Taxing of deemed income under the Income Tax Act, 1961

Under the Income Tax Act, apart from the actual income, the deemed income or notional income is also liable to tax. Income is defined under Section 2(24) of the Income Tax Act which is an inclusive defination of income. This means that the Act specifically defines certain nature of receipts which are regarded as income of the assessee and there could be certain other nature of receipts which, though may or may not be in the nature of income, may also be regarded as or deemed as the income of the assessee.

There are certain receipts which are not real income but with this deeming fiction in the Act, are regarded as income and these kinds of income too are subject to income tax. The provisions of deemed income are measures to prevent tax avoidance. Such measures are, therefore, justifiable considering the purpose for which they have been enacted. There are certain receipts which are not real income but with the deeming fiction in the Act, are regarded as income and these kinds of income too are subject to income tax. Therefore, it is extremely important to understand which are the nature of these kind of receipts which are not in the nature of income but which will be deemed as income and tax liability arises on such deemed income.

Burden of proof under deeming provisions of Income-tax Act, 1961

The words, ‘Burden of Proof’ and ‘Onus of Proof’ do not find mention in any of the provisions of the Act. The law relating to the Burden of Proof and Onus of Proof has been provided under the provisions of the Indian Evidence Act, 1872. The Evidence Act does not apply to proceedings under the Income-tax Act. The rigours of rule of evidence contained in the Evidence Act though not applicable to the Income-tax Act, on first principles and on general law, are applicable to proceedings under the Income-tax Act. Sections 101 to 106 of the Indian Evidence Act, 1872 contain the provisions regarding the burden of proof in various contexts. 

 

The question as to whether on whom burden of proof lies when a deeming provision is applicable under the Income-tax Act, 1961 has assumed significance with the emergence of judicial opinions having been expressed by various Hon’ble High Courts and the Hon’ble Supreme Court. 

So far as section 68 is concerned, the onus is wholly upon the Assessee to explain the source of the entry. But in cases falling under section 69, 69A, 69B and 69C, the words used show that before any of these sections are invoked, the condition precedent as to existence of investment, expenditure, etc. must be conclusively established by material on record/ evidence.

 

Deeming provision has to be interpreted strictly

It is settled principle of interpretation of tax statute that a deeming provision has to be interpreted strictly in terms of the language employed. It is also a cardinal principle of interpretation of taxing statute that a deeming fiction over a deeming fiction cannot be applied.

Following are various instances where even though a receipt of money that prima facie does not represent income, is treated as income under a deeming fiction on which tax is payable.

 

[1] Section 2(22)(e): deemed dividend

If a Company (which is not a company in which public are substantially interested) makes any payment by way of loan or advance to a shareholder, who holds not less than 10% of the voting power in the company, such receipt will be deemed to be dividend income for the receiving shareholder.

This section also covers instances where, if such company gives loans or advance to any concern in which such shareholder is a member/partner beneficially holding at least 20% of its income, such receipt will also be deemed to be dividend income for the receiving shareholder.

However, the amount of such deemed dividend will be restricted to the accumulated profits in the company. Thus, if a Pvt. Ltd. Company gives a temporary loan to one of its shareholders (say Mr. A) holding more than 10% of voting power, the said amount will be deemed as dividend income in the hands of Mr. A.

Further, if a Pvt. Ltd. Company gives temporary loan to another company in which A owns more than 20% shares, the amount shall also re deemed as dividend income in the hands of Mr. A.

Therefore, even if such shareholder has received temporary money from the company which he has returned to the company after a certain period of time, the receipt will be deemed to be his dividend and he will be required to pay tax on such ‘deemed income’.

[2] Section 7 : Income deemed to be received in the previous year

As per section 7, the following incomes shall be deemed to be received in India in the previous year even in the absence of actual receipt:

1.      Contribution made by the employer to the recognized provident fund in excess of 12% of the salary of the employee;

2.      Interest credited to the RPF of the employee which is in excess of 9.5% p.a.

3.      Transfer balance from the unrecognized fund to a Recognised Provident Fund (It has been discussed in the Chapter on 'Income from Salaries');

4.      The contribution made, by the Central Government or any other employer in the previous year, to the account of an employee under a notified contributory pension scheme referred to in section 80CCD.

Text of Section 7

INCOME DEEMED TO BE RECEIVED.

7. The following incomes shall be deemed to be received in the previous year :—

 (i)  the annual accretion in the previous year to the balance at the credit of an employee participating in a recognised provident fund, to the extent provided in rule 6 of Part A of the Fourth Schedule ;

(ii)  the transferred balance in a recognised provident fund, to the extent provided in sub-rule (4) of rule 11 of Part A of the Fourth Schedule;

(iii) the contribution made, by the Central Government or any other employer in the previous year, to the account of an employee under a pension scheme referred to in section 80CCD.

RECEIVED IN INDIA

Any income which is received in India, during the previous year by any assessee, is liable to tax in India, irrespective of the residential status of the assessee and the place of accrual of such income.

 

RECEIPTS MEANS THE FIRST RECEIPT:

The receipt of income refers to the first occasion when the recipient gets the money under his own control. Once an amount is received as income, any remittance or transmission of the amount to another place does not result in receipt within the meaning of this clause at the other place.

This principle is of importance, firstly, in determining the year of receipt, and secondly, for ascertaining the incidence of taxation where it depends purely upon receipt of income. For instance, in the case of non-residents, their foreign income is not assessable, unless it is actually received in India. In their case, unless, at the time the money is received in India, it is received as income from an outside source, such receipt will not be an income receipt. If a non-resident had already received moneys outside India (in an earlier year or during the previous year) as income or exempt income and he was transferring the funds into India in the accounting year, such moneys will not count as income in the eyes of law.

[3] Section 9: Income deemed to accrue or arise in India

Section 9(1)(i) mandates that income shall be deemed to accrue or arise in India whether directly or indirectly, through or from any business connection in India or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India.

 

 

[4] Section 11(3): Deemed income of charitable and religious trusts - If such Accumulated Income 

     in excess of 15% is not Applied / Invested in the prescribed manner

     Section 11(3) provides that where the income of the trust referred to in section 11(2)

:

(a)    If it is applied for purposes other than charitable or religious purposes, or ceases to be  

accumulated or set apart for application thereto, or

(b)   If it ceases to remain invested or deposited in any mode mentioned under section 11(5) above, or

(c)    If it is not utilized for the purpose for which it is so accumulated or set apart during the period specified (not exceeding 5 years) or in the year immediately following thereof.

(d)   If it is credited or paid to any trust or institution registered under section 12AA or 12AB or any institution or trust referred to in section 10(23C)(iv), (v), (vi) or (via),

such income shall be deemed to be the income,—

• in case of (a) of the previous year in which it is so applied for other purpose or ceases to be accumulated or set apart, or
• in case (b) of the previous year in which it ceases to remain so invested or deposited, or
• in case of (c) of the previous year immediately following the expiry of period specified therein, or
• in case of (d) of the previous year in which it is paid or credited.

[5]  Section 23(4) - Where assessee has more than one house for self occupation

If there are more than one residential houses which are occupied by the assessee for his own residential purpose, then he shall exercise an option to treat any one of the houses as self occupied and the other house will be deemed to be let out.

 

Section 23(2) provides that where the property consists of a house or part of a house which

(a) is in the occupation of the owner for the purposes of his own residence; or

(b) cannot actually be occupied by the owner by reason of the fact that owing to his employment, business or profession carried on at any other place, he has to reside at that other place in a building not belonging to him, the annual value of such house or part of the house shall be taken to be nil.

 

Section 23(4) provides deeming where the property referred to in sub-section (2) consists of more than two houses (with effect from assessment year 2010-21) -

(a) the provisions of that Section 23(2) shall apply only in respect of 2 of such houses, which the assessee may, at his option, specify in this behalf;

(b) the annual value of the house or houses, other than the 2 houses in respect of which the assessee has exercised an option under clause (a), shall be determined under sub-section (1) as if such house or houses had been let.

[6]  Section 23(5) : House or Flat held as stock in trade

Section 23(5) was inserted by the Finance Act, 2017, with effect from 01.04.2018 which provides that “Where the property consisting of any building or land appurtenant thereto is held asstock-in-trade and the property or any part of the property is not let during the whole orany part of the previous year, the annual value of such property or part of the property,for the period up to two years from the end of the financial year in which the certificateof completion of construction of the property is obtained from the competent authority,shall be taken to be nil”.

FM Speech while presenting the Budget:

“At present, the houses which are unoccupied after getting completion certificates are subjected to tax on notional rental income. For builders for whom constructed buildings are stock-in-trade, I propose to apply this rule only after one year of the end of the year in which completion certificate is received so that they get some breathing time for liquidating their inventory”

Explanatory Memorandum

NO NOTIONAL INCOME FOR HOUSE PROPERTY HELD AS STOCK-IN-TRADE

Section 23 of the Act provides for the manner of determination of annual value of house property. Considering the business exigencies in case of real estate developers, it is proposed to amend the said section so as to provide that where the house property consisting of any building and land appurtenant thereto is held as stock-in-trade and the property or any part of the property is not let during the whole or any part of the previous year, the annual value of such property or part of the property, for the period upto one year from the end of the financial year in which the certificate of completion of construction of the property is obtained from the competent authority, shall be taken to be nil.

 

[7]  Section 56(2)(viib) - Issue of shares by Company –  Share Premium in excess of the Fair Market Value to be treated as deemed Income

 

Section 56(2)(viib) was inserted by the Finance Act, 2012, with effect from 01.04.2013 which requires a Company (issuer), not being a company in which the public are substantially interested, to issue shares at Fair Market Value (FMV). Any consideration received by such issuing Company in excess of the FMV, to the extent it exceeds the face value of such shall be liable to tax. this deeming fiction does not apply when the shares are issued to a non-resident.

In other words, when a Company (in which public are not substantially interested) receives any consideration, from a resident, for issue of shares exceeding the fair market value (FMV) of the share, the excess amount so received will be regarded as income of the company.

Applicability of Section 56(2)(viib)

Section 56(2)(viib) is applicable as follows –

(i)       Recipient is a company (not being a company in which the public are substantially interested).

(ii)      It receives consideration for issue of shares (preference shares or equity shares) from a resident person.

(iii)    The consideration received for issue of shares exceeds the face value of such shares. In other words, shares are issued at a premium.

 Fair Market Value (FMV) of the shares of the company

For the purpose of section 56(2)(viib), FMV shall be the value, Higher of the following :

(a) as may be determined in accordance with such methods as may be prescribed (Methods prescribed under Rule 11UA are Book value Method (NAV) and Discounted Cash flow method); or

(b) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,

If the shares are issues at a price which is higher than the Net worth of the company, the same needs to be justified and supported by a valuation report as valued and certified by a certified valuer. The method of valuation is prescribed under Rule 11UA of the Income Tax Rules.

In such case, the company has actually received money against issue of its own shares at a premium, which essentially is a ‘Capital Account transaction’.

Provisions of section 56(2)(viib) not applicable

Provisions of section 56(2)(viib) not applicable in the following two cases –

 

(i)       where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund; or

 

(ii)      where the consideration for issue of shares is received by a company from a class or classes of person as notified by the Central Government.

 

Exemption given to Start Ups for the purpose section 56(2)(viib)

CBDT has vide Notification No. 13/2019 dated 05.03.2019 granted exemption to startup companies from angel tax with effect from 19.02.2019 if such companies fulfill the conditions specified in para 4 of the notification number G.S.R. 127(E), dated 19.02.2019.

 

CBDT Notification No. 13/2019, dated 05.02.2019

S.O. 1131(E). - In exercise of the powers conferred by clause (ii) of the proviso to clause (viib) of sub-section (2) of section 56 of the Income-tax Act, 1961 (43 of 1961) and in supersession of the notification of Government of India in the Ministry of Finance, Department of Revenue, Central Board of Direct Taxes published in the Gazettee of India, Extraordinary, Part-II, Section (3), Sub-section (ii) vide number S.O. 2088(E) dated 24th May, 2018, except as respect things done or omitted to be done before such supersession, the Central Government, hereby notifies that the provisions of clause (viib) of sub-section (2) of section 56 of the said Act shall not apply to consideration received by a company for issue of shares that exceeds the face value of such shares, if the said consideration has been received from a person, being a resident, by a company which fulfills the conditions specified in para 4 of the notification number G.S.R. 127(E), dated the 19th February, 2019 issued by the Ministry of Commerce and Industry in the Department for Promotion of Industry and Internal Trade and published in the Gazette of India, Extraordinary, Part-II, section 3, Sub-Section (i) on 19th February, 2019 and files the declaration referred to in para 5 of the said notification of the Department for Promotion of Industry and Internal Trade.

2. This notification shall be deemed to have come into force retrospectively from the 19th February, 2019.

 

Text of para 4 of the notification no. G.S.R. 127(E), dated 19.02.2019.

Exemption for the purpose of clause (viib) of sub-section (2) of section 56 of the Act
4. A Startup shall be eligible for notification under clause (ii) of the proviso to clause (viib) of
sub-section (2) of section 56 of the Act and consequent exemption from the provisions of that clause,
if it fulfils the following conditions:
(i)   it has been recognised by DPIIT under para 2(iii)(a) or as per any earlier notification on the
       subject
(ii)  aggregate amount of paid up share capital and share premium of the startup after issue or
       proposed issue of share, if any, does not exceed, twenty five crore rupees:

Provided that in computing the aggregate amount of paid up share capital, the amount of paid up
share capital and share premium of twenty five crore rupees in respect of shares issued to any of the
following persons shall not be included─
(a) a non-resident; or
(b) a venture capital company or a venture capital fund;

Provided further that considerations received by such startup for shares issued or proposed to be issued to a specified company shall also be exempt and shall not be included in computing the aggregate amount of paid up share capital and share premium of twenty five crore rupees.
(iii) It has not invested in any of the following assets,─
       (a) building or land appurtenant thereto, being a residential house, other than that used by the Startup    

            for the purposes of renting or held by it as stock-in-trade, in the ordinary course of business;
      (b) land or building, or both, not being a residential house, other than that occupied by the
            Startup for its business or used by it for purposes of renting or held by it as stock-in trade, in the    

            ordinary course of business;
       (c) loans and advances, other than loans or advances extended in the ordinary course of business by     

             the Startup where the lending of money is substantial part of its business;
       (d) capital contribution made to any other entity;
       (e) shares and securities;
       (f) a motor vehicle, aircraft, yacht or any other mode of transport, the actual cost of which exceeds  

            ten lakh rupees, other than that held by the Startup for the purpose of plying, hiring,
            leasing or as stock-in-trade, in the ordinary course of business;
       (g) jewellary other than that held by the Startup as stock-in-trade in the ordinary course of business;
       (h) any other asset, whether in the nature of capital asset or otherwise, of the nature specified in sub-  

             clauses (iv) to (ix) of clause (d) of Explanation to clause (vii) of sub-section (2) of section 56 of  

             the Act.

Provided the Startup shall not invest in any of the assets specified in sub-clauses (a) to (h) for the period of seven years from the end of the latest financial year in which shares are issued at premium;

Explanation.─ For the purposes of this paragraph,-

(i) “specified company” means a company whose shares are frequently traded within the meaning of Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 and whose net worth on the last date of financial year preceding the year in which shares are issued exceeds one hundred crore rupees or turnover for the financial year preceding the year in which shares are issued exceeds two hundred fifty crore rupees.

(ii)  the expressions “venture capital company” and “venture capital fund” shall have the same meanings as respectively assigned to them in the explanation to clause (viib) of sub Section( 2) of Section 56 of the Act.

 

[8] Section 56(2)(ix) : Forfeiture of advance money on failed negotiation will be deemed to be the income of the assessee

Section 56(2)(ix) was inserted by the Finance (No.2) Act 2014, with effect from 01.04.2015. It provides for taxability as Income from Other Sources of any sum of money received as an advance or otherwise in the course of negotiations for transfer of a capital asset, if an assessee has received any sum of money during the course of negotiation for transfer of a capital asset, which is in the nature of advance and if the negotiation does not result into a deal of transfer of the capital asset and if the assessee forfeits the advance money so received, the money so received will be deemed to be the income of the assessee. Earlier, this advance receipt would go on to reduce the cost of the capital asset but now the section is amended to state that the advance so received and forfeited will be regarded as the income of the assessee.

Section 51 has also been amended to provide that any amount taxed under section 56(2)(ix) shall not be deducted from the cost or written down value. The effect of this amendment shall be that the assessee may now take the entire cost of the capital asset for the purpose of cost of acquisition; thereby the tax exposure on the gains computed in accordance with the Act at the time of transfer of capital asset get reduced.

Tax Implication of advance money forfeited on failure of negotiations

(A)     If advance is received & forfeited before 01.04.2014

§  Advance forfeited shall be reduced from the cost of acquisition for computing capital gains

§  Taxability is postponed to the year in which in which the transfer materializes

 

(B)     If advance is received & forfeited on or after 01.04.2014

§  Advance forfeited to be taxed under the head “Income from other sources”

§  Tax liability is attracted in the year in which the advance is forfeited.

PROVISIONS ILLUSTRATED

Mr. ‘X’ purchased a house property in the year 2005 for a sum of Rs. 125 lakhs. He negotiated with Mr. ‘Y’ to transfer the property and received a sum of Rs. 10 lakhs as advance money. Mr. ‘Y’ failed to pay the stipulated price fixed for the property on the due date. The sum of Rs.20 lakhs was forfeited on 1stApril 2016 and retained by Mr. ‘X’. Mr ‘X’ sold the said property in August 2020 for sum Rs. 300 lakhs For the purpose computation of capital gains, Mr. ‘X’ took the cost of the asset at Rs. 125 lakhs.

SOLUTION

With effect from 2015-16, the advance money forfeited will taxed under section 56(2)(ix) of the Income Tax Act, 1961 and will not be reduced from the cost asset. Hence the cost of the asset will be Rs. 125 lakhs.

 

[9] Section 56(2)(x) : Receives sum of money or property without any consideration or for a consideration which is less than its fair market value

Section 56(2)(x), was inserted by the Finance Act, 2017, with effect from 01.04.2017. (in place of Section 56(2)(vii). It provides that where any person “receives” any “specified property” (which includes sum of money or the property or shares and securities without any consideration or for a consideration which is less than its fair market value, as determined in accordance with the applicable rules (tax FMV), then, the tax FMV (where the property is received without consideration) or the excess of the Tax FMV over the consideration paid would be subject to tax in the hands of the recipient of “property” as “income from other sources”.

The taxation on gifts received by an Individual/ HUF is also governed by the provisions of Section 56(2)(x) of the Income Tax Act.

Under the erstwhile provision of section 56(2)(vii), any sum of money or any property received without any consideration by any Individual or HUF was chargeable to income tax. Section 56(2) (viia), applicable upto assessment year 2017-18, was applicable only to the Firm and Closely held company. Whereas, section 56(2)(x) is applicable to all kinds of the assessees.

The following receipts are to be taxed as deemed income:

(a) Any sum of money that is received without consideration, in aggregate exceeding Rs.50,000 during the financial year

(b) Any immovable property without any consideration, the stamp duty value of which exceeds Rs.50,000

(c) Any immovable property with the consideration which is less than stamp duty value by an amount exceeding Rs.50,000

(d) Any movable property (as defined and specified) without consideration where aggregate fair market value whereof exceeds Rs.50,000

(e) Any movable property (as defined and specified) for consideration which is less than fair market value by an amount exceeding Rs.50,000

 

Exceptions to Section 56(2)(x)

This section does not apply to following if any sum of money or any property received:

(i)           From any relative

(ii)         On the occasion of marriage of individual

(iii)        Under a will or by way of inheritance

(iv)        In contemplation of death of the payer or donor, as the case maybe

(v)         From any local authority as defined in the explanation to section 10(20)

(vi)        By 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).

(vii)      Amalgamations, Successions, Demerger which is not a transfer under section 47.

(viii)     From or by any trust or institution registered under section 12AA or 12AB.

(ix)        From an individual by a trust created or established solely for the benefit of relative of the individual.

 

[10] Section 68 : Cash Credits

As per section 68, any sum found credited in the books of an assessee maintained for any previous year for which he offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

 

In case of a taxpayer being a closely held company (i.e., not being a company in which the public are substantially interested), if the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such company shall be deemed to be not satisfactory if prescribed conditions are not fulfilled.

 

In case of a taxpayer being a closely held company (i.e., not being a company in which the public are substantially interested), if the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such company shall be deemed to be not satisfactory, unless:

(a) the person, being a resident in whose name such credit is recorded in the books of such company, also offers an explanation about the nature and source of such sum so credited; and

(b) such explanation in the opinion of the Assessing Officer has been found to be satisfactory.

The above provisions of share application money, share capital, etc., shall not apply if the person, in whose name such sum is recorded, is a venture capital fund or a venture capital company as referred to in section 10(23FB).

Conditions to be satisfied for applicability of section 68:

Following conditions can be stated to attract the applicability of section 68 :

(i)       Assessee has maintained ‘books;

(ii)     there has to be credit of amounts in the books maintained by the assessee of a sum during the year; and

(iii)   the assessee offers no explanation about the nature and source of such credit found in the books or the explanation offered by the taxpayer in the opinion of the Assessing Officer is not satisfactory. If all these conditions exist, sum so credited may be charged to tax as income of the assessee of that year.

 

[11] Section 69 : Unexplained investments

Where in the financial year immediately preceding the assessment year the assessee has made investments which are not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of the investments or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the value of the investments may be deemed to be the income of the assessee of such financial year.

 

[12]  Section 69A : Unexplained money, etc.

Where in any financial year the assessee is found to be the owner of any money, bullion, jewelry or other valuable article and such money, bullion, jewelry or valuable article is not recorded in the books of account, if any, maintained by him for any source of income, and the assessee offers no explanation about the nature and source of acquisition of the money, bullion, jewelry or other valuable article, or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the money and the value of the bullion, jewelry or other valuable article may be deemed to be the income of the assessee for such financial year.

 

[13] Section 69B : Amount of investments, etc., not fully disclosed in books of account

Where in any financial year the assessee has made investments or is found to be the owner of any bullion, jewelry or other valuable article, and the Assessing Officer finds that the amount expended on making such investments or in acquiring such bullion, jewelry or other valuable article exceeds the amount recorded in this behalf in the books of account maintained by the assessee for any source of income, and the assessee offers no explanation about such excess amount or the explanation offered by him is not, in the opinion of the  Assessing Officer, satisfactory, the excess amount may be deemed to be the income of the assessee for such financial year.

 

[14] Section 69C : Unexplained expenditure, etc.

Where in any financial year an assessee has incurred any expenditure and he offers no explanation about the source of such expenditure or part thereof, or the explanation, if any, offered by him is not, in the opinion of the Assessing Officer, satisfactory, then the amount covered by such expenditure or part thereof, as the case may be, may be deemed to be the income of the assessee for such year.

 

It may be noted that the aforesaid unexplained expenditure which is deemed to be the income of the assessee by virtue of section 69C shall not be allowed as a deduction under any head of income.

 

[15] Section 69D: Amount borrowed or repaid on hundi

Where any amount is borrowed on a hundi from, or any amount due thereon is repaid to, any person otherwise than through an account payee cheque drawn on a bank, the amount so borrowed or repaid shall be deemed to be the income of the person borrowing or repaying the such amount. It will be treated as income for the year in which it was borrowed or repaid, as the case may be.

 

However, it should be noted that if any amount borrowed on a hundi has been treated as income of any person by virtue of section 69D, then such person shall not be liable to be assessed again in respect of the same amount on repayment thereof. Amount repaid shall include the amount of interest paid on the amount borrowed.