Important Keyword: Business Income, Capital Gains, Equity Trading, Income Tax Rates, ITR-2, Tax Audit.
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Income Tax on Equity Share Trading
Trading in equity shares and stocks has witnessed a remarkable surge in accessibility, thanks to the proliferation of online trading platforms. This convenience has empowered individuals to engage in equity trading, encompassing a spectrum of financial instruments like delivery stocks, intraday trades, futures, options, and more. However, it’s imperative to fulfill tax obligations by filing Income Tax Returns (ITR) and settling taxes on such earnings. Equity share trading typically manifests in two primary forms: Equity Delivery Trading and Equity Intraday Trading.
What is Equity Trading?
Equity Delivery Trading
When a trader engages in Equity Delivery Trading, they purchase equity shares from the stock market with the intention of holding onto them for more than a day. The term “delivery” denotes the transfer of ownership of shares to the buyer’s Demat account. The primary objective here is to capitalize on potential short or long-term capital gains. Income generated from Equity Delivery Trading is categorized as either Capital Gains or Non-Speculative Business Income.
Moreover, when an investor subscribes to an IPO (Initial Public Offering) and receives shares, any income generated from selling these shares is treated as capital gains for tax purposes.
Equity Intraday Trading
Equity Intraday Trading involves the purchase and sale of equity shares within the same trading day. The aim is to capitalize on price fluctuations and generate profits swiftly. Unlike Equity Delivery Trading, there is no transfer of ownership of shares in Equity Intraday Trading, as trades are executed on the same day.
For tax purposes, Income Tax treats Equity Intraday Trading as Speculative Business Income. This is because it involves trading without the actual delivery of shares and with the objective of making rapid profits. Consequently, traders engaged in intraday trading are required to pay taxes at slab rates.
Equity F&O Trading
Equity Futures and Options (F&O) Trading involves buying or selling futures contracts or options contracts based on an underlying asset, such as equity shares. Income generated from equity F&O trading is categorized as non-speculative business income for income tax purposes.
Unlike speculative income, which is associated with activities like intraday trading, non-speculative business income is derived from trading activities where contracts are held for longer durations and involve predetermined terms. Therefore, income from equity F&O trading is taxed differently from speculative income, and traders are subject to specific tax regulations governing non-speculative business income.
How to treat sale of shares as Capital Gains or Business Income?
The classification of income from the sale of equity shares and mutual funds as either Capital Gains or Business Income hinges on several key factors. These factors are essential in determining the tax treatment of such income and have been subject to interpretation and debate between traders and tax authorities.
Significant Trading Activity: The level of trading activity conducted by the taxpayer is a crucial factor. If the trader engages in substantial and regular trading of shares, securities, or derivatives like futures and options, the income derived from these activities is typically classified as Business Income. Conversely, if the volume of trading transactions is low, irregular, and not a primary activity, the income is usually treated as Capital Gains.
Intention of the Taxpayer: The taxpayer’s intention behind the transactions also plays a vital role. If the primary objective is to actively trade shares and securities for short-term gains, the income is considered Business Income. Conversely, if the taxpayer’s intention is to hold investments for long-term appreciation, earning dividends and interest, the income is categorized as Capital Gains.
These factors collectively guide the tax authorities in determining the appropriate classification of income from equity trading. It’s essential for traders to understand these distinctions to ensure compliance with tax regulations and accurately report their income.
Clarification from CBDT Circular
To streamline tax procedures and minimize disputes, the CBDT has proposed a structured approach regarding the classification of income from shares and securities:
Listed Shares and Securities:
Taxpayers have the flexibility to choose whether to report income as Capital Gains or Business Income for listed shares and securities.
If the taxpayer treats listed shares and securities as stock-in-trade, regardless of the holding period, the income will be categorized as Business Income.
If the taxpayer considers listed shares and securities held for over 12 months as investments, the income will be treated as Capital Gains. Continuity in this method is required in subsequent years unless there’s a significant change in circumstances.
Unlisted Shares and Securities:
Income from unlisted shares and securities should uniformly be treated as capital gains, irrespective of the holding period.
Other Cases:
For all other scenarios, including listed shares and securities not falling under the above categories, the determination of income head will be based on significant trading activity and the taxpayer’s intention regarding holding them as stock or investment.
This structured approach aims to provide clarity and consistency in the treatment of income from shares and securities, thereby reducing ambiguity and potential litigations.
Determining whether income from the sale of shares should be classified as Capital Gains or Business Income involves considering various factors:
Nature of Activity:
Whether the purchase or sale of securities is linked to the taxpayer’s usual trade or business, or if it’s an occasional independent activity.
Intention of Purchase:
Whether the purchase of shares is for resale at a profit or for long-term appreciation and earning interest/dividends.
Volume and Frequency:
The significance of the volume of transactions in the financial year and whether there were continuous and regular trading activities.
Holding Period:
The duration for which shares and securities are held by the taxpayer.
Impact on Livelihood:
The time devoted to trading and its impact on the taxpayer’s livelihood.
Regarding the treatment of income, taxpayers can maintain two portfolios:
An investment portfolio comprising securities treated as capital assets.
A trading portfolio comprising securities treated as trading assets.
Income under both Capital Gains and Business Income heads can be possible in such cases. However, taxpayers must maintain clear records to distinguish between shares held for investment and those held as stock in trade.
For Equity Share Trading, the income is classified as Capital Gains in the following manner:
Long-Term Capital Gain (LTCG) under section 112A for listed securities held for over 12 months.
Short-Term Capital Gain (STCG) under section 111A for listed securities held for up to 12 months.
By adhering to these guidelines and accurately documenting transactions, taxpayers can ensure proper classification of income from equity share trading.
Equity Trading as Non-Speculative Business Income
In cases where a trader engages in significant trading activity and derives trading income as their sole source of earnings, the resulting profit or loss is categorized as Non-Speculative Business Income. Under this classification, the trader is eligible to claim expenses incurred in generating this business income. Consequently, the trader must file their income tax return using Form ITR-3. This form is specifically designed to accommodate individuals or Hindu Undivided Families (HUFs) with income from business or profession, ensuring accurate reporting and compliance with tax regulations.
Income Tax on Equity Share Trading
The taxation rates on trading in equity shares vary depending on how the income is classified. When the income from trading is categorized as Non-Speculative Business Income, it is subject to taxation at the applicable income tax slab rates. However, if the income is treated as Capital Gains Income, the following tax rates apply:
Long-Term Capital Gains (LTCG) under Section 112A:
For listed securities held for more than 12 months: LTCG exceeding INR 1,00,000 is taxed at a rate of 10%.
Short-Term Capital Gains (STCG) under Section 111A:
For listed securities held for up to 12 months: STCG is taxed at a rate of 15%.
It’s essential for traders to accurately determine the nature of their income and apply the corresponding tax rates to ensure compliance with tax laws and regulations.
Income Tax on Equity treated as Capital Gains Income
Type of Security
Period of Holding
Long Term Capital Gain (LTCG)
Short Term Capital Gain (STCG)
Domestic Company
Listed Equity Share (STT paid)
12 months
10% in excess of Rs. 1,00,000 under Section 112A
15% under Section 111A
Listed Equity Share (STT not paid)
12 months
10% without Indexation
Slab Rates
Unlisted Equity Share (STT not paid)
24 months
20% with Indexation
Slab Rates
Foreign Company
Listed Equity Share
24 months
10% without Indexation
Slab Rates
Unlisted Equity Share
24 months
20% with Indexation
Slab Rates
Income Tax on Equity treated as Non-Speculative Business Income
Non-Speculative Business Income is taxable at slab rates.
Slab Rates if Equity Trader opts for Old Tax Regime
Taxable Income (INR)
Slab Rate
Up to 2,50,000
NIL
2,50,001 to 5,00,000
5%
5,00,001 to 10,00,000
20%
More than 10,00,000
30%
Certainly, it’s important to consider the additional surcharge and cess while calculating the total tax liability. Here’s how it works:
Surcharge: Surcharge is applicable on the total income as per the prescribed surcharge slab rates. These rates vary depending on the level of income.
Health and Education Cess: Additionally, the Health and Education cess is levied at a rate of 4% on the total tax amount, including the basic tax and surcharge.
By factoring in both the surcharge and the Health and Education cess, taxpayers can accurately determine their total tax liability on trading income from equity shares.
Slab Rates if Equity Trader opts for New Tax Regime
Taxable Income (INR)
Slab Rate
Up to 2,50,000
NIL
2,50,001 to 5,00,000
5%
5,00,001 to 7,50,000
10%
7,50,001 to 10,00,000
15%
10,00,001 to 12,50,000
20%
12,50,001 to 15,00,000
25%
More than 15,00,000
30%
Turnover Calculation for Equity Trading
Correct, turnover is a crucial factor in determining the applicability of tax audit, especially when equity trading is treated as a business income. Here’s how turnover is calculated:
For Equity Delivery Trading, turnover is calculated as the absolute profit. This means summing up the positive and negative differences resulting from trading activities. Turnover calculation can be done either through a scrip-wise method or a trade-wise method, depending on the preference and ease of calculation for the trader.
Tax Audit for Equity Trading
Understandably, determining when a tax audit is necessary can be complex, especially for equity delivery trading treated as business income. Here’s a breakdown of the conditions:
Trading Turnover up to INR 2 Cr:
Tax audit is applicable if:
The taxpayer incurs a loss or the profit is less than 6% of the trading turnover, and
The total income exceeds the basic exemption limit.
If the profit is equal to or more than 6% of the trading turnover, tax audit is not required.
Trading Turnover of more than INR 2 Cr and up to INR 10 Cr:
Tax audit is applicable if:
The taxpayer incurs a loss or the profit is less than 6% of the trading turnover, or
The profit is equal to or more than 6% of the trading turnover, and the taxpayer has not opted for the Presumptive Taxation Scheme under Section 44AD.
Tax audit is not applicable if:
The profit is equal to or more than 6% of the trading turnover, and the taxpayer has opted for the Presumptive Taxation Scheme under Section 44AD.
Trading Turnover of more than INR 10 Cr:
Tax audit is mandatorily applicable if the turnover of intraday trading exceeds INR 10 Cr.
These guidelines aim to ensure compliance with tax regulations while providing clarity to traders on when a tax audit is necessary.
ITR Form, Due Date, and Tax Audit Applicability for Equity Traders
ITR Form
ITR-2 if the trading is treated as Capital Gains. ITR-3 if the trading is treated as Business Income.
Due Date
31st July if Tax audit is not applicable 31st October if Tax audit is applicable
Tax Audit
If trading is treated as business income then trader have to verify the audit applicability
Advance Tax for Equity Share Trading
Here’s how the Advance Tax payment schedule works for equity traders who don’t opt for presumptive taxation:
Advance Tax Payment Schedule for Equity Traders (Non-Presumptive Taxation):
15% of Estimated Tax by 15th June: Estimate your total tax liability for the financial year and pay 15% of it by 15th June.
45% of Estimated Tax by 15th September: By 15th September, pay 45% of your estimated tax liability for the year.
75% of Estimated Tax by 15th December: Pay 75% of your estimated tax liability by 15th December.
100% of Estimated Tax by 15th March: Finally, pay the remaining 100% of your estimated tax liability by 15th March of the financial year.
These installments help ensure that taxpayers meet their tax obligations progressively throughout the year, rather than facing a large tax bill at the end. It’s important for equity traders to estimate their tax liability accurately and make timely payments to avoid penalties and interest charges.
Advance Tax Liability
Due Date
15% of Tax Liability
On or before 15th June
45% of Tax Liability
On or before 15th September
75% of Tax Liability
On or before 15th December
100% of Tax Liability
On or before 15th March
For equity traders who opt for presumptive taxation under Section 44AD and have profits, the Advance Tax payment differs from those who don’t opt for this scheme. Here’s how it works:
Advance Tax Payment for Equity Traders (Presumptive Taxation):
Single Installment by 15th March: The entire amount of Advance Tax must be paid in a single installment on or before 15th March of the financial year.
Under the presumptive taxation scheme, traders are not required to make quarterly installments. Instead, they pay the entire Advance Tax amount at once by the specified date. This simplifies the tax payment process for eligible traders, allowing them to fulfill their tax obligations efficiently.
Carry Forward Losses for Equity Trading
Under the tax treatment of equity trading as capital gains, different rules apply depending on whether the gains or losses are short-term or long-term. Here’s a summary:
Short-Term Capital Losses:
Can be set off against both short-term and long-term gains in the current financial year.
If any loss remains after set off, it can be carried forward for up to 8 years.
Such carried forward losses can be adjusted against any capital gains in the subsequent years, regardless of whether they are short-term or long-term.
Long-Term Capital Losses:
Can only be set off against long-term gains in the current financial year.
If any loss remains after set off, it can be carried forward for up to 8 years.
Subsequent years’ gains can only be adjusted against these carried forward losses if they are long-term gains.
When equity trading is treated as business income, the losses incurred are considered non-speculative business losses. Here’s how they are treated:
These losses can be adjusted against any income except salaries.
The trader can carry forward these losses for 8 years.
In any of the upcoming years, these losses can be adjusted against gains earned from speculative or non-speculative business activities.
These provisions provide traders with options to manage their losses effectively, whether they are trading as investors with capital gains or as active traders with business income.
Important keyword: Capital Gains, ETF, ITR-2, Trading Income.
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ETF: Exchange Traded Fund
Exchange-traded funds (ETFs) made their debut in India in 2002, offering investors a diversified and cost-effective investment option. Unlike investing in individual stocks, where the risk is concentrated in a single company, ETFs allow investors to spread their risk across multiple companies within a specific sector or index.
Compared to mutual funds, ETFs offer several advantages, including lower expenses and higher liquidity. ETFs typically have lower expense ratios compared to mutual funds, making them a cost-effective option for investors. Additionally, since ETFs are traded on stock exchanges like individual stocks, investors can buy and sell them throughout the trading day at market prices, providing greater liquidity compared to traditional mutual funds.
Overall, ETFs provide investors with a convenient and efficient way to gain exposure to a diversified portfolio of assets while enjoying the benefits of lower costs and increased liquidity.
ETF: Meaning
Exchange-traded funds (ETFs) are investment vehicles that mirror the composition of an index, such as the BSE Sensex or CNX Nifty. They hold a diversified portfolio of stocks in proportions similar to those of the underlying index. ETFs are listed and traded on stock exchanges, allowing investors to buy and sell them throughout the trading day at market prices, similar to individual stocks.
There are various types of ETFs based on the securities they invest in:
Equity ETFs: These invest in equity shares and related instruments.
Debt ETFs: These invest in fixed-return securities like bonds and debentures.
Gold ETFs: These invest in physical gold assets.
Currency ETFs: These invest in currency instruments.
Tax treatment of income from ETFs is similar to that of mutual funds:
Capital gains on the sale of ETFs are taxed as follows:
For Equity ETFs:
Long-term capital gains (LTCG): Gains from holding equity ETFs for over 12 months are taxed at 10% above INR 1,00,000.
Short-term capital gains (STCG): Gains from holding equity ETFs for less than 12 months are taxed at 15%.
For Other ETFs (where less than 35% of funds are invested in equity shares of domestic companies):
For ETFs acquired after April 1, 2023: LTCG is taxed at applicable slab rates, as indexation benefits are no longer available.
For ETFs acquired before April 1, 2023:
LTCG: Gains from holding other ETFs for over 36 months are taxed at 20% with indexation benefit.
STCG: Gains from holding other ETFs for less than 36 months are taxed at slab rates.
Other Income from ETF (Exchange Traded Funds)
Interest Income:
Interest income is considered taxable income under the head “Income From Other Sources” (IFOS) and is taxed at slab rates. This includes interest earned from bank deposits, fixed deposits, savings accounts, bonds, etc.
Dividend Income:
In the case of dividend income, the tax treatment depends on the fiscal year:
Up to the financial year 2019-20: Dividend income was exempt from tax.
From the financial year 2020-21 onwards: Dividend income is treated as taxable income under the head “Income From Other Sources” (IFOS) and is taxed at slab rates. This applies whether the dividend is reinvested in the scheme or distributed to investors.
Income Tax on ETF (Exchange Traded Funds)
Income Tax on Trading in ETFs is similar to the tax treatment of mutual funds. The following are the income tax rates:
Type of ETF
Period of Holding
Long-Term Capital Gain
Short-Term Capital Gain
Equity ETF
12 months
10% over INR 1,00,000 under Section 112A
15% under Sec 111A
Other ETF
36 months
Slab Rate
Slab Rates
ITR Form, Due Date and Tax Audit Applicability for ETF Investors
ITR Form:
Traders should file ITR 2 (ITR for Capital Gains Income) on the Income Tax Website since income from the sale of ETFs is considered Capital Gains Income.
Due Date:
Up to the financial year 2019-20:
31st July: For traders not subject to Tax Audit.
30th September: For traders subject to Tax Audit.
From the financial year 2020-21 onwards:
31st July: For traders not subject to Tax Audit.
31st October: For traders subject to Tax Audit.
Tax Audit:
As income from the sale of ETFs is considered Capital Gains Income, taxpayers do not need to determine the applicability of tax audit under Section 44AB.
Carry Forward Loss for sale of ETFs
Gain or loss on the sale of ETFs is classified as either Capital Gain or Capital Loss. Here are the rules for setting off and carrying forward losses on the sale of ETFs:
Short Term Capital Loss (STCL):
STCL can be set off against both Short Term Capital Gain (STCG) and Long Term Capital Gain (LTCG).
The remaining loss can be carried forward for up to 8 years and set off against STCG and LTCG only.
Long Term Capital Loss (LTCL):
LTCL can be set off against Long Term Capital Gain (LTCG) only.
The remaining loss can be carried forward for up to 8 years and set off against LTCG only.
Important Keyword: Capital Gains, ITR-2, Trading Income, Unlisted Shares.
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Tax on Unlisted Shares
Investing in unlisted shares means buying ownership stakes in companies that haven’t gone through the process of making their shares available for public trading through an Initial Public Offering (IPO). Unlike shares of listed companies that are traded on stock exchanges, unlisted share is not accessible to the general public for buying and selling. Consequently, determining their value and understanding the tax implications can be more complex compared to publicly traded shares.
Unlisted shares are typically bought and sold through private transactions or platforms known as over-the-counter (OTC) markets. In these scenarios, buyers and sellers negotiate directly, and there is often less transparency and liquidity compared to trading on stock exchanges.
When it comes to taxation, the gains or profits made from selling unlisted shares are subject to capital gains tax, similar to listed shares. However, determining the cost of acquiring these shares and establishing their fair market value can pose challenges, especially since there isn’t a readily available market price. Investors may need to employ various valuation methods, such as the net asset value approach or discounted cash flow analysis, to assess the worth of unlisted shares for tax purposes.
Furthermore, investors should be aware of the tax implications associated with the duration of their investment, as different tax rates may apply depending on whether the gains are categorized as short-term or long-term capital gains.
While investing in unlisted share can offer opportunities for portfolio diversification and potentially higher returns, it’s essential for investors to carefully evaluate the risks and complexities involved, including valuation challenges and tax considerations, before making investment decisions in this domain.
What are Unlisted Shares?
Unlisted shares represent ownership in companies not traded on recognized stock exchanges. Unlike their listed counterparts, which are openly traded, unlisted shares are typically held by private entities like startups or privately-owned firms. Individuals investing in these shares often include founders, early backers, or employees of the company.
While unlisted shares offer potential returns, they come with unique considerations and risks. Valuing them can be subjective, and finding buyers for these shares may be challenging due to limited market activity. Additionally, compared to publicly traded companies, information about unlisted firms may be less accessible.
Taxation on the sale of unlisted shares differs from that of listed shares due to the absence of Securities Transaction Tax (STT) since they are not traded on recognized stock exchanges. For determining tax liability, the holding period for unlisted shares is considered 24 months:
Long-Term Capital Gain (LTCG): Profits from selling unlisted share held for over 24 months are classified as LTCG.
Short-Term Capital Gain (STCG): Gains from selling unlisted share held for up to 24 months are treated as STCG.
Income Tax on Unlisted Shares
Capital Gains
Holding Period
Taxability
Short Term Capital Gains
< 24 Months
Slab rates
Long Term Capital Gains
> 24 Months
20% under section 112
For the calculation of capital gains on unlisted shares, determining the sales consideration and purchase value is crucial.
Sales Consideration:
The Fair Market Value (FMV) dictates the sale value of unlisted share, regardless of market conditions. If the transfer occurs below the FMV, section 50CA of the Income Tax Act mandates using the FMV as the sales consideration. Conversely, if the transfer happens at or above the FMV, the original transfer value is considered.
Sales consideration = Higher of Actual sales value or FMV as on the date of transfer
Cost of Acquisition:
The purchase value for unlisted share is the actual price paid by the investor during the purchase. Moreover, the benefit of Indexation is applicable for unlisted shares.
Let’s illustrate this with an example:
Mr. Swapnil acquired unlisted share for INR 10,000 on 30th September 2020 and sold them for INR 15,000 on 31st December 2023. The FMV on the sale date was INR 14,000. Since the actual transaction price exceeds the FMV, the sales consideration is INR 15,000. Additionally, as the holding period exceeds 24 months, the shares qualify as long-term capital assets.
Particulars
Amount (INR)
Sales Consideration Higher of: Actual sale value i.e.150 or, FMV on date of sales i.e. 140
15,000
Purchase Value
10,000
Indexed Purchase Value
11,561
Long Term Capital Gains (15,000 – 11,561)
3,439
Tax @20% under section 112
688
ITR Form, Due Date, and Tax Audit Applicability
For reporting income from the sale of unlisted stocks, traders should file ITR 2, specifically designed for capital gains income.
The due dates for filing income tax returns are as follows:
July 31st: For traders not subject to tax audit
October 31st: For traders subject to tax audit
Tax Audit is not applicable for income from the sale of unlisted stocks as it falls under capital gains income. Therefore, traders are exempt from tax audit requirements in this regard.
Carry Forward Loss on Sale of Unlisted Shares
Investors have the flexibility to set off short-term capital losses against both short-term and long-term capital gains. Any remaining loss after set off can be carried forward for up to 8 years and utilized against both short-term and long-term capital gains within this period.
Long-term capital losses, on the other hand, can only be set off against long-term capital gains. Similarly, any unabsorbed long-term capital losses can be carried forward for up to 8 years and utilized against long-term capital gains during this period.
Important Keyword: Income from House Property, Income Heads, Income Tax, ITR-2.
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What is Pre-construction Interest?
During the pre-construction period, which spans from the approval of the home loan until the completion of the construction of the house property, interest deduction is not permitted as the property is still under construction. However, the interest paid during this pre-construction period, known as Pre-construction Interest, is eligible for deduction. This deduction is allowed in five equal installments starting from the year in which the construction of the property is completed. This provision allows taxpayers to spread out the benefit of interest deduction over multiple years, easing the financial burden associated with constructing the property.
How to calculate Pre-construction Interest?
To calculate the pre-construction period of a constructed house property, we need to determine the period from the year the home loan was taken until the year in which construction is completed. However, for interest deduction purposes, the interest will be allowed from the date of the loan taken until the 31st of March before the financial year in which construction is completed.
Let’s illustrate with an example:
Suppose the home loan was taken in the financial year 2018-2019 (FY 2018-19), and the construction of the property was completed in the financial year 2021-2022 (FY 2021-22).
Pre-construction period:
From FY 2018-19 (year of loan taken) to FY 2020-21 (the year before completion).
This spans three financial years.
Interest paid during the pre-construction period:
Obtain the annual home loan certificate issued by the bank for each financial year.
Add up the interest paid for the pre-construction period from FY 2018-19 to FY 2020-21.
Divide the total pre-construction interest into 5 equal installments:
Once the total pre-construction interest is determined, divide it into five equal parts.
Claiming deduction:
Claim the deduction of pre-construction interest from the financial year of completion of construction (FY 2021-22).
This deduction can be claimed while filing the Income Tax Return (ITR) on the Income Tax e-Filing portal under the head “Income from House Property.”
Example
Kunal has taken a loan for the construction of house property in Pune. Here are the loan details:
Loan amount
Rs. 30,00,000
Loan taken in
November 2017
EMI
Rs. 25,000
Construction completed in
December 2019
To calculate the tax deduction Kunal can claim for the home loan while filing his return for the Financial Year (FY) 2019-20, we need to consider the pre-construction interest and the interest paid during the FY 2019-20.
Pre-construction interest:
Calculate the total pre-construction interest paid by Kunal from the year the home loan was taken until the completion of construction. Let’s assume this total pre-construction interest is INR X.
Interest paid during FY 2019-20:
Obtain the annual home loan certificate issued by the bank for FY 2019-20.
Determine the total interest paid by Kunal during FY 2019-20. Let’s assume this total interest paid during FY 2019-20 is INR Y.
Total deductible interest for FY 2019-20:
Add the pre-construction interest (INR X) and the interest paid during FY 2019-20 (INR Y) to get the total deductible interest for FY 2019-20.
Claiming the deduction:
Kunal can claim this total deductible interest as a deduction while filing his return for FY 2019-20 under the head “Income from House Property.”
Calculation of EMI payments for FY 2019-20
In the financial year 2019-20, Kunal paid a total of Rs. 3,00,000 as EMIs, out of which Rs. 1,35,000 went towards principal repayment, making him eligible for a deduction under Section 80C of the Income Tax Act. This deduction reduces his taxable income by Rs. 1,35,000.
Considering the property is rented out, Kunal can claim the entire interest amount of Rs. 1,65,000 as a deduction under Section 24(b) while filing his Income Tax Return (ITR) for the financial year 2019-20. This deduction helps reduce his taxable rental income, thereby lowering his overall tax liability.
let’s calculate the amount paid for pre-construction interest:
The pre-construction interest is allowed to be claimed in five equal installments starting from the year in which the construction is completed. In this case, since the construction was completed in December 2019, we need to calculate the pre-construction interest for the period from November 2017 to March 2019, which spans 17 months.
By determining the total pre-construction interest paid during this period and dividing it into five equal installments, Kunal can accurately calculate the amount of pre-construction interest to be claimed as a deduction in each financial year following the completion of construction.
Financial year
Period
EMI calculation
2017-18
November 2017 to March 2018
Rs. 25,000 x 5 = Rs. 1,25,000
2018-19
April 2018 to March 2019
Rs. 25,000 x 12 = Rs. 3,00,000
Total
= Rs. 4,25,000
Out of the total EMI payments amounting to Rs. 4,25,000, Rs. 1,91,250 is allocated towards principal repayment. This leaves Rs. 2,33,750 (Rs. 4,25,000 – Rs. 1,91,250) as the pre-construction interest, which is eligible to be claimed in five equal installments of Rs. 46,750 each, starting from the financial year 2019-20.
Therefore, Kunal will be able to claim a deduction of Rs. 1,65,000 (the interest paid during the financial year 2019-20) plus Rs. 46,750 (the first installment of pre-construction interest) totaling Rs. 2,11,750 as deduction towards home loan interest for the financial year 2019-20.
Important Keyword: Clubbing of Income, HUF, ITR-2, Salary Income.
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Clubbing of Income under Section 64
In the realm of income taxation in India, taxpayers are obligated to report and pay taxes on all earnings accrued throughout the fiscal year. Yet, there are instances where the income of another individual is amalgamated, or “clubbed,” with the taxpayer’s taxable income. In such scenarios, the taxpayer assumes the responsibility of paying taxes not only on their own income but also on the income of others. This practice, termed as “clubbing of income,” is governed by the provisions delineated in Section 64 of the Income Tax Act.
Under these regulations, taxpayers are mandated to incorporate the total income, including any clubbed income, when filing their Income Tax Returns (ITRs) on the designated income tax website. By adhering to these provisions, taxpayers ensure compliance with tax laws and fulfill their obligations towards reporting and paying taxes on their combined incomes.
What is Clubbing of Income under section 64 of the Income Tax Act?
Clubbing of income occurs when the income of another person is included in the total income of the assessee as per the provisions outlined in Section 64 of the Income Tax Act. Essentially, this means that individuals cannot divert their income to others to evade tax liabilities. For instance, if the income of one’s spouse is amalgamated with their own income, resulting in the taxpayer paying taxes on both their income and their spouse’s, it constitutes clubbing of income.
However, certain exceptions exist where income earned from the investment of clubbed income is not subjected to clubbing provisions. For example, if Hari transfers INR 10,000 to his wife Priya, and Priya invests the amount in a Fixed Deposit (FD) scheme, the interest earned on the FD will be clubbed with Hari’s total income, making him liable to pay tax on it. Yet, if Priya reinvests the interest earned from the FD in another investment scheme, the income from this reinvestment will be taxable solely in Priya’s hands. Consequently, Hari is not obligated to pay tax on the reinvested interest income.
According to Section 64, specific persons’ incomes must be clubbed with that of the individual taxpayer. Let’s explore the scenarios where the provisions of clubbing of income are applicable.
Section
Specified person
Specified scenario
Clubbing of Income
Section 60
Any person
Transfer of Income without transfer of Assets either by way of an agreement or any other way,
– Any income from such asset will be clubbed in the hands of the transferor. – Irrespective of whether such transfer is revocable or not.
Section 61
Any person
Transferring asset on the condition that it can be revoked
Any income from such asset will be clubbed in the hands of the transferor
Section 64(1A)
Minor child
Any income arising or accruing to your minor child [Child includes step child, adopted child, and minor married daughter]
– Income will be clubbed in the hands of higher-earning parent. Note: If marriage of child’s parents does not subsist, income shall be clubbed in the income of that parent who maintains the minor child in the previous year
– If minor child’s income is clubbed in the hands of parent, then exemption of INR 1,500 is allowed to the parent.
– Exceptions to clubbing Income of a disabled child (disability of the nature specified in section 80U)
– Income earned by manual work done by the child or by activity involving application of his skill and talent or specialized knowledge and experience
– Income earned by a major child. This would also include income earned from investments made out of money gifted to the adult child. Also, money gifted to an adult child is exempt from gift tax under gifts to ‘relative’.
Section 64(1)(ii)
Spouse
If your spouse receives any remuneration irrespective of its nomenclatures such as Salary, commission, fees, or any other form and by any mode i.e., cash or in-kind from any concern in which you have a substantial interest
– Income shall be clubbed in the hands of the taxpayer or spouse, whose income is greater (before clubbing). The exception to clubbing: – Clubbing is not applicable if the spouse possesses technical or professional qualifications in relation to any income arising to the spouse and such income is solely attributable to the application of his/her technical or professional knowledge and experience
Section 64(1)(iv)
Spouse
Income from assets that taxpayer transfers directly or indirectly to the spouse without adequate consideration
– Income from out of such asset is clubbed in the hands of the transferor. Provided the asset is other than the house property.
– Exceptions to clubbing i.e. no clubbing of income in the following cases:
a. Where the spouse receives the asset as part of the divorce settlement
b. If the taxpayer transfers the asset before marriage
c. No husband and wife relationship subsists on the date of accrual of income
Section 64(1)(vi)
Daughter-in-law
Income from the assets that taxpayer transfers to son’s wife for inadequate consideration
Any income from such assets transferred is clubbed in the hands of the transferor
Section 64(1)(vii)
Any person or association of person
Transferring any assets directly or directly for inadequate consideration to any person or AOP to benefit your daughter-in-law either immediately or on a deferred basis
Income of taxpayer shall include income from such assets
Section 64(1)(viii)
Any person or association of person
Transferring any assets directly or directly for inadequate consideration to any person or association of persons to benefit your spouse either immediately or on a deferred basis
Income of taxpayer shall include income from such assets
Section 64(2)
Hindu Undivided Family
In case, a member of HUF transfers his individual property to HUF for inadequate consideration or converts such property into HUF property
Income of taxpayer shall include income from such property
Transfer of income without transfer of an asset to any person
Clubbing of income occurs when the transferor directs income from an asset to another person without transferring ownership of the asset itself. According to clubbing provisions, the total income of the transferor will include this income, and they are responsible for paying tax on it.
For instance, let’s consider Pranav, who owns a property and directs the rental income to his wife Divya without transferring ownership of the property to her. In this scenario, as per the clubbing provisions, although Divya receives the rental income, Pranav is still liable to pay tax on it since he is the original owner of the property generating the income.
Transfer of asset (revocable transfer) to any person
When a transfer of assets is revocable, it means that the transferor maintains the right or authority to reclaim the entire asset or its income at any point during the transferee’s lifetime. In such cases, the provisions of clubbing come into effect. This implies that even if the owner transfers the asset to the transferee, the income generated from that asset remains taxable in the hands of the transferor.
However, if the transfer is made via an irrevocable trust during the lifetime of the beneficiaries or transferee, clubbing of income does not apply. For instance, let’s consider Pranav, who transfers both the rental income and the property to Divya but retains the option to reclaim the property at any time. Since this transfer is revocable, the rental income remains taxable in Pranav’s hands, despite the assets being transferred to Divya.
Clubbing of Spouse Income
Income earned by your Spouse from the firm/company in which you have substantial interest
A substantial interest in a company or firm refers to a significant ownership stake or entitlement to profits. This can manifest in two ways:
Ownership of Shares: If an individual, either independently or jointly with relatives, owns shares that account for 20% or more of the voting power in a company.
Entitlement to Profits: If an individual, either independently or jointly with relatives, is entitled to 20% or more of the profits in a firm.
When an individual possesses a substantial interest in a firm or company where their spouse earns income, specific tax provisions regarding the clubbing of income apply:
Inclusion of Spouse’s Income: If the individual’s total income exceeds that of their spouse, the individual’s total income must include the income earned by their spouse.
Exception for Professional or Technical Skills: If the income earned by the spouse results from the practical application of their professional or technical skills, the clubbing provisions do not apply.
Limited Application: Clubbing provisions only apply to certain types of income such as salary, commission, fees, or remuneration.
For instance, consider Pranav, who holds a 51% stake in a private limited company. His wife Divya receives a monthly salary of Rs. 20,000 from the same company, despite not actively contributing to its operations. Pranav’s total annual income amounts to Rs. 10,00,000, whereas Divya’s total income (excluding her salary from the company) is Rs. 5,00,000. In this scenario, Pranav’s total income should include Divya’s salary of INR 2,40,000, resulting in a taxable income of INR 12,40,000 for Pranav.
Income from the asset transferred to the Spouse against inadequate consideration
When a taxpayer transfers an asset to their spouse for inadequate consideration, specific tax provisions regarding the clubbing of income from such assets come into play:
Inclusion of Income: The taxpayer’s total income must include income from the transferred asset if it was transferred to the spouse for inadequate consideration. The taxpayer will be liable to pay tax on the income derived from the asset.
Exception for Separation or Divorce: If the transfer of the asset is part of an agreement to live apart or divorce, the provisions for clubbing of income do not apply.
Let’s illustrate these provisions with examples:
First Scenario: Rohan transfers an asset worth INR 1,50,000 to his wife for a consideration of INR 50,000. In this case, Rohan’s total income shall include ⅔rd (two-thirds) of the income from the asset, and he would be liable to pay tax on this income. However, the remaining ⅓rd will be taxable in the hands of his wife, as she has paid INR 50,000, which represents 1/3rd (one-third) of the value of the property.
Second Scenario: Mr. Akash gifts INR 5,00,000 to his wife, who invests this amount in a fixed deposit and receives interest of INR 4,500 per annum. Since Mrs. Akash converts the cash received into another asset (FD), the interest she earns of INR 4,500 would be clubbed into the income of Mr. Akash as per Section 64(1)(iv) of the Income Tax Act.
Note: As per the judgment in R Dalmia Vs CIT (1982) and similar judgments, pin money (i.e., an allowance given to the wife by her husband for her personal and household expenses) is not taxable. Furthermore, if the spouse acquires the asset out of pin money, the provisions for clubbing of income shall not apply.
When taxpayer transfers an asset to any person or association of person for the immediate or deferred benefit of Spouse
When a taxpayer transfers an asset to their spouse for inadequate consideration, specific tax provisions come into effect:
Inclusion of Income: The taxpayer’s total income must include the income that arises from such an asset. They are liable to pay tax on this income.
In simple terms, if a taxpayer transfers an asset to their spouse for a lower value than its actual worth or for no consideration, any income generated from that asset will still be considered as part of the taxpayer’s income for tax purposes. Consequently, the taxpayer will be responsible for paying taxes on that income.
Clubbing of Income of Son’s Wife
When taxpayer transfers asset to son’s wife
When a taxpayer transfers an asset to their son’s wife for inadequate consideration, specific tax provisions apply:
Inclusion of Income: The taxpayer’s total income will include any income earned by their son’s wife from the transferred asset. Consequently, the taxpayer is liable to pay tax on the total income, including the income earned by their son’s wife.
When taxpayer transfers asset to any person or association of person for the immediate or deferred benefit of son’s wife
When a taxpayer transfers an asset for the benefit of their son’s wife for inadequate consideration, specific tax rules come into play:
Inclusion of Income: The taxpayer’s total income will encompass any income generated from the transferred asset. Consequently, they are responsible for paying taxes on the income derived from the asset, even if it’s earned by their son’s wife.
It’s important to note that clubbing provisions are applicable only if the taxpayer maintains a relationship with both their spouse and their son’s wife at the time of transferring the asset and when the income is earned.
Clubbing of Income of a Minor Child
When it comes to the income of a minor child, specific rules apply to determine which parent’s total income should include the minor’s earnings:
Higher Total Income: The parent with the higher total income will need to include the income earned by the minor child, including a married minor daughter, as per the clubbing of income provisions.
Separated Parents: In cases where the parents are living apart due to the absence of a marital relationship, the income earned by the minor child will be clubbed in the total income of the parent who is responsible for the child’s maintenance.
Exceptions to Clubbing of Income for Minor Child:
There are certain circumstances where the clubbing of income provisions for a minor child does not apply:
Income from Manual Work: If the minor child earns income through their manual work, the clubbing provisions will not be applicable.
Utilization of Skill: Similarly, if the minor child uses their skill, talent, specialized knowledge, or experience to earn income, clubbing of income will not apply.
Disability: In cases where the minor child is disabled as per Section 80U, clubbing of income does not apply.
Transfer to Married Minor Daughter: If a house property is transferred to a married minor daughter, clubbing provisions do not apply, and any income generated by the house property remains taxable in the hands of the parents.
Clubbing of Income of a Major Child
For a child who has attained the age of 18 years or above (major child), there is no clubbing of their income with the total income of the parents. Whether the major child earns income through their specialization/skill or invests money or assets transferred by their parents, the income remains taxable in their hands.
For instance, if Rohan, who is 18 years old, receives a gift of Rs. 50,000 from his parents and invests it in an FD scheme, the interest income earned on the FD will be taxable in Rohan’s hands alone, without any application of clubbing provisions.
Clubbing of Income from HUF Property
If an individual is a member of a Hindu Undivided Family (HUF) and transfers their property to the common pool of the HUF for inadequate consideration, the total income of the individual will include the income from such property. Consequently, the individual will be liable to pay tax on the total income as per the clubbing of income provisions.
However, if the transferred asset is subsequently distributed among family members due to a complete or partial partition of the HUF, any income derived from the asset by the individual’s spouse will be clubbed in the individual’s total income, and tax will be payable accordingly.
