefit obtained from the firm. The director’s service has no link to any
advantage gained by the director under Section 2(24) of the IT Act, 1961. The provision
is not intended to limit the company’s ability to advance security deposits to its directors
or relatives in exchange for beneficial compensation, such as getting housing property
on rent18 or advancing interest-free loans. The phrase “whether converted into money
or not” refers to a benefit other than financial payments. The burden is on the assessee
to allege and establish that the benefit was provided to him in violation of any legal
right.

Section 2(24) (iv) of the Income-Tax Act is a unique piece of legislation that includes
both capital and revenue advantages. This clause is meant to take care of a company’s
benefit distribution to its directors, who are in a fiduciary relationship and hold an
office of trust. The primary goal of this legislation is to prohibit corporate directors
from abusing or misusing their official positions for personal gain.
 APPLICATION OF INCOME & DIVERSION OF INCOME BY OVERIDING
TITLES.
INTRODUCTION
Application of Income: when the income is applied after it reaches the assessee, either due to
contractual obligation or exercise of discretion, it is called as application of income.
Application of income refers to a situation where income is applied by a taxpayer for a
specific purpose or utilized in a particular manner, and such application or utilization is
considered as a taxable event. In other words, the income is applied or utilized by the
taxpayer for a particular purpose, and it is treated as the taxpayer's income for tax purposes.
Example: Mr. A is liable to pay Rs. 2,000/- per month to Ms. B (his ex-wife) as an alimony
sum. Mr. A being an employee of Mr. C, instructs him to pay Rs. 2,000/- per month out of his
salary and disburse the remaining salary to him. Whether this amount of Rs. 2,000/- per
month be included in the Total Income of Mr. A or is it a case of diversion of income of Mr. A
and not taxable in his hands?
This is a case of Application of Income by Mr. A and not diversion of Income and hence it
will be included in the Total Income of Mr. A. This is because this amount of Rs. 2,000/- per
month is an obligation of Mr. A to pay to Ms. B out of his income and not an income in which
Ms. B had over riding entitlement from Mr. C before being earned by Mr. A. In other words,
this is an Income of Mr. A, which is applied by him to fulfill an obligation and hence included
in his Total Income and a mere arrangement to make Mr. C make such payments directly to
Ms. B won’t make it a case of Diversion of Income.
Determination test
The respondent in Commissioner of Income Tax, Bombay v. Sitaldas Tirathdas sought to
deduct a sum of Rs. 1,350 in the first assessment year and a sum of Rs. 18,000 in the second
assessment year on the ground that under a decree he was required to pay these sums as
maintenance to his wife and his children. This was disallowed by the Income Tax Officer. The
matter reached till the Supreme Court.

The Supreme Court made a distinction between the amount which a person is obliged to
apply out of his income and an amount which by the nature of an obligation cannot be said to
be the part of the income of the assessee. When the income does not reach the hands of the
assessee due to diversion under an obligation, it is deductible. But on the other hand when the
income is required to be applied to discharge an obligation after such income reaches the
assessee, the same consequence in law does not follow. The first kind of payment is exempted
under the Income Tax Act but not the second one. The second one is a case of application of
income which has been received. The first is a case in which the income never reaches the
assessee, who even if he were to collect it, does so, not as part of his income, but for and on
behalf of the person to whom it is payable. On the facts and circumstances of the case it was
held that it was a mere case of application of income to discharge an obligation. The wife and
children of the assessee who continued to be members of the family received a portion of the
income of the assessee only after the assessee had received the income as his own. Therefore
there was no diversion of income by an overriding charge.
The testator in P.C. Mullick and Another v. Commissioner of Income Tax, Bengal appointed
the appellants as executors and directed them to pay Rs. 10,000 out of the income on the
occasion of his addya sradh. The executors paid Rs. 5,537 for such expenses, and sought to
deduct the amount from the assessable income. The Judicial Committee disallowed the
deduction. It held that whatever payments were made, were done once the income had
reached the hands of the assessee and in pursuance of the obligation imposed upon them by
the testator. This was not the case of diversion of income. It is submitted that the decision of
the Judicial Committee in the above case rightly brings out the intention of the drafters of the
Act. The Act is not concerned about how one spends his money, that is, the Act is indifferent
to the destination of the income. What is of material concern is that whether the income has
reached the hands of the assessee or not. Once it is in the hands of the assessee it is liable for
tax.
The appellant in Provat Kumar Mitter v. Commissioner of Income Tax, West Bengal had
under a contract assigned to his wife the right, title and interest to all dividends and sums of
money which might be declared or might become due on account for the term of her natural
life. In assessing the assessee the Income Tax Officer included the dividend paid to his wife
as his income. It was contended by the assessee that the dividend which his wife received
could not be deemed to be his income.. The department argued that since the shares continued
to stand in the name of the assessee and the dividends had been declared in his name, the
transfer of the dividend to the beneficiary was only an application of the dividend income
and, therefore, the assessee could not claim exemption from being taxed on it as a part of his
own income.

The Court rejected the contention of the assessee and said that since the assessee did not
assign the shares to his wife he therefore, retained the right to participate in the profits of the
company. He did not part with that right. So the dividend accrued to him which was later
given to his wife as per the contract. Therefore it was a case of application of income

Diversion of income by overriding titles

Diversion of income by overriding titles refers to a tax avoidance scheme where an

individual or company transfers their income or assets to another party through a legal
document known as an overriding title. This is done in order to reduce the amount of tax that
would be payable on the income or assets. In this scheme, the individual or company creates
an overriding title, which is essentially a legal document that transfers the right to receive
income or assets from one party to another. The overriding title can be in the form of a lease,
license, or other legal agreement that allows the income or assets to be diverted to another
party.The use of overriding titles to divert income is considered to be an aggressive tax
planning strategy, and may be illegal in some jurisdictions. Tax authorities are typically very
vigilant in monitoring these types of schemes, and individuals or companies who engage in
them may face legal consequences and heavy penalties.

Diversion of Income:
Diversion of income refers to a situation where income is legally diverted by a taxpayer to a
third party before it reaches the taxpayer, and the diverted income is not considered as the
taxpayer's income for tax purposes. In other words, the income is diverted to another person
before it becomes taxable in the hands of the taxpayer.
Essentials
Under the Income Tax Act, for a diversion of income to be recognized, the following
conditions must be met:
a) Existence of a legal obligation: There must be a legal obligation on the taxpayer to apply
the income in a particular manner before it accrues or arises to the taxpayer. This legal
obligation can arise from a contract, an agreement, a statute, or any other legal arrangement.
b) Diversion before accrual or arising of income: The income must be legally diverted to a
third party before it accrues or arises to the taxpayer. Once the income accrues or arises to the
taxpayer, it becomes taxable in the hands of the taxpayer unless it satisfies the conditions for
diversion of income.
c) Diversion without the taxpayer's control: The income must be diverted to a third party
without the taxpayer having control over it. The taxpayer must not have any power or control
over the diverted income after it is diverted.
d) Genuine and bona fide transaction: The diversion of income must be a genuine and bona
fide transaction, and it must not be a sham or colorable transaction intended to evade taxes.
If all these conditions are met, the diverted income will not be treated as the taxpayer's
income for tax purposes, and it will be taxable in the hands of the third party to whom it is
diverted.
Example: M/s ABC is a partnership firm in which A and his two sons B & C are partners.
The partnership deed provides that after the death of Mr. A, B & C shall continue the business
of the firm subject to a condition that 20% of profit of the firm shall be given to Mrs. D (Wife
of Mr. A/ Mother of B & C). After the death of Mr. A, whether this 20% amount of profit be
included in the Total Income of Firm M/s ABC or is a case of diversion of income of M/s
ABC and not taxable in its hands?
This is a case if Diversion of Income and the said 20% amount shall not be included in the
Total Income of M/s ABC, i.e., it is deductible from its Total Income. This is because the
clause mentioned in partnership deed has given an overriding title of 20% profit to Mrs. D
and such income is a precondition for the firm to continue its business. In other words, this
20% profit reaches Mrs. D before it becomes income of the firm and hence it is a case of
diversion of Income.

Case law
Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom)
In Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom), the Bombay
High Court held that the principle of diversion of income by overriding title can be applied
only when there is a legal obligation to divert the income. The case involved a university that
made voluntary donations to its trust, and the trust, in turn, used the donations for charitable
purposes. The university claimed that these donations were a legitimate diversion of income
by overriding title, and, therefore, they were not taxable.
However, the court held that the donations made by the university were voluntary and not
made under any legal obligation. Therefore, these donations could not be treated as a
diversion of income by overriding title, and they were taxable as the income of the university.
The court also observed that a diversion of income by overriding title must be made under a
genuine and legal obligation, and not merely a voluntary payment or transfer of income
Overall, the case of Padmshree Dr. D.Y. Patil Vidyapeeth v. ACIT (2010) 329 ITR 242 (Bom)
reinforces the principle that the diversion of income by overriding title is only applicable
when there is a legal obligation to divert the income.
Commissioner Of Income-Tax Bombay ... vs Nariman B. Bharucha & Sons 1980
Nariman B. Bharucha originally ran his business by himself as a sole proprietor. Later, he
decided to convert this sole proprietorship into a partnership by bringing in his two sons as
partners. In the new partnership, he allocated 37.5% of the profits to each son and kept 25%
of the profits for himself.
The partnership agreement included a specific clause stating that if Nariman passed away, his
25% share of the profits would be paid to his widow. Unfortunately, Nariman did pass away,
and according to the agreement, the firm paid 25% of the profits to his widow.
The firm then tried to claim this 25% payment to the widow as a business expense, hoping to
reduce its taxable income. However, the tax authorities rejected this claim.
To resolve this, the court referred to an earlier case (CIT v. Patuck). In that case, it was
determined that when a specific portion of income is set aside for a particular person or
purpose (creating a “charge”), that income does not actually belong to the person receiving it.
Instead, it directly goes to the designated person or purpose before it can be counted as the
recipient’s income.Applying this principle to the Bharucha case: Since the partnership
agreement designated 25% of the profits to go to Nariman's widow, this amount was
considered “diverted” before it reached the business partners. Because of this diversion, the
money did not technically belong to the partners, and therefore, it couldn’t be used as an
expense deduction for tax purposes. Essentially, the firm couldn’t claim it as a tax-deductible
expense because the money was allocated to the widow right from the start and didn’t form
part of the firm's taxable income.
CIT v. Travancore Sugars and Chemicals Ltd. (1973)
Travancore Sugars and Chemicals Ltd. was a company involved in manufacturing. The
company had a specific arrangement where it paid a certain percentage of its profits to a
charitable trust. This payment was made based on an agreement where the company had
committed to making these payments.
Legal issue: The central issue in the case was whether the payments made to the charitable
trust could be claimed as a deduction from the company's taxable income.
The court held that the payments made to the charitable trust were not deductible expenses
for the company. Here’s the reasoning behind the decision:
1. Nature of the Payment: The court decided that the payments to the charitable trust
were not genuine business expenses. Instead, they were a part of the company’s
commitments based on a pre-determined agreement. Because of this, they did not
qualify as deductions from the company's taxable income.
2. Diverted Income: The payments to the charitable trust were seen as diverting a
portion of the company's profits away from the company's use. Essentially, the court
viewed these payments as amounts that were already earmarked and not available to
the company for its own use. As such, they were not considered part of the company's
taxable income.
 3. Legal Precedents: The court’s decision was influenced by legal precedents that
established how income can be diverted and its implications on taxation. If income is
legally diverted or earmarked for a specific purpose or person, it does not remain as
part of the taxable income of the entity that earns it.
D.ASSESSEE and ASSESSMENT
“Assessee” means
a. a person by whom any tax or any other sum of money (i.e., penalty or interest) is
payable under this Act (irrespective of the fact whether any proceeding under the Act has
been taken against him or not);
b. every person in respect of whom any proceeding under this Act has been taken
(whether or not he is liable for any tax, interest or penalty) for the assessment of his
income or loss or the amount of refund due to him;
c. a person who is assessable in respect of income or loss of another person;
d. every person who is deemed to be an assessee under any provision of this Act; and e. a
person who is deemed to be an ‘assessee in default’ under any provision of this Act. E.g.
A person, who was liable to deduct tax but has failed to do so, shall be treated as an
‘assessee in default’
Types of Assessees9
1. Normal assessee
2. Representative assessee
3. Deemed assessee
4. Assessee in default
 Normal assessee: An individual who is liable to pay taxes for the income earned
during a financial year is known as a normal assessee. Every individual who has
earned any income earned or losses incurred during the previous financial years is
liable to pay taxes to the government in the current financial year. All individuals
who pay interest/penalty or who are supposed to get a refund from the government
are categorised as normal assessees. Say, Mr A is a salaried individual who has
been paying taxes on time over the past 5 years. Then, Mr A can be considered as
a normal assessee under the Income Tax Act, 1961.
 Assessee representative: A person who is Liable to pay taxes on income or losses
caused by a third party. Such a person is known as a representative assessee.
Representatives come into the picture when the person liable for taxes is a non-
resident, minor, or lunatic. Such people will not be able to file taxes by
themselves. The people representing them can either be an agent or guardian.
Consider the case of Mr. X. He has been residing abroad for the past 7 years.
However, he receives rent for two house properties he owns in India. He takes the
help of a relative, Mr. Y, to file taxes in India. In this case, Mr. Y acts as a
representative assessee. If the assessing officer plans to investigate the tax filing,
Mr. Y will be asked to provide the necessary documents as he is the guardian of
the property and represents Mr. X.
  Deemed assessee: An individual might be assigned the responsibility of paying
taxes by the legal authorities and such individuals are called deemed
assessees. Deemed assessees can be:
 The eldest son or a legal heir of a deceased person who has expired without writing a
will.
 The executor or a legal heir of the property of a deceased person who has passed on
his property to the executor in writing.
 The guardian of a lunatic, an idiot, or a minor.
 The agent of a non-resident Indian receiving income from India.
For example, Mr P owns a commercial building from which he earns rent income. He has
prepared and signed a will stating the property should be handed over to his niece after
his death. Upon his death, his niece will be considered as the executor of the property, i.e.
deemed assessee. She will be responsible for paying tax on the rental income thereon.

 Assessee-in-default: Assessee-in-default is a person who has failed to fulfil his

statutory obligations as per the income tax act such as not paying taxes to the
government or not filing his income tax return. For example, an employer is
supposed to deduct taxes from the salary of his employees before disbursing the
salary. He is, then, required to pay the deducted taxes to the government by the
specified due date. If the employer fails to deposit the tax deducted, he will be
considered as an assessee-in-default.
Duty of an assessee
Assesses must file their returns on time and pay their taxes when they are due.
However, an assessee may frequently fail to file their return on time. In this situation,
they may receive a notice from the IT department or the relevant Assessing Officer
requesting information about why the return was not filed for that particular fiscal
year. In this scenario, the assessee must provide a response to the Assessing Officer
explaining why they did not file his returns on time, and he must also file the returns
as soon as he receives the notification.
Assessment- Section 2(8)
Assessment under Section 2(8) is a process of assessing the validity of the assessee’s
claimed income and computing the amount of tax payable by him, followed by the
practise of imposing that tax responsibility on that individual. Every taxpayer has to
furnish the details of his income to the Income-tax Department. These details are to be
furnished by filing up his return of income. Once the return of income is filed by the
taxpayer, the next step is processing the income return by the Income Tax Department.
The Income Tax Department examines the return of income for its correctness. The
process of examining the return of income by the Income Tax department is called
“Assessment”.

Self-Assessment
The assessee himself determines the income tax payable. The tax department has made
available various forms for filing income tax returns. The assessee consolidates his
income from various sources and adjusts the same against losses or deductions or various
exemptions if any, available to him during the year. The total income of the assessee is
then arrived at. The assessee reduces the TDS and Advance Tax from that amount to
determine the tax payable on such income. Tax, if still payable by him, is called self-
assessment tax and must be paid by him before he files his return of income. This process
is known as Self Assessment.
Summary Assessment
It is a type of assessment carried out without any human intervention. In this type of
assessment, the information submitted by the assessee in his income tax return is cross-
checked against the information that the income tax department has access to. In the
process, the reasonableness and correctness of the return are verified by the department.
The return gets processed online, and adjustments for arithmetical errors, incorrect
claims, and disallowances are automatically done.

For example, credit for TDS claimed by the taxpayer is found to be higher than what is
available against his PAN as per department records. Making an adjustment in this regard
can increase the tax liability of the taxpayer. After making the aforementioned
adjustments, if the assessee is required to pay tax, he will be sent an intimation under
Section 143(1). The assessee must respond to this intimation accordingly.
Regular Assessment
The income tax department authorizes the Assessing Officer or Income Tax authority, not
below the rank of an income tax officer, to conduct this assessment. The purpose is to
ensure that the assessee has neither understated his income nor overstated any expense or
loss nor underpaid any tax. The CBDT has set certain parameters based on which a
taxpayer’s case gets picked for a scrutiny assessment.
a. If an assessee is subject to a scrutiny assessment, the Department will send a notice
well in advance. However, such notice cannot be served after the expiry of 6 months from
the end of the Financial year, in which the return is filed.
b. The assessee will be asked to produce the books of accounts, and other evidence to
validate the income he has stated in his return. After verifying all the details available, the
assessing officer passes an order either confirming the return of income filed or making
additions. This raises an income tax demand, which the assessee must respond to
accordingly.
Scrutiny Assessment
After submitting an income tax return, an Income Tax Officer may be assigned by the
Income Tax Department to assess the tax filing. The taxpayer is informed of this through
an Income Tax Notice under Section 143(2). The officer may request information,
documents, and books of accounts for scrutiny assessment, which will be thoroughly
examined. The officer then calculates the income tax payable by the taxpayer, and if there
is a mismatch between the income and the tax due, the taxpayer can either pay the extra
amount or receive a refund.
If the taxpayer is not satisfied with the assessment, they can apply for recitation under
Section 154 or submit a revision application under Section 263 or Section 264. If the
Scrutiny Assessment order is still considered invalid, the taxpayer can appeal to higher
authorities such as CIT (A), ITAT, High Court, and The Supreme Court, in that order.
Best Judgement Assessment
 This assessment gets invoked in the following scenarios:
a. If the assessee fails to respond to a notice issued by the department instructing him to
produce certain information or books of accounts.
b. If he/she fails to comply with a Special Audit ordered by the Income-tax authorities.
c. The assessee fails to file the return within the due date or such extended time limit as
allowed by the CBDT
d. The assessee fails to comply with the terms as contained in the notice issued under
Summary Assessment After providing an opportunity to hear the assessee’s argument, the
assessing officer passes an order based on all the relevant materials and evidence
available to him. This is known as the Best Judgement Assessment.
Income Escaping Assessment
When the assessing officer has sufficient reasons to believe that any taxable income has
escaped assessment, he has the authority to assess or reassess the assessee’s income. The
time limit for issuing a notice to reopen an assessment is 4 years from the end of the
relevant assessment Year.
Some scenarios where reassessment gets triggered are given below.
a. The assessee has taxable income but has not yet filed his return.
b. The assessee, after filing the income tax return, is found to have either understated his
income or claimed excess allowances or deductions.
c. The assessee has failed to furnish reports on international transactions, where he is
required to do so. Assessment could close quickly for some taxpayers, while it could
prove to be quite gruelling for others. If you are not comfortable dealing with income tax
officers, it is suggested that you take the help of a Chartered Accountant to help you with
your case.

E. What is a Capital Receipt?

Capital receipts hese are the cash inflow in business arising from financial (capital)
activities and not from operating activities, since these are the funds received by a
business which are not revenue in nature and lead to an overall increase in the total
capital of a company.
These are receipts which are of occasional nature and not of routine nature
As these funds are generated from non-operating activities of a business so these are not
displayed inside the income statement instead, they are shown inside a balance sheet
and these ends up increasing the liability or reducing the assets of a company. Receipts
of this kind do not affect the overall profit or loss of an organization and are booked on
accrual basis.
Purpose of Capital Receipt
The main goal of capital receipts is to increase an enterprise's revenue-generating ability. This
can lead to a significant inflow of cash in a short period, which can be used for long-term
investments or paying off debts, thus enhancing the financial viability of an enterprise.
For example, the Government of India sets yearly disinvestment targets as a means to raise
revenue and manage the fiscal deficit of the economy.
Capital Receipt is Taxable or Not
As per the official website of the Income Tax department, “all capital receipts are exempt
from tax unless there is a specific provision for taxing them."
Capital receipts are subject to capital gains tax only when they involve a transaction in capital
assets. Otherwise, there is no specific provision for taxing capital receipts.
Capital gains are essentially the rise in the price of an asset while it is sold. It is applicable to
the difference between the final and original price of the capital asset. A capital asset can be a
stock or bond and tangible fixed assets such as machinery, inventory and land.
Capital Receipts Examples
There are several ways in which a company can receive capital receipts. We illustrate it with
some examples:
 Selling Shares to the Public and Shareholders: When a private company sells its
shares to the public for the first time, it has to opt for an Initial Public Offering (IPO).
It is the debut of the company on the stock exchange. Those who buy the shares of the
company are shareholders in the primary market.
After a stock is listed on a stock exchange, these investors can sell these shares at a
higher price than what they bought them for. The sale of shares in the secondary
market results in capital gains.
In the process of buying shares, they are essentially giving money to the company.
Thus it shores up the capital receipts of the company. IPOs are a major source of
money for companies.
 Sale of Assets: Selling assets is an important way of raising capital receipts.
Such capital receipts lead to an increase in a company's net worth. It can include the
sale of property, land, buildings, machinery, inventory, patents, copyrights, goodwill
and other fixed assets. It can also include the selling of bonus shares.
In the case of the Indian Government, this also includes disinvestment of Public
Sector Undertakings (PSU).
 Borrowing Loans: Borrowings are capital receipts created by taking loans or issuing
debt instruments such as bonds or treasury bills (T-bills). On the balance sheet, these
borrowings are recorded as a liability. When the interest is paid for these borrowings,
it will be registered as an expense. Thus borrowings create a debt-oriented capital
receipt.
A company can take a loan from a bank or financial institution to finance a new
project or business endeavour. This is registered as a liability in the balance sheet as
the company is bound to repay it with interest. It is also a capital receipt as it is
recorded as inflows in the company’s cash account.
  Small Savings Scheme: Like borrowings, this is also a debt capital receipt as it
creates a liability for a government. Some of the famous examples of small savings
schemes in India are National Saving Certificates, Kisan Vikas Patra, Sukanya
Samriddhi Scheme, and Post Office Time Deposits.
 Issuing Debentures and Other Debt Instruments: Government entities and
companies often issue debt instruments in the form of bonds and debentures. They
practically act like a loan and help finance a company or government’s activities.
Debentures are not backed by any collateral and their purchase depends on the
creditworthiness and reputation of the issuer. Companies issue debentures because
they have a long repayment period and lower interest rates.
 Insurance Claims for Physical Damage: A company can buy insurance for reasons
such as protection for its equipment or hardware. After judging its exposure to risks, a
company can judge how much it should invest into buying an insurance plan. Once
insurance is claimed, it will be categorised as a capital receipt because it entails cash
inflows.
 Government Grants: Non-repayable funds provided by the government for specific
projects or purposes, such as infrastructure development or research and development
activities.
A. Bodiless Considerations5
In deciding whether a particular receipt is of a capital or earnings type, the following
considerations are considered to be immaterial and not going to decide or change the
character or nature of the receipt.
1. Receipt in lump sum or in Instalments. Whether any income is received in lump sum
or in instalments, it’ll not make any difference as regards its nature, e.g., a jobholder
is to get a payment of 1,000p.m. rather of this he enters into an agreement to get a
sum of 36,000 in lump sum to serve for a period of three years. The receipt where it’s
yearly remuneration or lump sum for 3 years is a revenue receipt. It has been decided
in so numerous court cases that a lump sum receipt may be an item of revenue nature
and a periodic receipt reoccurring over many years may be a capital receipt. therefore,
whether a receipt is a periodic receipt or a single receipt is immaterial for the purposes
of determining its nature. (Rajah Manyain Meenak and Shammav.C.I.T.(1956) 30
1.T.R. 286).
2. Nature of receipt in the hands of beneficiary- Whether a receipt is capital or revenue
will be determined in the hands of the persons entering similar income. No attention
will be paid towards the source from which the quantum is coming. payment indeed if
paid out of capital by a new business will be it revenue receipt in the hands of
jobholder.
3. Magnitude of receipt- The magnitude of the receipt, whether big or small, cannot
decide the nature of the receipt although the size of a receipt in a transaction isn’t an
entirely inapplicable consideration. A receipt of 10,000 may be of revenue nature
whereas a receipt of only ‘1,000 may be a capital receipt. Supreme Court has presided
in a case Divenchav.C.I.T.(48 1.T.R. 222), that the magnitude of a receipt is
immaterial for the purpose of determining its nature.
4. Name given by parties and treatment in books of accounts- What name the beneficiary
or payer of the receipt has given in the books of accounts or with what name he has
 called a particular transaction, all similar considerations are immaterial to decide the
nature of the receipt. A capital payment by a dealer may be a revenue receipt in the
hands of the recipient. The character of the receipt shall be decided by considerations
other than by what name the parties call it. (Divenchav.C.I.T.). The nature of the
receipt will be determined in the hands of the person receiving similar income.
5. Payment made out of capital- No attention will be paid towards the source from which
quantum is coming. payment indeed paid out of capital by a new business will be a
revenue receipt in the hands of the employee. It was also decided in a case that if a
receipt is made out of capital, the receipt may also be a capital receipt. However,
payments given to him by his trustees out of the corpus would be capital receipts, if a
recipient is beneficially entitled not only to the income but also to the capital.
(Brodie’s Trusteesv.I.R. 25T.C. 13, 16).
 Time of receipt- The nature of the receipt has to be determined at the time when it’s
took and not latterly when it has been appropriated by the recipient.
 Quality of receipt- Whether the income is received willingly or under a legal
obligation, it’ll not make any difference as regards its nature.
Distinguishing Tests6
It’s truly delicate to draw a line of separation between capital receipts and revenue receipts.
Indeed the courts have institute it delicate to lay down some points of distinction on the base
of which a capital receipt may be distinguished from a revenue receipt. Some tests, still, can
be applied in particular cases. These tests are
1. On the bedrock of nature of assets. However, it’s capital receipt and if it’s referable to
circulating asset it’s revenue receipt, if a receipt is preferable to fixed asset.
 Fixed asset is that with the help of which holder earns gains by keeping it in his
possession, e.g., factory, instrument, structure or manufactory, etc.
 Circulating asset is that with the help of which possessors earn profit by parting with
it and letting others to become its proprietor, e.g., stock- in- trade.
 Circulating asset is asset which is turned over and while being turned over yields
profit or loss whereas fixed asset is one on which the proprietor earns profit by
keeping it in his own possession.
 Profit on the sale of motor car used in business by an assessee is capital receipt
whereas the profit earned by an automobile dealer, dealing in cars, by selling a car is
his revenue receipt.
2. Termination of source of income. Any sum entered in compensation for the termination
of source of income is capital receipt, e.g., compensation received by a jobholder from its
employer on termination of his services is capital receipt.
3. Amount received in replacement of income. Any sum entered in replacement of income
is revenue receipt, e.g., ‘A’ company bought the right to produce a film from its earlier
director with the condition that no other stage director will be given these rights. Latterly it’s
found that the rights for producing this film had formerly been vended. The ‘A’ company
claimed damages and was awarded 60,000. It was held that damages admitted are the
compensation for the gains which were to be earned. Hence this is revenue receipt.
4. Compensation received on termination of lease. Where a sum is received as
compensation for termination of a lease, it’s capital receipt because it’s termination of source
of income.
5. Compensation on rendition of a right. Any quantum received as compensation on
surrendering a right is capital receipt whereas any quantum received for loss of unborn
income is a revenue receipt. An author gives up his right to publish a book and receives as
compensation. It’s capital receipt but if he receives it as advance royalty for 5 years it’s
revenue receipt.
6. Tests as to the purpose of keeping an article. However, if sold latterly on, will bring
unproductive receipt but if the same sculpture is sold by an art dealer it’ll be his revenue
receipt, if a person purchases a piece of sculpture to keep as decoration piece in his house.
7. Still, the profit arising from its revenue receipt, if an article is acquired for the purpose of
trade.

What is a Revenue Receipt?

Revenue receipts refer to the receipts of income which a company or government makes
from its day-to-day activities. It does not involve the creation of liabilities or the sale of
assets. It is a function of the products and services which are offered in the market.
These revenues are recurring in nature as they are the products of the daily business of a
company or government. It is part of the profit-and-loss or income statement of a company.
From the definition, it is clear that any type of receipt needs to satisfy one of the two
conditions to be called as revenue receipt –
 First, it must not reduce the assets of the company.
 Second, it must not create any liability for the company.
Purpose of Revenue Receipt
Revenue receipts are a key resource for a company. The very reason for a business’s
existence is to generate revenue. Revenue receipts help to accomplish this on a day-to-day
basis. This has further implications.
For example, when a business offers goods and services in the market it expands the number
of choices available to customers. With more revenue receipts, a company will also be able
to expand operations, thus hiring more people, and creating more jobs and wealth for the
national economy.
The two main advantages of revenue receipt are that it does not lead to the creation of
liabilities or the selling of major assets. It is recurring in nature. Thus, it is essential for not
just the success but for the very survival of a business.
Revenue Receipt is Taxable or Not
As per the official website of the Income Tax department, under the IT Act, 1961, all revenue
receipts are taxable, unless they are specifically granted exemption from tax.
Thus, all revenue receipts of a company are taxed as part of its annual income.
Revenue Receipts Examples
In this section, we will explain revenue receipts with some examples:
 Selling of Products or Services: The revenue that a company makes by selling goods
and services regularly is part of its revenue receipts. For example, every time you
buy food from a food delivery app or clothes from an e-commerce website, the
transaction is registered in its income statement and becomes part of its revenue
receipts.
 Tax Revenue: The revenue which a government earns by imposing taxes becomes
part of revenue receipts. The government uses this money to fund schemes, projects
and the welfare of the country.
This can be further divided into direct and indirect taxes.
 Direct Tax: It refers to taxes imposed on individuals, companies, and specific
things like inherited wealth. Some examples are income tax, wealth tax,
corporate tax, capital gains tax, etc. All of these can boost the revenue receipts
of a government.
 Indirect Tax: This includes taxes imposed on goods and services. In this case,
the actual responsibility for paying tax can be shifted from one part of the
supply chain to the other.
For example, if the government imposes a tax on any commodity, then sellers
should be the ones paying tax. Instead, the seller can shift the burden of paying
taxes to the consumer. This is also a recurring transaction and part of
the revenue receipt of a government body.
 Non-Tax Revenue: As the name suggests, it refers to revenue receipts which are not
generated from taxes. In the case of governments, this includes fees charged for
services, interest on loans, fines and penalties, profits and dividends from PSUs, etc.
 Receiving Discounts: When a company receives discounts from its supplier or
vendor, it is also considered a revenue receipt because it doesn’t lead to an increase
in liabilities of the company.
 Government Grants and Subsidies: Regular grants and subsidies received from the
government to support operational activities.
 Miscellaneous Income: Any other minor or irregular income not classified under the
above categories, such as gains from foreign exchange fluctuations, recovery of bad
debts, or refunds and rebates.
 Proportional and regressive rates of taxation

The tax is levied on the income of individuals and businesses, and the rate of tax depends on the
amount of income earned. Considering the relation between the tax rate and the tax base (income),
there can be four types of taxation, viz.: (i) Proportional taxes, ii) Progressive taxes, (iti) Regressive
taxes and (iv) Digressive taxes.

In India, there are two types of rates of income tax proportional rate of taxation and progressive rate
of taxation

Income tax is one of the primary sources of revenue for governments around the world. It is a direct
tax levied on the income of individuals, companies, and other entities. The rates of income tax can be
levied through two methods-

a proportional rate of taxation or a

progressive rate of taxation.