Income Tax: Definitions | Commerce & Accountancy Optional Notes for UPSC PDF Download

Concept Of Income

Income tax is levied on income of an entity; it is important to know what income is and how it is computed. In this section, we will deal with the definition of Income and some basic principles related to it. The procedure of computing the total income will be dealt with in detail in some consequent sections. 

The subject matter of income tax is ‘Income’, but no definition of income has been given in the Income Tax Act. Section 2(24), of the Act only indicates inclusion of certain items which are given below: 

• Profits and Gains 
• Dividend 
• Income from voluntary contributions received by following:
  a) Any trust or institution which has been established for the purpose of charitable or religions purposes
  b) A scientific research association
  c) A games or sports association
  d) A charitable fund or a trust or institutions created for wholly public religion purposes
  e) Any university or other educational institution
  f) Any hospital or other institution 
• Perquisites or profits in lieu of salary to employees 
• Any special allowance or benefit besides perquisites to employees to meet expenses for performing their duties 
• Income from units of Unit Trust of India (tax free W.e.f. A Y. 2004-05) 
• Income from units of Mutual Fund (tax free W.e.f. AY. 2004-05) 
• Income from Marketing Association (W.e.f. AY. 2003-04) 
• Any allowance granted to meet increased cost of living 
• Value of any benefit or perquisites received by any director of company or any person having substantial interest in company or his relative 
• Value of benefit or perquisite received by representative assessee 
• Profits generated from any business or profession 
• Capital gain 
• Recovery of bad debts allowed in the past 
• Refund of excise duty 
• Balancing charge 
• Any interest, salary, bonus, commission and other remuneration received by partner of a firm 
• Amount received from winning of lottery, crossword puzzles, play cards and horse race with effect from Assessment Year 2002-03. The  term ‘lottery’ shall include winnings through draws or any other ways. Play cards and other games shall also include any game or any other entertainment programme on televisions, for the purpose of winning the prize 
• Amount received from employees for contribution in following funds:
  a) Any fund established under Employees State Insurance Act, 1948
  b) Any fund established for labour welfare
  c) Provident fund or superannuation fund for employees 
• Profits from sale of license received under import control order, 1995 
• Cash subsidy in respect of export under any scheme of Government of India 
• Sum received  exceeding R s. 50,000 from non- r e l a t i ve w i t h out consideration
• Sum received under Keyman Insurance Policy. This sum also includes bonus
• Income shall include the profits and gain of any business of banking (including providing credit facilities) carried on by a co-operative society with its members (W.e.f. A.Y. 2007-08)
• Maximum amount of casual income upto Rs 10,000 is exempt from tax deduction at source. However, there is no TDS on winnings from other than horse races, gambling, or betting. 

The above definitions of income are not comprehensive. Besides the above items, other receipts and benefits are also treated incomes under Income-tax Act. 

Basic Principles

As mentioned at the very outset, the Act does not define the concept of income but merely states what amounts are to be included in the term ‘Income’. The word income has been given a very wide meaning. Therefore, in the absence of any such guidelines, the Income Tax Department and the taxpayers have to depend upon various judgments of the High Courts and the Supreme Court. 

All receipts are not income. Only those receipts must be treated as incomes which satisfy the guidelines laid down by various High Court and Supreme Court.

1. The word ‘Income’ connotes a periodical monetary receipt coming in from some definite source with some sort of regularity. The source need not be continuously productive one but must be one whose object is income.
2. Income is a periodical yield measurable in terms of money or money’s worth and arises out of use of real or personal property i.e., the income may be received in cash or kind. Thus, the receipts in kind, which can be measured in terms of money, shall be taxable as income.
3. Periodicity or regularity or at least expected regularity is an important element of income. Regularity does not imply that a single receipt is not income.
4. Income includes money that has become due though not received.
5. A receipt which is ‘income’ will continue to be so even if it is exempt from tax.
6. Income means real income. Fictional or technical income cannot be termed as income for the purpose of the Income Tax Act, 1961.
7. Income must come from outside. Pocket money received by a student from his father cannot be termed as an income.
8. Legality or otherwise of income or source of income does not dictate whether a receipt can be termed income. You are required to pay tax on illegally earned income as well. This, however, does not grant immunity from prosecution.

Definition of Person

The term “Person” is defined in Section 2(31) of the Act. It is an inclusive definition implying list of entities which can be treated as a “person”. The term person includes the following:

1. An individual, e.g., Ramesh, Hari, Sita, etc.
2. A Hindu Undivided Family
3. A Company
4. A Firm
5. An Association of Persons or a body of individuals whether incorporated or not, e.g., co-operative society,
6. A Local Authority, e.g., Municipality, District Board, etc. and
7. Every artificial juridical person not falling within any of the categories mentioned above.

It will, thus, be seen that the word person is defined in very wide terms. A minor would also be included in the definition of persons in some circumstances. All the persons described above are liable to pay income tax under the Income Tax Act, 1961.

Definition Of Assessee

The term assessee has been defined in Section 2(7) of the Income Tax Act, 1961. “Assessee” means a person by whom any tax or any other sum is payable under this Act. The term is defined to include the following:

1. Every person in respect of whom proceedings have been started for the assessment of his income.
2. Every person who is assessable in respect of income of any other person.
3. Every person to whom a refund of tax is due.
4. Every person who is deemed to be an assessee under this Act.
5. Every person who is deemed to be an assessee in default under any provision of this Act.

An assessee in default is a person

• Who is liable to deduct tax at source but does not do so.
• Who deducts the tax but does not pay it to the Government.
• Who fails to pay instalments of advance income tax in time.

The Act has given a very wide definition of this term. Anyone who is even remotely connected with the payment or refund of tax can be termed as assessee. 

Assessment Year

• Assessment Year (AY) is defined in Section 2(9) of the Income Tax Act, 1961. It means the period of 12 months commencing on the April 1 of each year and ending on March 31 next. For example, the current assessment year is 2023-24 which commences on April 1,2023 and will end on March 31, 2024. 
• It is the financial year in which the assessment takes place. An assessee is required to pay tax in the AY on the income earned by him in the Previous Year according to the rates of tax prescribed by Annual Finance Act. 
• To illustrate, the current assessment year is 2023-24 and an assessee is required to pay tax in this AY on the income that was earned by him in the previous year 2022-23. 
• As a precaution, it should be pointed out here that there are a few exceptions to the general rule that income earned in the previous year only is taxed in the assessment year. These exceptions are explained in sub-section 1.9. 

Previous Year

Income tax is levied on net taxable income of previous year. So, it is very important to make clear the meaning of the term ‘Previous Year’. It is defined in section 3 of Income Tax Act. In simple words, a previous year is that year in which the  income is earned and received and the year in which it is taxed is termed as Assessment Year. As the Assessment Year starts on 1st April every year, it is essential to end previous year prior to 1st April or till 31st March every year. Previous year is also called ‘Financial Year’ or ‘Accounting Year’.
In other words, previous year is a period of maximum twelve months which will certainly end on 31st March every year (prior to assessment year). For example, the period of previous year related to the assessment year 2023-24 ended on 31st March, 2023. Following points are important in reference to previous year.

1. Preceding Financial Year: Financial year immediately preceding the Assessment Year is called Previous Year; for example, Financial Year of 2022-23 will be Previous Year for the Assessment Year 2023-24.
2. Previous year for every source of income: Earlier, the assessee had the option to choose any previous year, i.e., Diwali Year, Dussehra Year, Calendar Year, etc. But at present, no assessee can choose separate previous year under the Direct Tax Amendment Act, 1987. Thus, amendment came into force from the assessment year 1989-90. Now for every source of income, it is essential to have only one previous year (from 1st April to 31st March). In brief, the previous year will be uniform for all assesses and for all sources of income.
3. Separate Account Year: If an assessee, due to any reason, does not keep accounts on financial year basis but keeps on any other basis, he may do so. But he must have his accounts upto 31st March every year separately for income tax purposes. Thus, the assessee will have to keep accounts two times, which is not practical. To avoid this difficulty, mostly the assesses keep their accounts on financial year basis (from 1st April to 31st March).
4. Previous Year for newly started business or profession: If a business or a profession is started on any day of financial year (during 1st April to 31st March), its duration from the date of commencing the business to next 31st March will be treated as previous year for the relevant assessment year. For example, Mr. Amit commences his business on 30th January, 2023; the previous year of his business shall be treated from 30th January, 2023 to 31st March, 2023.
5. Previous Year for new source of income: The period, from the date of new source of income to next March, will be treated as previous year for the relevant assessment year. For example, Mr.Rakesh a bank officer lets his house on rent for the first time on 1st January, 2023. The previous year for this source of income shall be from 1st January, 2023- 31st March, 2023.
6. Previous Year undisclosed money: If an income tax officer finds any undisclosed money in case of any person’s account for which he does not explain its source satisfactorily, it is called undisclosed or unexplained money. This is considered as assessee’s income. The previous year for this income shall be the same as in case of that business in which this unexplained income is found.
7. Previous Year for the share in firm’s profits: In this case, the previous year of the firm’s business will be treated as the previous year. 

Taxation Of Previous Year’s Income During The Same Year

As stated earlier, the income of the previous year is taxed in the assessment year. But there are certain incomes for which the tax is paid in the same year. They are discussed below: (Exceptions of income of Previous Year is taxable in the assessment Year)

1. Income of non-resident shipping companies (Section 172): The income earned by a non-resident shipping company in India will be taxed in the year in which it is earned. This has been provided for in Section 172 of the Income Tax Act, 1962. It specifies that before the departure of the ship from port in India, the master of the ship shall prepare and furnish to the concerned Assessing Officer a return of the full, amount paid or payable to the owner on account of the carriage of passengers, livestock etc. The Assessing Officer shall immediately assess the income and determine the tax payable. Seven and a half per cent (7.5 %) of the local freight (including demurrage charge or any amount of similar nature) earned at Indian port by the owner or charter or any other person on their behalf shall be deemed to be the taxable income of the shipping business of non-resident shipping company.
2. Income of Persons leaving India (Section 174): This section provides that if the Assessing Officer feels that an individual may leave India without the intention of coming back, he may determine the total income of the person from the date of expiry of the immediately preceding previous year to the date of intended departure. The Assessing Officer will also compute the tax payable and will ask the individual to pay the tax so computed before leaving the country. 
3. Income of an association of persons or body of individuals or artificial juridical person formed for a particular event or purpose (Section 174A): If it appears to the assessing officer that any AOP or a BOI or an artificial judicial person, formed or established or incorporated for a particular event or purpose is likely to be dissolved in the assessment year in which such AOP or BOI or an artificial juridical person was formed or established or incorporated immediately after such assessment year, the total income of such association or body or juridical person for the period from the expiry of the previous year for that assessment year upto the date of its dissolution, shall be chargeable to tax in that assessment year.
4. Income of Persons trying to alienate their assets (Section 175): This section provides for the taxation of income of any person who, it appears to the Assessing Officer, is likely to sell, charge, transfer or dispose or otherwise part with, any of his assets with a view to avoiding payment of tax on his income in the same year in which it is earned. The Assessing Officer will determine the income from the date of expiry of the immediately preceding previous year to the day when such proceedings commence and will serve a demand notice on the assessee.
5. Income of discontinued business: Where any business or profession is discontinued in any year, the income of the period from the date of expiry of the immediately preceding previous year to the date of discontinuance of such business shall be determined and tax on that income shall be computed. It has been provided that any person discontinuing any business or profession shall inform the Assessing Officer of such discontinuance within 15 days thereof. 

Concept of Total Income

The term ‘total income’ is quite important as it is the total income that is put to tax. The term is defined in Section 2(45) which says that “total income” means the total amount of income, profits and gains as referred to in Section 5 and computed in the manner laid down in the Act.

• Compute taxable income under various heads of income i.e., salaries, house property, profits and gains of business and profession, capital gains and other sources, by allowing deductions in respect of expenses incurred by the assessee in earning those incomes up to the extent permissible under the provisions.
• Net result of adding taxable incomes from various heads of income is Gross Total Income.
• Out of the Gross Total Income so computed, give deductions allowed under Section 80 C to 80 U etc. in respect of various expenses such as L.I.C premium, contribution to Provident Fund, Medical Expenses etc., and various incomes such as dividends, interests etc. 

The net income so remaining after allowing all such deductions is termed as total income which will be relevant for computation of tax liability. It is also called Taxable Income. 

Agricultural Income

• Agricultural income is not taxed under the Income Tax Act, 1961, because agriculture being a State subject, it is the State Government alone which is competent to tax income there from. The exemption to this income is provided  under Section 10 (1) of the Act. Since, it is not taxed, the definition thereof has assumed significance. 
• The assessee would naturally be interested in classifying his income as agricultural incomes; however, distantly it might have been related to agriculture. On the other hand, the tax authorities would like to interpret the term conservatively and, thus, there is a possibility of some dispute between the parties as regards the meaning of the term. The Income Tax Act, 1961, has defined the term ‘agricultural income’ under Section 2 (1A) exhaustively. 

Definition of Agricultural Income

Agricultural income as defined under Section 2(1A) means any rent or revenue derived from land which is situated in India and is used for agricultural purposes. The definition makes it very clear that any rent or revenue (in cash or kind) will be agricultural in nature only if the following conditions are fully satisfied:

• Rent or revenue is derived from land,
• The land is situated in India, and
• The land is used for agricultural purposes.

Since the term ‘agriculture’ will determine the nature of income, it is necessary for us to understand what agriculture is. Income is said to have been derived from land when that land is subjected to the labour and skill of man, whether in the form of cultivation or otherwise. Though tilling is not a necessary part of agriculture, human labour and skill are supposed to be expended on the land itself and not merely on the growth from land.

The Supreme Court has in CIT v. Raja Benoy Kumar Sahas Roy expounded on the terms’ Agriculture’ and’ Agricultural Purposes’. The relevant portion of the judgment is given below:

• Agriculture in its most primary sense denotes the cultivation of the field and is restricted to the cultivation of the land in the strict sense of the term, meaning thereby tilling of land, sowing of seeds, planting, and similar operations on the land. It also includes in its scope all the operations which foster the growth and preservation of the produce along with the operations required to make the produce ‘marketable’. The term comprises within its scope all types of produce regardless of its nature.
• To decide whether a particular piece of land has been used for agricultural purpose, there has to be some measure of cultivation of land and some expenditure of skill and labour upon it. Consequently, income from the sale of forest trees growing naturally and without any human intervention cannot be treated as agricultural income. 

Kinds of Agricultural Income

Agricultural Income is of five kinds:

• Any rent or revenue derived from land
• Income derived from Agriculture
• Any income derived from marketing process performed by cultivator or receiver of rent in kind 
• Any income derived from the sale of product
• Income from farm building
• (ii), (iii) and (iv) can be combined under one heading and explained. Let us now discuss the different kinds of income in detail.

i) Any rent or revenue derived from land (Section 2(1A) (a)) 

Rent or revenue derived from land situated in India and used for agricultural purposes is agricultural income. Rent is received by one person from another for the grant of right to the other person to use land. It may be in cash or in kind and the recipient of rent may or may not be the owner of the land. If the land has been let out by the person on rent and the rent is in the nature of produce, he is termed as ‘receiver of rent in kind’. Where the land is used by the receiver of rent in kind for carrying out any process to make the produce marketable or where he derives any income on the sale of such produce, this will be treated as agricultural income in his hands too. It is, of course, agricultural income in the hands of the cultivator. 

ii) Income derived from such land by agriculture or from manufacturing process [Section 2(1A)(b)] 

The words ‘such land’ are of significance here. These words limit agricultural income to the land situated in India which is used for agricultural purposes; the income generated by the following activities is considered agricultural income:
a) Agriculture
b) Process ordinarily employed by a cultivator to render the produce marketable
c) Sale by cultivator of the produce without any further processing except the one mentioned in (b) above.

It is, thus, clear that the cultivator may need to make the produce marketable as the produce as such may not be sold. He is allowed the use of a process which is generally employed by all the cultivators to make the produce marketable. Tobacco leaves are generally dried before being sold, and therefore, the income from the sale of dried tobacco leaves will be agricultural in nature. However, the income from the sale of beedies made out of the same tobacco will not be treated as agricultural income, because marketable produce has been further processed and made more valuable. 

iii) Income from agricultural house property or farm buildings [Section (2 (1A) (c] 

Income derived from any building in the following cases will be agricultural income:

• The building is owned and occupied by the receiver of rent or revenue of any such land.
• The building is on or in the immediate vicinity of the agricultural land in India.
• The agriculturist needs it by virtue of his connection with the land and uses it as a dwelling house, store house or as an outhouse.
• The land on which such building is situated must be subject to land revenue in India or subject to a local rate assessed and collected by the officers of the said Government.
• If the land is not subject to land revenue, it must be outside the urban area, i.e., area comprising a cantonment board, municipal board, notified area, town area, municipal corporation or any other name by which it is known and which has a population of 10,000 or more;
• If it is notified by the Central Government in the Official Gazette, it must not be situated within 8 kilometre or within the area of such lower limits from the jurisdiction of such municipal board etc. as the Central Government may notify in this regard.

Instances of Non-agricultural Income
The following incomes though connected with land are not agricultural in nature: 

1. Annuity payable to vendor of agricultural land or to a person giving up his claim to a piece of agricultural land. 
2. Commission for selling agricultural produce. 
3. Income from Dairy Farm. 
4. Forest produce resulting from wild growth. 
5. Fisheries 
6. Ginning of cotton. 
7. Harvesting of crop on purchased land. 
8. Letting out of land for stocking timber or crops. 
9. Dividend paid out of agricultural income. 
10. Commission earned by the landlord for selling agricultural produce. 
11. Profit earned on purchase of standing crop. 
12. Rearing of silkworms. 
13. Income from stone quarries. 
14. Royalty income of mines. 
15. Income from poultry farming. 
16. Income from land used for brick making. 
17. Income from producing water fruits in a tank. 
18. Compensation for requisition of land for military use. 
19. Remuneration of mutawalli or trustee out of agricultural income of Wakf. 
20. Income from sale of tender forms by the assessee engaged in the cultivation of sugarcane. 
21. Income from maintaining or running nurseries. 

Partly Agricultural Income

There are certain instances where it becomes extremely difficult to classify an income as agricultural or non-agricultural. These are cases where the said income satisfies some characteristics of agricultural income and a few characteristics of business income. Such incomes are said to be partly agricultural in nature. Profit of a sugar mill which grows its own sugarcane is cited as one of the examples of partly agricultural income. In this case, income earned till harvesting of sugarcane is agricultural in nature whereas income accruing from the manufacture of sugar is taxable income. Hence, 60% income is agricultural income and remaining 40% is commercial income. Similarly, income from growing and selling of tea is partly agricultural income. These cases have been dealt with under rules 7 and 8 of the Income Tax Rules, 1962. 

Example of Partly Agricultural Income 

1) Income from growing and manufacturing of any product other than tea (Rule 7): 

This rule is applicable in factories of oil, vegetable ghee, flour, sugar etc. It is applicable on those manufacturers who manufacture and sell goods by using their agricultural products as raw materials. It includes both agricultural and non-agricultural income. In this case, sale of agricultural produce would be partly agricultural income and market value would be taken as agricultural income. For computing business income, market value of agricultural produce raised or received as rent in kind and used as raw material shall be deducted. For computing agricultural income, market value of the produce will be considered as receipts and cost of cultivation etc. shall be deducted from it. 

2) Income of Tea Gardens (Rule 8): 

Total Income from manufacture and sale of tea is not treated as agricultural income. However, 60% of the total income is treated as agricultural income and the rest is treated as nonagricultural or business income. 

3) Income from the manufacture of latex or canex (Rule 7A): 

65% of the total income derived from sale of latex or canex or block rubber manufactured and processed by the assessee will be treated as agricultural income and the balance 35% as non–agricultural income. Expenses related to new plant in place of dead plant shall be included in cost. Any subsidy received from rubber board shall be subtracted from the cost of production.

4) Income from manufacture of Coffee (Rule 7B): 

If coffee is sold just after curing 75% of income from sale will be treated as agricultural income and 25% as non–agricultural income. However, if coffee is sold after curing roasting and grounding and after adding some flavor etc, 60% of such income will be treated as agricultural income and remaining 40% as business income or non–agricultural income. For computing total regarding it, expenses related to these plants shall be included in cost of production, which are replaced in place of dead plants, but any subsidy which was received by coffee boards, will not be subtracted from the cost. 

Integration of Agricultural income with the Non– Agricultural income

As discussed, that there is no tax on agricultural income, but if an assessee earns both agricultural as well as non–agricultural income, then such  agricultural income is added in his total income for computation of income tax on non–agricultural income. This concept is called as ‘partial integration of agricultural income with non–agricultural income’. 

The partial integration is done only when the following two conditions are satisfied: 

1. The Net agricultural income exceeds Rs. 5,000, and 
2. Non– agricultural income of the assessee exceeds the exemption limits of Rs. 2,50,000 in case of an individual (other than individual of the age of 60 years or above) HUF, AOP/BOI. etc. 

The partial integration is applicable only in case of 

• Individual 
• HUF 
• AOP/BOI 
• Artificial juridical person 

It is not applicable in case of 

• firm 
• company 
• cooperative society 
• local authority 

Individual (whether male or female), who is a resident in India and is of the age of 60 years or more but less than 80 years at any time during the previous year, the maximum exemption limit shall be Rs 3,00,000 instead of Rs 2,50,000, but if the individual is of age of 80 years or more, the maximum exemption limit shall be Rs 5,00,000 instead of Rs 2,50,000. If an individual opts for tax under section 115 BAC, this exemption limit is Rs. 2,50,000 for all age groups of assesses. 

Steps of computation of tax when there is agricultural income along with non-aricultural income The given below are the steps to calculate the tax: 

1. 1) Add agricultural income and non–agricultural income and calculate tax on the aggregate as if such aggregate is the total income. 
2. 2) Add agricultural income to the maximum exemption limit available and compute tax on such amount as if it in the total income. 
3. 3) Deduct the amount of income tax computed under step 2 from the tax computed under step 1. 
4. The amount so calculated shall be total income tax payable by the assesse 
5. 4) Claim rebate u/s 87A, if applicable. 
6. 5) Add surcharge, if applicable and health and education cess @ 4% 

Concept of Casual Income

You will remember from earlier unit that one of the important characteristics of the term ‘income’ is its regularity or at least expected regularity. However, there may be certain Incomes which are not regular and which do not arise from any source of income. They are known as ‘casual incomes’. 

Definition and Chargeability of Casual Income 

If an assessee, accidentally or without any pre–expectation, gets any income of non-recurring nature, it is treated as casual income. It includes income from betting, lottery winnings, playing cards, income from horse race, cross word puzzles etc. The maximum amount of casual income upto Rs.10,000 in case of winnings from lotteries, crossword puzzles, card games, other games, horse race is not subjected to tax deduction at source. 

Following point should be kept in mind regarding casual income: 

1. Casual income shall be taxable @ 30% 
2. Any expenses, if paid, in receiving casual income, shall not be deducted from any income. 
3. Any casual loss shall not be set off against any income. 
4. Personal gift such as birthday gift are given on account of family affection, hence, will not be included in income. For example–gift to wife by her husband, gift to son by his father, gift to a relative by another relative etc.

Some Examples of Casual Income 

1. Accidently or fortuitous receipt of money or precious article in the way. 
2. Money won in lotteries. 
3. Crossword puzzles, card games, betting, or gambling of any nature. 
4. Receipt of remuneration for acting as an arbitrator in any disputes (without any prior provision or stipulation). 
5. Receipt of reward to a person for tracing out any lost child (Prior to declaration of reward or without any stipulation). 
6. Winnings from horse race or any other race. 
7. Prize awarded for coin collection or stamp collection or gardening. 

Anyone or all the following winnings will be taxable: 

• Winning from lotteries 
• Winning from crossword puzzles 
• Races (including horse races) 
• Winning from gambling or betting of any form or nature  

Following Incomes shall not be Treated as Casual Income 

• Any amount paid under an agreement like payments by husband to his wife under an agreement to live apart as maintenance allowance, will not be covered in casual income, hence, it will be taxable. 
• Capital gain or receipt accrued in any business or profession. 
• Receipts like bonus, gratuity, or perquisites, received by a salaried person. 
• Voluntary payments are not casual income like tips to maids, servants’ tips to waiter, excess money than prescribed fee for any services given to the client (either in money or in kind).

Capital And Revenue Receipts

• It is important to distinguish between capital and revenue. The distinction is significant not only from the point of view of accounting but also for tax matters. Ordinarily speaking, when we buy something of durable nature, we say that we have incurred capital expenditure. For example, buying of furniture is capital expenditure and it is shown on the assets side of the Balance Sheet. On the other hand, expenditure incurred on repairs is supposed to be of routine type and it is therefore, shown on the debit side of the Profit and Loss Account. In the same way, when some receipt is affected from disposing off a capital asset, we classify it as capital receipt. 
• For example, an amount of Rs. 2,00,000 received on the sale of a piece of land will be receipt of capital nature. On the other hand, fees received by an advocate for rendering of professional services will be of revenue nature. It might be of interest to note that the Income Tax Act, 1961, has not defined the concept of capital and revenue anywhere and therefore, we have to depend on the accounting conventions and pronouncements by courts in this area. 
• Apart from accounting implications, the distinction between capital and revenue receipts is of great significance in tax matter and in determining the tax liability. Revenue receipts are taxable in general whereas capital receipts are not. However, where the asset sold brings in some surplus (excess of selling price over the cost of an asset), it is termed as capital gain and will be treated under special provisions of the Act. Tax liability, therefore, cannot be determined accurately, if the receipts are not properly classified as above.  

Determine the Nature of a Receipt 

Based on the judicial pronouncements, a few guidelines have been laid down for the purpose of determining the nature of a receipt. Some important guidelines are discussed below: 

1. A receipt by way of price or compensation on the disposal of circulating capital or stock in trade is a revenue receipt whereas a receipt on the disposal of a capital asset is capital in nature. A capital asset is used to manufacture items or generate income e.g., machines. 
2. Receipt in substitution of a source of income is of capital nature while the amount that substitutes income itself shall be the income chargeable to tax For example, compensation for the loss of an agency is a capital receipt while the amount received for the breach of a business contract is a revenue receipt. 
3. In the case of an isolated transaction of purchase and sale of property, the motive of the seller is a deciding factor in determining the nature of receipt. Sale proceeds of securities (where they are held as investment) will be capital receipt whereas it will be of revenue nature if the securities are held as stock in trade. 
4. When a sum is received for the surrender of certain rights under an agreement, it is a capital receipt because a certain capital asset in the form of those rights are being given up. If, however, the sum is received in the nature of compensation for the loss of future profits, it will be treated as a revenue receipt. 

It would also help, if the following are also taken into consideration when trying to distinguish between capital and revenue receipts:

1) Nature of receipt at the initial stage: If the receipt at the initial stage possesses the characteristics of a trading receipt, it will be taxed as such. If, however, at the initial stages, it looks like a capital receipt, it cannot be taxed irrespective of the magnitude and the appropriation of the same by the assessee. 

2) Nomenclature not decisive: Irrespective of what the parties to a contract call the transaction and the receipt arising there from, the true nature of the receipt must be ascertained based on the principles laid down and the circumstances of the case. 

3) Nature of receipt in the hands of the receiver: It is important to note that when considering a receipt, its nature in the hands of the receiver is important. This implies that even if an item of expenditure is of a capital nature in the hands of the giver, it very well could be an item of revenue receipt in the hands of the receiver. It is, therefore, the nature of receipt in the hands of the receiver that is important and not the nature of the expenditure in the hands of the giver. 

4) Nature under company law not important: It has been held by the Supreme Court that there is no inconsistency between a receipt being a capital receipt under the Company Law and being a revenue receipt under the Income Tax Act, 1961. 

5) Lack of assessment in earlier years immaterial: The mere fact that the Income Tax Authorities have failed to levy tax on the interest part of the annual receipt does not change the nature of the receipt, it continues to be part capital and part revenue in nature and thereby chargeable to tax on the revenue part. 

6) Income from consumable assets: Profits arising from consumable assets would be of revenue nature although capital asset seems to be getting exhausted or consumed. 

7) Exchange rate fluctuation: Excess income arising to the assessee because of exchange rate fluctuation will be taxed as revenue receipt. If, however, the profit arises not as a result of the business of the assessee but as accrual to the investment, it will be treated as a capital receipt. 

8) Perpetual annuity: The annuity receivable in exchange for a capital asset is taxable income. However, if the annuity is described as instalment of a capital sum received in exchange for the capital asset, it is not taxable.  

Examples of Capital and Revenue Receipts 

The following are a few examples of capital receipts: 

1. Receipt to meet the capital expenditure is a capital receipt. 
2. Compensation received for the suspension of an export license.
3. Pagdee received as consideration for grant of monthly tenancies. 
4. Profit due to fluctuations in the rate of exchange of foreign currency. 
5. Profit from the sale of foreign exchange when the purchase of capital goods in foreign country became impossible. 
6. Entrance fee collected by a company in respect of new shares. 
7. Sale of assets of a firm at the time of its conversion to a company to the extent the consideration is attributable to sale of land. 
8. Compensation received for relinquishing the rights of a partnership. 

The following are a few examples of revenue receipts: 

1. Receipt of annuity for transfer of a capital asset. 
2. Income from compensation received by the Government for compulsory acquisition of land. 
3. Damages received in respect of repairs not carried out in time. 
4. Cash assistance received under an export promotion scheme. 
5. Lump sum amount received for waiver of royalty. 
6. Subsidy received by a cooperative society from Government. 
7. Surplus left with the seller due to a reduction in export duty. 
8. Damages received by a company for breach of contract. 
9. Sale of import entitlement received under an export promotion scheme against export.  

Example: 

State whether the following receipts are casual income: 

1. Mr. A received Rs 6,000 for acting as an arbitrator without any stipulations as to remuneration. 
2. Mr. B received Rs 10,000 for acting as an arbitrator with a clear and definite stipulation for the said remuneration. 
3. Mr. C, a decree holder received interest of Rs 1,000 under an order of court granting stay of execution of the decree on judgment debtor Mr. D. 
4. Mr. E is in service of Mr. F. Mr. F’s sons was lost and Mr. E traced him out without any stipulations of rewards, but Mr. F gave him a rewards of Rs 1,000. 

Sol: 

1. This receipt is casual income; it is of non–recurring nature as there was no stipulation for remuneration. 
2. There was an offer of definite remuneration to Mr. B for acting as an arbitrator. He accepted the work. Hence, this is not a casual income. 
3. It is not a casual income 
4. It is of non–recurring nature. There was no stipulation of reward, hence, it is casual income of Mr. E