Simplifying Tax for C.A's and Taxpayers

Incomes that we unwittingly ignore

Incomes that we unwittingly ignore

July 31 is not far away. It is the time to gather all your income details and proofs for the purpose of filing of income tax return for the Assessment year 2016-17.  Wait! Think twice before you submit your return. Have you included all your incomes?

Yes, there are many incomes which a tax payer ignores while filing the return mainly due to ignorance or otherwise. And the result is, notices from tax department, is stashing of black money etc. Have a look:

1. Notional Income from second house property is taxable

The first house property that one buys is exempt from income tax. However, the second property onwards, even if it’s kept under lock and key, a notional rent value based on the market rental value will be adopted as taxable income from the second property.

To put it differently, even if a taxpayer earns no income whatsoever from the second property, it will be taxable as if he has put it out on rent. House property does not include plot of land.

To give some relaxation, there are certain deductions allowed from this notional rental income namely Municipal Taxes Paid, standard deduction of 30% and interest on the housing loan.

2. All Dividend income is not exempt

The common understanding is that all dividends are exempt from tax. Please note that:

  • Only the dividends received from an Indian Company which has suffered dividend distribution tax in the hands of company, is exempt from tax under Sec 10(34). Dividends from foreign company are not exempt.
  • Dividends received in the hands of unit holder for a mutual fund, whether equity or debt, is tax free.

Secondly, being exempt does not mean it is not an income. Many people do not show dividends in the return assuming that it won’t matter since they are exempt. Remember, the correct way is to include them under “Income from other sources” and then claiming exemption under Sec 10(34).

3. PPF income is exempt but to be disclosed as income and then claimed exempt

PPF income is exempt under Section 10(11). To reiterate, please include it under interest income in the return and then claiming exemption under the aforesaid section.

4. Long term capital gains on sale of equity shares or units of equity oriented mutual funds exempt but to be disclosed as income and then claimed exempt

Long term capital gain on sale of equity shares or units of equity oriented mutual fund is exempt under Sec 10(38) subject to fulfillment of certain conditions. To reiterate, please include it under capital gain in the return and then claim exemption under the aforesaid section.

5. Interest on fixed deposit and recurring deposit taxed on accrual basis and not on maturity.

Usually the interest on fixed deposit and recurring deposit are received on maturity and the taxpayers accordingly include the interest in the return of year of receipt. This is not correct. The interest is to be considered on accrual basis i.e. even if the deposit is not matured at the year end, interest credited to the account shall be added to the total income and should be shown in the ITR but many taxpayers tend to forget it.

6. Interest on tax saving fixed deposit is not tax free

This is a major misconception that tax payers have. Tax saving Deposit is eligible for deduction under Section 80C but the interest earned on it is 100% taxable.

7. Don’t ignore saving bank account interest

Many taxpayers ignore the saving bank interest in their returns. Perhaps the main reason is that many tax return preparers do not call for the information on this interest. Remember, sum up interest on all saving bank accounts and include this interest in return and claim relaxation under Section 80TTA up to Rs 10000.

8. Certain gifts are taxable.

Tax Laws does not barred you from receiving gifts but put a limit of which you can receive gift without paying any tax.  Gifts received from friends or other persons, other than blood relatives, for more than Rs 50000, whether in cash or otherwise, are taxable. However there are some specified cases where such gifts will not be taxable e.g. gifts received on marriage.

Further, any gifts given to the spouse, minor child and daughter-in-law for inadequate consideration shall be construed as income in the hands of the individual making the gift.

9. Interest on tax refund is taxable

We get happy when we receive tax refund from income tax department for return filed. But the department pays the amount of refund together with interest. Remember, this interest is taxable and to be included in ITR.

10. Investments made out of Pin money to homemaker is taxable

Usually we see that that the husbands give a certain amount to wife for household expenses every month. Many of them manage to save money to buy gold, invest in shares and make investments like RD or FD etc. Clubbing provision of Income Tax Act does not apply on the income from the investment made out the pin money.

But since might be incomes from such investments, which are to be shown in the return of homemaker. But only few of them file ITR, which results into creation of black money.

11. Minor child income is taxable in the hands of the parents.

Income from investments made in the name of child, like fixed deposit, NSC, PPF, shares etc. evokes the clubbing provision and the gift needs to be included in the income of the parent whose total income is higher before including the income of the minor. However, if the child earns income from his/her own skills or experience than the clubbing provision remains silent and he/she is required to file ITR in his/her own name.

12. Loan Principal repayments claimed as deduction under Sec 80C are taxable on sale of residential property before 5 years

If an individual sells this house before the expiry of five year from the end of year in which he gets possession or receives the loan, then the amount of deductions under section 80C in prior years, allowed as repayment of home loan principal is to be added back his taxable income in the year of transfer or receipt.

However, this rollback is not applicable on deduction claimed under Section 24 (b) on interest payable on such loan.

Hope you find the article useful.

Amendments to rule 8D

Amendments to rule 8D

Section 14A of Income tax Act, 1961 and amendments to Rule 8D by Income Tax (14th Amendment) Rules, 2016

Requirement of calculating disallowance of interest expenditure not directly attributable to any income or receipt eliminated. Considering investments, income from  which shall not form part of total income, for the purpose of disallowance remained as it is  . Standard disallowance to be based on annual average of monthly average of opening and closing balances of investments instead of  average of  investment as appearing in the balance sheet of the assessee, on the first and the last day of the previous  year . Quantum of disallowance to be 1% instead of ½%. Sub rule 3 defining meaning of “total asset” deleted due to its becoming redundant on elimination of formulae for calculating disallowance of interest expenditure not directly attributable to any income or receipt.

Section 14A  inserted by Finance Act, 2001( Text of Section 14A given in Appendix 1 below)  provides that no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act. It also provides that the Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act. Right to determine the expenditure by prescribed method was also given  in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act

Accordingly in exercise of powers under  Section 14A,  Rule 8D was inserted w.e.f. 24.3.2008 ( Text of unamended rule 8 D is given as appendix 1) prescribing the manner to quantify the amount of expenditure in relation to exempt income liable to be disallowed. It provided that disallowance shall be aggregate of

  • amount of  expenditure directly relating to   income which does not form part of  total income
  • amount of interest expenditure not directly attributable to any particular income or receipt  calculated on the basis of formulae given in the rule
  • amount equal to ½% of the average value of the investment the income from which does not or shall not form part of total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year

This Section 14A read with rule 8D  has resulted into excessive litigation due to disallowances worked out by applying rule 8D resulted in abnormal disallowances even exceeding the total expenditure claimed by the assessee particularly due to applying sub rule(2)(ii).

Vide notification No.43/2016 on 2nd June, 2016  Income Tax ( 14th Amendment) Rules, 2016 were notified. Vide these amendment rules  , sub rule 2 to Rule 8D has been substituted by the following sub rule 2 and sub rule (3) stands omitted:

“(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely:—

  • the amount of expenditure directly relating to income which does not form part of total income; and
  • an amount equal to one per cent of the annual average of the monthly averages of the opening and closing balances of the value of investment, income from which does not or shall not form part of total income: Provided that the amount referred to in clause (i) and clause (ii) shall not exceed the total expenditure claimed by the assessee.”;

Thus  by these amendments in Rule 8D, now

  • there will be no disallowance based on the formulae prescribed ( Rule 8D as existed before this amendment is reproduced below) of interest expenditure which is not directly attributable to the exempt income or receipt.
  • Further standard disallowance of ½% has been increased to 1% and  calculation method has been changed to “annual average of the monthly averages of the opening and closing balances of the value of investment”.
  • No  amendment has been made for not considering  the value of investment , income from which shall not form part of total income. This may continue to result in  litigations  in respect of investments made not for the purpose of earning dividend but made as strategic investments in unlisted companies. These strategic investments are generally sold at a future date and will be liable for capital gains being not covered by Section 10(38) due to absence of payment of  STT.  There may not be any dividend earning on such investments. But assessing authority may not be agreeing to this aspect and will be more inclined otherwise.
  • A limit has been placed for disallowance to a maximum of total expenditure claimed by the assessee.
  • Sub rule 3 defining meaning of “total asset” deleted due to its becoming redundant on elimination of formulae for calculating disallowance of interest expenditure not directly attributable to any income or receipt.

APPENDIX 1

Expenditure incurred in relation to income not includible in total income.

Section 14A.

(1) For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act.

(2) The Assessing Officer shall determine the amount of expenditure incurred in relation to such income which does not form part of the total income under this Act in accordance with such method as may be prescribed19, if the Assessing Officer, having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of such expenditure in relation to income which does not form part of the total income under this Act.

(3) The provisions of sub­section (2) shall also apply in relation to a case where an assessee claims that no expenditure has been incurred by him in relation to income which does not form part of the total income under this Act :

Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.

Method for determining amount of expenditure in relation to income not includible in total income.

Rule 8D. (1) Where the Assessing Officer, having regard to the accounts of the assessee of a previous year, is not satisfied with—

      (i) the correctness of the claim of expenditure made by the assessee; or

      (ii) the claim made by the assessee that no expenditure has been incurred,

in relation to income which does not form part of the total income under the Act for such previous year, he shall determine the amount of expenditure in relation to such income in accordance with the provisions of sub­rule (2).

(2) The expenditure in relation to income which does not form part of the total income shall be the aggregate of following amounts, namely :—

       (i) the amount of expenditure directly relating to income which does not form part of total income;

      (ii) in a case where the assessee has incurred expenditure by way of interest during the previous Year which is not directly attributable to any particular income or receipt, an amount computed in accordance with the following formula, namely: 

Screen Shot 2016-06-08 at 1.28.52 PM

Where

 A =amount of expenditure by way of interest other than the amount of interest included in clause (i) incurred during the previous year ;

B = the average of value of investment, income from which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the  last day of the previous year ;

C = the average of total assets as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year ;

(iii) an amount equal to one­half per cent of the average of the value of investment, income which does not or shall not form part of the total income, as appearing in the balance sheet of the assessee, on the first day and the last day of the previous year.

(3.) For the purposes of this rule, the “total assets” shall mean, total assets as appearing in the balance sheet excluding the increase on account of revaluation of assets but including the decrease on account of revaluation of assets.

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