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Unit 1: Income Tax: Basic Framework

the question whether a particular receipt is capital or revenue in nature, care must be taken to Notes
ensure that the following are not taken as the basis for determination although these factors
may, to a certain extent, is helpful to arrive at the conclusion:
1. Character and source of income: The nature of receipt should be decided entirely on the
basis of its character in the hands of the recipient, the source from which the payment has
been received being immaterial for the purpose. For instance, there may be cases where
the payer makes the payment out of capital while the recipient gets it as income. This may
happen in cases like the payment of interest out of capital under Section 208 of the Companies
Act, 1956 which the recipient gets as income chargeable to tax. Another instance would be
of a businessman who deals in plant and machinery; while the purchaser of the machinery
would pay the price out of his capital, the seller would get it as income from business.
Therefore, the taxability of the receipt does not depend upon the character of payment in
the hands of the payer.

2. Application of income: The application of the income after its receipt by the recipient is
also immaterial for purposes of taxability.
3. Allowance or disallowance of the amount to the payer: The payment may represent
expenditure in the hands of the payer and in certain cases may be disallowed in computing
the taxable income of the payer. But the disallowance in the payer’s hands would not in
any way affect the taxability of the entire amount of remuneration in the employees or
directors hands although there may be double taxation of the same amount in two hands
for the same period. Thus, the allowance or disallowance of the amount to the payer is
immaterial for taxing the recipient.

4. Treatment given in the books: The name by which the payment is called by the parties
concerned and the treatment given to it in the books of accounts of the parties would also
be irrelevant. For instance, every item of income from employment is taxable as salary
income whether it is called salary, wages, bonus, pension, and annuity or by any other
name. In other words, it is only the real character of the receipt and not what the parties
call it that would determine its taxability.
5. Magnitude and method of payment: The quantum of the payment, whether it is paid in
instalments or in lump sum and also whether it is paid at regular intervals of time or
otherwise and even the magnitude of the payment are not the factors that determine the
capital or revenue character of the receipt for tax purpose.
6. Basis for measurement of the receipt: The basis for measurement of the receipt (a specified
percentage of the estimated profit taken as the basis for measuring damages) should not
be taken as the deciding factor for determining the capital or revenue character of the
receipt.
7. Ways or devices resorted by payer: The various devices resorted to by tax payers in arranging
their financial affairs do not also conclusively establish the nature of the receipt because a
tax payer is legally entitled to arrange his affairs in such a way as to reduce his tax burden
to the minimum. In the light of the aforesaid principles the capital or revenue nature of the
receipt should be first determined before proceeding to compute the taxable income.

Example: The following examples will help you to understand whether the concept of
capital or revenue receipts or expenses and giving reasons:
1. AB & Co. received ` 2, 00,000 as compensation from CD & Co. for premature termination
of contract of agency.
2. Sales-tax collected from the buyer of goods.

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