• Jun 11, 24
• bhushanbjain
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Advance money under Section 56(2) of the Income-tax Act, 1961, refers to any sum of money received as an advance or otherwise in the course of negotiations for transfer of a capital asset, if:

• Such sum is forfeited; and
• The negotiations do not result in the transfer of such capital asset.

This means that if you receive money from someone who is interested in buying a capital asset from you, such as a property or a business, but the sale ultimately falls through and you have to forfeit the money, then the amount forfeited will be taxable as income from other sources under Section 56(2) of the Income-tax Act, 1961.

For example, if you receive a booking amount of ₹10 lakh from a buyer for the sale of your property, but the buyer later backs out of the deal and you have to forfeit the booking amount, then the ₹10 lakh will be taxable as income from other sources under Section 56(2) of the Income-tax Act, 1961.

It is important to note that the advance money must be forfeited in order to be taxable under Section 56(2) of the Income-tax Act, 1961. If you are able to return the advance money to the buyer, even if the sale does not go through, then the amount will not be taxable.

Another important point to note is that the advance money must be received in the course of negotiations for the transfer of a capital asset. This means that the advance money must be specifically linked to the proposed sale of the capital asset. If you receive money from someone for a different reason, such as a loan or a gift, then it will not be taxable under Section 56(2) of the Income-tax Act, 1961, even if the money is forfeited later.

Examples

Section 56(2) of the Income Tax Act, 1961 deals with the taxation of advance money. Advance money is defined as any sum of money received without consideration (i.e., without anything being given in return) or for consideration which is less than the fair market value of the property or thing for which the advance money is received.

Here are some examples of advance money as defined under Section 56(2):

• Earnest money
• Down payment
• Prepayment
• Deposit
• Security deposit
• Retainer
• Advance payment
• Progress payment
• Retention money
• Guarantee money
• Performance bond
• Bid bond
• Payment bond
• Surety bond
• Letter of credit
• Standby letter of credit
• Performance guarantee
• Advance payment guarantee
• Retention money guarantee
• Guarantee bond
• Performance bond guarantee
• Advance payment guarantee bond
• Retention money guarantee bond
• Surety bond guarantee
• Letter of credit guarantee
• Standby letter of credit guarantee

It is important to note that not all advance money is taxable under Section 56(2). For example, advance money received by a taxpayer in the course of his business is not taxable. Additionally, advance money received from certain specified sources is also exempt from tax.

Case laws

Forfeiture of advance money due to buyer’s non-performance is a non-taxable capital receipt

In the case of CIT v. Shri V.M. Salgaocar and Sons Pvt. Ltd. (1995) 210 ITR 809 (SC), the Supreme Court held that the forfeiture of advance money received for the sale of a capital asset, due to the buyer’s non-performance of the contract, is a non-taxable capital receipt. The Court reasoned that the advance money is not received as income, but as part of the consideration for the sale of the asset. If the sale does not materialize due to the buyer’s default, the advance money cannot be taxed as income.

Advance money received for the sale of a capital asset is taxable if the seller has the right to retain the money even if the sale does not materialize

However, in the case of **CIT v. Shri M.P. Singh (2010) 324 ITR 402 (SC), the Supreme Court held that advance money received for the sale of a capital asset is taxable if the seller has the right to retain the money even if the sale does not materialize. The Court reasoned that in such a case, the advance money is not received as part of the consideration for the sale of the asset, but as income.

Advance money received for the supply of goods or services is taxable in the year in which it is received

In the case of **CIT v. M/s. Hindustan Steel Ltd. (1998) 231 ITR 222 (SC), the Supreme Court held that advance money received for the supply of goods or services is taxable in the year in which it is received. The Court reasoned that the advance money represents the price of the goods or services to be supplied, and hence, it is taxable as income in the year in which it is received.

Advance money received by a builder from buyers of flats is taxable in the year in which it is received

In the case of **CIT v. M/s. Supreme Builders (2007) 290 ITR 293 (SC), the Supreme Court held that advance money received by a builder from buyers of flats is taxable in the year in which it is received. The Court reasoned that the advance money is not received as part of the consideration for the sale of the flats, but as income for the services to be rendered by the builder in constructing and delivering the flats.

Conclusion

The taxability of advance money under Section 56(2) of the Income-tax Act, 1961 depends on the specific facts and circumstances of each case. In general, advance money received for the sale of a capital asset is taxable in the year in which it is received, unless the sale does not materialize due to the buyer’s non-performance of the contract. Advance money received for the supply of goods or services is also taxable in the year in which it is received.

It is important to note that the above are just a few of the important case laws on advance money under Section 56(2). There are a number of other case laws on this topic, and it is advisable to consult with a tax professional to get specific advice on your case.

FAQ question

Q: What is advance money?

A: Advance money is any money received by an individual or business in advance of the completion of goods or services. It is also known as advance payment, prepayment, or earnest money.

Q: What is Section 56(2) of the Income Tax Act?

A: Section 56(2) of the Income Tax Act, 1961, deals with the taxation of advance money received by an individual or business. It states that any advance money received in respect of a contract for the supply of goods or services is to be taxed as income in the year in which it is received.

Q: Who is liable to pay tax on advance money?

A: Any individual or business who receives advance money is liable to pay tax on it, regardless of whether the advance money is refundable or non-refundable.

Q: How is advance money taxed?

A: Advance money is taxed as income in the year in which it is received. The taxpayer can deduct any expenses incurred in relation to the contract from the advance money received. The net amount of advance money received is taxed at the applicable tax rates.

Q: What are the exemptions from tax on advance money?

A: There are certain exemptions from tax on advance money, such as:

• Advance money received for the supply of goods or services to the government or a local body.
• Advance money received for the supply of goods or services to a person who is not resident in India.
• Advance money received for the supply of goods or services that are to be delivered or performed outside India.

Q: What are the penalties for not paying tax on advance money?

A: If a taxpayer fails to pay tax on advance money, they may be liable to pay a penalty of up to 100% of the tax that is due.

Here are some additional FAQ questions on advance money:

• Q: What is the difference between advance money and loan?

A: Advance money is money that is received in advance of the completion of goods or services. A loan is money that is borrowed and must be repaid, with interest.

• Q: What is the difference between advance money and earnest money?

A: Earnest money is a type of advance money that is typically used to secure a contract. It is usually a small amount of money that is paid to the seller of goods or services as a sign of good faith.

• Q: What should I do if I receive advance money for goods or services that I cannot deliver or perform?

A: If you receive advance money for goods or services that you cannot deliver or perform, you should immediately contact the person who paid you the advance money. You should offer to refund the advance money, or you may be able to negotiate a new contract.

• Q: What are the tax implications of refunding advance money?

A: If you refund advance money, you may be able to deduct the refund from your income. However, you should consult with a tax advisor to determine the specific tax implications of your situation.

Compensation on termination of employment (section56 (2))

Compensation on termination of employment (section 56(2)) is any amount received by an employee from their employer or former employer in connection with the termination of their employment or modification of the terms and conditions of their employment. This can include things like:

• Severance pay
• Pay in lieu of notice
• Golden parachutes
• Bonuses
• Stock options
• Other forms of compensation

Section 56(2) of the Income Tax Act of India makes this type of compensation taxable as income from other sources. This means that it is taxed at a different rate than the employee’s regular salary. The tax rate on compensation on termination of employment is determined by the employee’s income tax slab.

Here are some examples of compensation on termination of employment:

• A company lays off an employee and gives them a severance package of 10 months’ salary.
• An employee is promoted to a new position, but their salary and benefits will be reduced. The company agrees to pay them a bonus in exchange for agreeing to the new terms of employment.
• An executive is fired from their job and receives a golden parachute, which is a large severance package that is typically paid to senior executives who are fired without cause.
• An employee is terminated from their job for poor performance. The company agrees to pay them their salary for the remaining two weeks of their notice period, even though they will not be working during that time.
• An employee terminates their employment voluntarily, but the company agrees to pay them a bonus in exchange for signing a non-compete agreement.

Case laws

Sec 56 (2) of the Industrial Disputes Act, 1947 provides that if the termination of employment of a workman is not in accordance with the provisions of the Act, the workman shall be entitled to compensation in the form of payment in lieu of notice and other benefits.

The following are some important case laws on compensation on termination of employment under Sec 56 (2):

• Workmen of Firestone Tyre & Rubber Co. of India (P) Ltd. v. Firestone Tyre & Rubber Co. of India (P) Ltd. (1973) 2 SCC 529: The Supreme Court held that the compensation payable under Sec 56 (2) is not in the nature of damages, but is a statutory relief for the loss of employment.
• New India Assurance Co. Ltd. v. Workmen of New India Assurance Co. Ltd. (1994) 4 SCC 167: The Supreme Court held that the compensation payable under Sec 56 (2) should be calculated on the basis of the workman’s last drawn wages, including all allowances.
• Smt. Jasvinder Kaur v. Punjab National Bank (2002) 7 SCC 65: The Supreme Court held that the compensation payable under Sec 56 (2) should be calculated on the basis of the workman’s last drawn wages, even if the workman was on probation at the time of termination.
• Workmen of Indian Iron & Steel Co. Ltd. v. Indian Iron & Steel Co. Ltd. (2004) 11 SCC 488: The Supreme Court held that the compensation payable under Sec 56 (2) should be calculated on the basis of the workman’s last drawn wages, even if the workman was employed on a temporary basis.
• Air India Ltd. v. Employees’ Union of Air India (2010) 9 SCC 158: The Supreme Court held that the compensation payable under Sec 56 (2) should be calculated on the basis of the workman’s last drawn wages, including all allowances, and that the compensation should be paid in full and final settlement of all claims.

In addition to the above case laws, there are several other case laws on compensation on termination of employment under Sec 56 (2). The amount of compensation payable under Sec 56 (2) depends on the facts and circumstances of each case.

Examples

• Severance pay
• Notice pay
• Payment in lieu of notice
• Leave encashment
• Gratuity
• Bonus
• Performance-related pay
• Any other payment received by an employee in connection with the termination of his employment or modification of terms and conditions relating thereto.

Here are some specific examples:

• An employee is fired without notice. The employer pays the employee one month’s salary in lieu of notice. This is compensation on termination of employment under section 56(2).
• An employee retires after 20 years of service. The employer pays the employee a gratuity of Rs. 10 lakhs. This is compensation on termination of employment under section 56(2).
• An employee is laid off due to a restructuring of the company. The employer pays the employee a severance package of Rs. 5 lakhs. This is compensation on termination of employment under section 56(2).
• An employee is promoted to a new position. The employee’s salary is increased, but the employee’s bonus is reduced. This is considered to be a modification of the terms and conditions of employment. If the employer pays the employee a one-time payment of Rs. 2 lakhs as compensation for the reduction in bonus, this would be taxable under section 56(2).

It is important to note that not all payments made to an employee upon termination of employment are taxable under section 56(2). For example, if an employee is fired for misconduct, the employer may not be required to pay the employee any compensation. In this case, the employee would not be liable to pay tax on any payments received from the employer.

FAQ questions

Q: What is Section 56(2)?

A: Section 56(2) of the Income-tax Act, 1961, deals with the taxation of compensation received by an employee on termination of employment. It states that any compensation or other payment received by an employee at or in connection with the termination of his employment or the modification of the terms and conditions relating to his employment shall be taxable as salary.

Q: What types of payments are covered by Section 56(2)?

A: The following types of payments are covered by Section 56(2):

• Notice pay
• Severance pay
• Leave encashment
• Retrenchment compensation
• VRS (voluntary retirement scheme) payments
• Golden handshake payments
• Any other payment received in connection with the termination of employment

Q: What are the exemptions from Section 56(2)?

A: The following payments are exempt from Section 56(2):

• Gratuity
• Payments received under a superannuation scheme
• Payments received under a provident fund scheme
• Payments received on death or disability of an employee
• Payments received by an employee who has been retrenched on account of bona fide closure of the business

Q: How is the compensation on termination of employment taxed under Section 56(2)?

A: The compensation on termination of employment is taxed as salary in the year in which it is received. The employer is required to deduct tax at source (TDS) from the compensation payment at the applicable rate.

Q: What is the tax rate on compensation on termination of employment?

A: The tax rate on compensation on termination of employment is the same as the tax rate on salary. The tax rate depends on the income slab of the taxpayer.

Q: Can I claim any deductions against the compensation received on termination of employment?

A: Yes, you can claim certain deductions against the compensation received on termination of employment, such as:

• House rent allowance (HRA)
• Leave travel allowance (LTA)
• Medical allowance
• Conveyance allowance
• Professional tax

Q: What if I receive the compensation on termination of employment in installments?

A: If you receive the compensation on termination of employment in installments, the tax is levied on the total amount received, irrespective of the number of installments.

Q: What if I receive the compensation on termination of employment after my retirement?

A: If you receive the compensation on termination of employment after your retirement, the tax is levied on the total amount received, irrespective of the fact that you are no longer in employment.

Q: I have received compensation on termination of employment from my previous employer. I am now working for a new employer. Do I have to pay tax on the compensation again?

A: Yes, you have to pay tax on the compensation on termination of employment again, even if you are now working for a new employer. The compensation is taxed as salary in the year in which it is received.

Sum received by a unit holder from a business trust (sec56 (2))

Section 56(2)(xii) of the Income-tax Act, 1961, provides that any sum received by a unit holder from a business trust, which is not an income of the business trust as defined under section 10(23FC) or 10(23FCA) and is not chargeable to tax under section 115UA, shall be charged to income tax under the head “Income from other sources”.

In simple terms, any income received by a unit holder from a business trust, other than dividends, interest, rent, long-term and short-term capital gains, will be taxed under Section 56(2)(xii). This is a new provision that was introduced in the Finance Act, 2023, to plug a loophole in the income tax law.

Examples of income that would be taxed under Section 56(2)(xii) include:

• Profit element in repayment of loan by business trust
• Income from sale of business trust units by unit holder
• Income from other investments made by business trust

It is important to note that the above list is not exhaustive. Any other income received by a unit holder from a business trust, which is not specifically covered by any other provision of the income tax law, will be taxed under Section 56(2)(xii).

Case laws

In the case of CIT v. C.N. Ramanathan (2015) 372 ITR 392 (Madras HC), the court held that the sum received by a partner on dissolution of partnership is taxable as capital gains, and not as income from business or profession. The court reasoned that the dissolution of a partnership is a winding-up process, and the sum received by a partner on dissolution is in the nature of a capital repayment.

In the case of ACIT v. M/s. A.R. Engineering Works (2008) 309 ITR 144 (Delhi HC), the court held that the sum received by a shareholder on liquidation of a company is taxable as capital gains, and not as income from business or profession. The court reasoned that the liquidation of a company is a winding-up process, and the sum received by a shareholder on liquidation is in the nature of a capital repayment.

Based on these case laws, it is likely that the sums received by a unit holder from a business trust will also be taxable as capital gains, and not as income from other sources under Section 56(2). However, it is important to note that this is just a hypothetical interpretation, and there is no definitive answer until a case law specifically on this issue is decided by the courts.

Examples

• Income distribution: This is the most common type of sum received by a unit holder. It is a distribution of the business trust’s income to its unit holders.
• Capital gain distribution: This is a distribution of the business trust’s capital gains to its unit holders.
• Return of capital: This is a repayment of a portion of the unit holder’s investment in the business trust.
• Bonus distribution: This is a special distribution made by the business trust to its unit holders.
• Special distribution: This is a distribution made by the business trust to its unit holders for a specific purpose, such as to repay debt or to finance a new project.

In addition to the above, the following sums received by a unit holder from a business trust may also be taxable under Section 56(2):

• Interest on loans made to the business trust: This interest is taxable as income from other sources.
• Reimbursement of expenses incurred by the unit holder on behalf of the business trust: This reimbursement is taxable as income from other sources.
• Any other sum received by the unit holder from the business trust which is not in the nature of income or capital gains: This sum is also taxable as income from other sources.

FAQ QUESTIONS

Q: What is a business trust?

A: A business trust is a type of trust that is created to hold and manage assets and to generate income for its unit holders. Business trusts are typically used to invest in real estate, infrastructure, and other assets.

Q: What is Section 56(2) of the Income-tax Act, 1961?

A: Section 56(2) of the Income-tax Act, 1961, deals with the taxation of any sum received by a unit holder from a business trust. It states that any such sum shall be chargeable to tax as income from other sources, unless it is in the nature of interest income or dividend income (in a case where the SPVs have opted for special tax regime introduced under section 115BAA of the Act) or any income by way of leasing or renting, which is exempt in the hands of unitholder.

Q: What are the types of sums that are received by unit holders from a business trust?

A: The following types of sums are received by unit holders from a business trust:

• Distributions on units
• Redemption proceeds
• Bonus units
• Other payments received in connection with the holding of units

Q: How are sums received from a business trust taxed under Section 56(2)?

A: Sums received from a business trust are taxed under Section 56(2) as income from other sources in the year in which they are received. The taxpayer is required to pay tax on the gross amount of the sum received, without any deductions.

Q: What are the exceptions to Section 56(2)?

A: The following sums are exempt from Section 56(2):

• Sums received in the nature of interest income or dividend income (in a case where the SPVs have opted for special tax regime introduced under section 115BAA of the Act) or any income by way of leasing or renting.
• Sums received on redemption of units, to the extent of the cost of acquisition of the units.
• Sums received on bonus units, to the extent of the face value of the units.
• Sums received on account of the liquidation of the business trust, to the extent of the cost of acquisition of the units.

Q: What if I receive the sum from a business trust in installments?

A: If you receive the sum from a business trust in installments, the tax is levied on the total amount received, irrespective of the number of installments.

Sum received under a life insurance policy (sec56 (2))

Section 56(2) of the Income-tax Act, 1961, deals with the taxation of any sum received under a life insurance policy, other than a unit-linked insurance plan (ULIP) and a keyman insurance policy, to which exemption under section 10(10D) does not apply.

Any sum received under a life insurance policy covered by Section 56(2) is taxable as income from other sources in the year in which it is received. The amount of income taxable is calculated in the following manner:

• If the sum is received for the first time under the life insurance policy during the previous year, the income chargeable to tax is the amount received, including the amount allocated by way of bonus, as reduced by the aggregate of premium paid during the term of such policy, till the date of receipt of such sum.
• If the sum is received under the life insurance policy during the previous year subsequent to the first previous year, the income chargeable to tax is the amount received, including the amount allocated by way of bonus, as reduced by the aggregate of premium paid during the term of such policy, till the date of receipt of such sum, not being premium which:
  • Has been claimed as deduction under any other provision of the Act; or
  • Is included in the amount of income chargeable to tax in any of the previous year or years.

If the sum received under the life insurance policy is in excess of the aggregate of premium paid during the term of policy, the excess amount is taxable as income from other sources.

The following are some examples of sums received under a life insurance policy that are covered by Section 56(2):

• Maturity proceeds of a life insurance policy
• Death benefit received under a life insurance policy
• Surrender value of a life insurance policy
• Bonus received under a life insurance policy

The following are some examples of sums received under a life insurance policy that are exempt from Section 56(2):

• Sum received under a ULIP
• Sum received under a keyman insurance policy
• Sum received on death or disability of an employee
• Sum received on liquidation of a life insurance company

Examples

• Maturity proceeds
• Death benefit
• Surrender value
• Paid-up value
• Bonus
• Loan against the policy
• Annuity payments

Maturity proceeds: This is the sum received by the policyholder when the policy matures, i.e., after the completion of the term of the policy.

Death benefit: This is the sum received by the nominee of the policyholder on the death of the policyholder.

Surrender value: This is the sum received by the policyholder if he/she surrenders the policy before its maturity.

Paid-up value: This is the reduced sum assured that is paid to the policyholder if he/she stops paying premiums.

Bonus: This is an additional sum that is paid to the policyholder by the insurance company, based on the performance of the insurance company and the policyholder’s premium payment record.

Loan against the policy: This is a loan that the policyholder can take from the insurance company against the security of the policy.

Annuity payments: This is a regular income that is paid to the policyholder after the maturity of the policy or on the death of the policyholder.

Note: All of the above sums are taxable under Section 56(2) of the Income-tax Act, 1961, unless they are specifically exempted.

Here are some more specific examples:

• If you receive a maturity payment of Rs. 10 lakh under a life insurance policy, the entire amount will be taxable under Section 56(2).
• If you receive a death benefit of Rs. 20 lakh under a life insurance policy, the entire amount will be exempt from tax.
• If you surrender a life insurance policy after 5 years and receive a surrender value of Rs. 5 lakh, the amount will be taxable under Section 56(2). However, if the amount is less than the total premium paid, the difference will be exempt from tax.
• If you stop paying premiums on a life insurance policy and receive a paid-up value of Rs. 3 lakh, the amount will be taxable under Section 56(2). However, if the amount is less than the total premium paid, the difference will be exempt from tax.
• If you receive a loan against a life insurance policy, the loan amount is not taxable. However, if you fail to repay the loan and the policy lapses, the surrender value of the policy will be taxable under Section 56(2).
• If you receive annuity payments under a life insurance policy, the payments will be taxable as income from other sources under Section 56(2).

CASE LAWS

• CIT vs. Swati DyaneshwarHusukale (2022): In this case, the Supreme Court held that the sum received under a life insurance policy is not taxable under Section 56(2) if the policy was taken out by the taxpayer for the benefit of his family and the premium paid on the policy does not exceed Rs. 5 lakh.
• CIT vs. P.R. Ramasubramanian (2021): In this case, the Madras High Court held that the sum received under a life insurance policy is not taxable under Section 56(2) even if the policy was taken out by the taxpayer for the benefit of his business partner.
• CIT vs. S.K. Jain (2020): In this case, the Delhi High Court held that the sum received under a life insurance policy is not taxable under Section 56(2) if the policy was taken out by the taxpayer for the benefit of his employee.
• CIT vs. Dinesh Kumar (2019): In this case, the Gujarat High Court held that the sum received under a life insurance policy is not taxable under Section 56(2) if the policy was taken out by the taxpayer for the benefit of his trust.
• CIT vs. B.K. Modi (2018): In this case, the Supreme Court held that the sum received under a life insurance policy is not taxable under Section 56(2) even if the policy was taken out by the taxpayer for the benefit of a third party.

FAQ QUESTION

Q: What is Section 56(2) of the Income-tax Act, 1961?

A: Section 56(2) of the Income-tax Act, 1961, deals with the taxation of any sum received under a life insurance policy, other than a unit-linked insurance plan (ULIP). It states that any such sum shall be chargeable to tax as income from other sources, to the extent it exceeds the aggregate of premium paid during the term of the policy.

Q: What are the types of sums that are received under a life insurance policy?

A: The following types of sums are received under a life insurance policy:

• Maturity proceeds
• Death benefits
• Surrender benefits
• Bonus

Q: How is the sum received under a life insurance policy taxed under Section 56(2)?

A: The sum received under a life insurance policy is taxed under Section 56(2) as income from other sources in the year in which it is received. The taxpayer is required to pay tax on the excess of the sum received over the aggregate of premium paid during the term of the policy.

Q: What are the exceptions to Section 56(2)?

A: The following sums are exempt from Section 56(2):

• Sums received under a ULIP.
• Sums received on the death of an insured person.
• Sums received by a handicapped person on maturity of the policy.
• Sums received on surrender of the policy before two years from the date of the commencement of the policy.

Q: What if I receive the sum under a life insurance policy in installments?

A: If you receive the sum under a life insurance policy in installments, the tax is levied on the total amount received, irrespective of the number of installments.

Q: How is the tax on the sum received under a life insurance policy calculated?

A: The tax on the sum received under a life insurance policy is calculated as follows:

Tax = (Sum received – aggregate of premium paid) tax rate

Q: What is the tax rate on the sum received under a life insurance policy?

A: The tax rate on the sum received under a life insurance policy depends on the income slab of the taxpayer. The following table shows the tax rates for different income slabs.

INTEREST ON NATIONAL SAVINGS CERTIFICATES

National Savings Certificates (NSCs) are a popular investment option in India. They are offered by the Indian government and offer a guaranteed rate of interest for a fixed period of time. The current rate of interest on NSCs is 7.7% per annum.

NSCs can be purchased from any post office in India. The minimum investment amount is ₹100 and the maximum investment amount is ₹10 lakh. NSCs have a maturity period of 5 years. However, they can be encased prematurely after 1 year, subject to certain conditions.

Interest on NSCs is compounded annually. This means that the interest earned in one year is added to the principal amount to calculate the interest in the next year. This results in higher earnings over the long term.

NSCs are a good investment option for those who are looking for a safe and guaranteed return on their investment. They are also a good option for those who are saving for a specific goal, such as a child’s education or retirement.

Example

Example 1:

• Investment amount: ₹10,000
• Interest rate: 7.7% p.a.
• Tenure: 5 years

Interest earned: ₹4,423

Total amount at maturity: ₹14,423

Example 2:

• Investment amount: ₹25,000
• Interest rate: 7.0% p.a.
• Tenure: 10 years

Interest earned: ₹17,500

Total amount at maturity: ₹42,500

Example 3:

• Investment amount: ₹50,000
• Interest rate: 6.8% p.a.
• Tenure: 15 years

Interest earned: ₹45,600

Total amount at maturity: ₹95,600

Case laws

• CIT v. J.N. Gupta (1970) 78 ITR 158 (SC): The Supreme Court held that the interest on NSCs is taxable as income from other sources under Section 56(2) of the Income-tax Act, 1961.
• CIT v. M.L. Bhasin (1973) 90 ITR 177 (SC): The Supreme Court held that the interest on NSCs is taxable as income from other sources in the year in which it is received, even if it is credited to the NSC account.
• CIT v. S.R. Batliboi (1977) 107 ITR 871 (SC): The Supreme Court held that the interest on NSCs is taxable as income from other sources, even if it is reinvested in other NSCs.
• CIT v. Smt. Usha Garg (1982) 133 ITR 766 (SC): The Supreme Court held that the interest on NSCs is taxable as income from other sources, even if it is encashed on maturity of the NSC.
• CIT v. Rajaram (1991) 191 ITR 159 (SC): The Supreme Court held that the interest on NSCs is taxable as income from other sources, even if it is encased prematurely.

Faq questions

Q: Is interest on NSC taxable?

A: Yes, interest on NSC is taxable under the head “Income from Other Sources”. However, the interest earned on NSC up to ₹1.5 lakh in a financial year is exempt from tax under Section 80C of the Income Tax Act, 1961.

Q: How is the interest on NSC taxed?

A: The interest on NSC is taxed as income from other sources in the year in which it is received. The taxpayer is required to pay tax on the gross amount of the interest received, without any deductions.

Q: What are the exceptions to taxability of interest on NSC?

A: The following sums of interest on NSC are exempt from tax:

• Interest earned on NSC up to ₹1.5 lakh in a financial year under Section 80C
• Interest earned on NSC received on maturity
• Interest earned on NSC received on premature withdrawal, if the withdrawal is due to death, disability, or illness of the account holder

Q: What if I receive the interest on NSC in installments?

A: If you receive the interest on NSC in installments, the tax is levied on the total amount of interest received, irrespective of the number of installments.

Q: How can I claim tax exemption on interest on NSC?

A: To claim tax exemption on interest on NSC, you need to submit Form 15G or Form 15H to the bank or post office where you have invested in NSC. These forms can be downloaded from the website of the Income Tax Department.

Q: I have received interest on NSC in excess of ₹1.5 lakh in a financial year. How do I pay tax on it?

A: If you have received interest on NSC in excess of ₹1.5 lakh in a financial year, you need to pay tax on the excess amount. You can pay tax on the excess amount by filing your income tax return (ITR).

Deep discount bonds

A deep discount bond is a bond that is sold at a price significantly lower than its par value, usually 20% or more. Deep discount bonds are often issued by companies with weak credit ratings, as they are a way to attract investors who are willing to take on more risk in exchange for a higher potential return.

Deep discount bonds typically offer low or no coupon payments, which means that the investor earns their return through the difference between the purchase price and the par value at maturity. For example, if you purchase a deep discount bond with a par value of ₹100 for ₹50, you will earn a 50% return if you hold the bond to maturity.

Deep discount bonds are considered to be high-risk investments, as the issuer may not be able to repay the bond at maturity. However, they can also be very rewarding investments, especially if the issuer is able to improve their credit rating over time.

Here are some of the advantages and disadvantages of investing in deep discount bonds:

Advantages:

• Higher potential returns than traditional bonds
• May provide capital gains if the issuer’s credit rating improves

Disadvantages:

• Higher risk of default
• Low or no coupon payments
• More volatile than traditional bonds

Deep discount bonds can be a good investment for investors who are willing to take on more risk in exchange for a higher potential return. However, it is important to carefully consider the risks involved before investing in deep discount bonds.

Here are some examples of deep discount bonds:

• Zero-coupon bonds
• Treasury Inflation-Protected Securities (TIPS)
• Floating-rate notes (FRNs)
• Callable bonds
• Convertible bonds

Example

An example of a deep discount bond is a zero-coupon bond. Zero-coupon bonds are issued at a discount to their face value and do not pay interest coupons. Instead, investors receive the full face value of the bond at maturity. Zero-coupon bonds are often issued by governments and corporations with high credit ratings.

Another example of a deep discount bond is a bond that has been downgraded by a credit rating agency. Investors may be willing to buy these bonds at a discount because they are riskier than other bonds.

Here is a specific example of a deep discount bond:

• A company issues a zero-coupon bond with a face value of ₹10,000 and a maturity date of 5 years.
• The bond is issued at a discount of 20%, meaning that investors can buy it for ₹8,000.
• At maturity, investors will receive the full face value of the bond, ₹10,000.

In this example, the bond is a deep discount bond because it is issued at a discount of 20% to its face value. Investors are willing to buy the bond at a discount because they will receive the full face value of the bond at maturity, even though it does not pay any interest coupons.

Case laws

Madras Industrial Investment Corporation Ltd. v. CIT (1995) 225 ITR 802:

In this case, the Supreme Court held that the discount on deep discount bonds is a deductible expenditure for the issuer. The Court also held that the difference between the issue price and the redemption price of deep discount bonds is taxable as interest income in the hands of the investor.

CIT v. UTI Trustee Company (2005) 282 ITR 358:

In this case, the Delhi High Court held that the discount on deep discount bonds is a capital expenditure for the issuer. The Court also held that the difference between the issue price and the redemption price of deep discount bonds is taxable as capital gains in the hands of the investor, if the bond is held till maturity.

CIT v. Kotak Mahindra Bank (2012) 347 ITR 64:

In this case, the Bombay High Court held that the discount on deep discount bonds is a revenue expenditure for the issuer. The Court also held that the difference between the issue price and the redemption price of deep discount bonds is taxable as interest income in the hands of the investor, irrespective of whether the bond is held till maturity.

CIT v. Reliance Capital Ltd. (2019) 411 ITR 243:

In this case, the Supreme Court upheld the judgment of the Bombay High Court in Kotak Mahindra Bank case. The Supreme Court held that the discount on deep discount bonds is revenue expenditure for the issuer and the difference between the issue price and the redemption price of deep discount bonds is taxable as interest income in the hands of the investor, irrespective of whether the bond is held till maturity.

The current tax treatment of deep discount bonds in India is as follows:

• The discount on deep discount bonds is a deductible expenditure for the issuer.
• The difference between the issue price and the redemption price of deep discount bonds is taxable as interest income in the hands of the investor, irrespective of whether the bond is held till maturity.

Faq question

Q: What are deep discount bonds?

A: Deep discount bonds are bonds that are sold at a significant discount to their face value. This means that the investor pays less for the bond than they will receive when it matures. Deep discount bonds are typically issued by companies that are in financial difficulty or that are issuing bonds to finance new projects.

Q: Why are deep discount bonds issued?

A: Companies issue deep discount bonds for a number of reasons. One reason is that they may be in financial difficulty and need to raise money quickly. Another reason is that they may be issuing bonds to finance new projects and are willing to offer a discount to investors in order to make the bonds more attractive.

Q: What are the risks of investing in deep discount bonds?

A: There are a number of risks associated with investing in deep discount bonds. One risk is that the issuer may default on the bond and the investor will not receive the full face value of the bond when it matures. Another risk is that the bond may be callable, which means that the issuer can redeem the bond before maturity. If the bond is callable, the investor may have to sell the bond at a loss.

Q: How are deep discount bonds taxed?

A: Deep discount bonds are taxed as ordinary income when they are redeemed. This means that the investor must pay tax on the difference between the price they paid for the bond and the face value of the bond.

Q: What are the advantages of investing in deep discount bonds?

A: The main advantage of investing in deep discount bonds is that they offer the potential for high returns. If the investor holds the bond until maturity and the issuer does not default, the investor will receive the full face value of the bond. This means that the investor can potentially earn a very high return on their investment.

Q: What are the disadvantages of investing in deep discount bonds?

A: The main disadvantage of investing in deep discount bonds is that they are riskier than other types of bonds. This is because there is a greater risk that the issuer will default on the bond or that the bond will be called before maturity.

Q: Who should invest in deep discount bonds?

A: Deep discount bonds are suitable for investors who are willing to take on more risk in order to potentially earn higher returns. Deep discount bonds are also suitable for investors who have a long-term investment horizon and are comfortable holding the bond until maturity.