This is a beautiful Prayer from Rig Veda. This is a prayer for all Noble thoughts to travel from all directions into us. The flow of and the reception of such thoughts is truly a divine “gift”. Is there a danger of such thought getting taxed under section 56. Hopefully not, but one must qualify that with the phrase “as of now”.
Now let’s start from where we left last time. The brief legislative history of how “Gifts” were taxed at different points of time in different forms were discussed. Now this time let’s make a small digression and see if “gift” at all could be taxed under Income Tax Act and if so what are the limitations of such a tax. Gift per se is considered and rightly so as a capital receipt. Now we should see if at all Capital receipts are liable for Income Tax. The primary battle between the tax-payer and the taxman has been to designate Income as ‘Capital’ or ‘Revenue’ to meet their respective objective. While the tax-payer has always been trying to designate every receipt as “Capital” so that he can be saved from tax, the taxman is equally vehement in trying to designate every receipt as “Revenue” so that the same could be brought to tax. One of the earliest such fight could be traced to the attempt to argue – royalty from a mine as a capital receipt, which the Privy council adjudicated in favour of the taxman. This was the famous Raja Bahadur Kamakshya Narain Singh of Ramgarh v. Commissioner of Income-tax  11 ITR 513 (The Privy Council). In this case the assessee contended that income derived from mines by way of Royalty were capital receipts as they were from a wasting property. This decision is famous not just for its topicality but also for its free flow of literature. It was a justice delivered like a poem though not a poetic justice. The reading of the judgement would give one the pleasure of reading a poetry. Let’s look at some of the extracts from the judgement. Quoting extensively from Lord Lowndes decision in the case of Commissioner of Income-tax, Bengal v. Shaw Wallace & Co.  59 IA 206, Lord Weight upheld the view of the department. In doing so he took out the words of Lord Lowndes: “Income has been likened pictorially to the fruit of a tree, or the crop of a field. It is essentially the produce of something which is often loosely spoken of as ‘capital,” and went on to add “Sir George Lowndes … speaks of “income ” being likened pictorially to the fruit of a tree or the crop of a field. But it is clear that such picturesque similies (sic) cannot be used to limit the true character of income in general, and particularly when it is constituted by mining rent or royalties.”
However, in this battle, over the years, the taxman has been bestowed with an advantage, if one may say so, an unfair one at that. Judicial sanction has been accorded to the power arrogated by the Governments to designate a ‘Capital’ receipt as Income. The word “arrogate” may sound harsh but that would be appropriate since the earliest such power was exercised at the dawn of Independence from the colonial rule though the judicial sanction was received in Independent India. This pertained to taxing “Capital Gains” taking a cue from British precedence ( Britain started taxing Capital Gains in 1945 which was soon followed in India in the year 1947). Tax on Capital Gains was first introduced into Indian Income Tax Law through Indian Income tax and Excess Profits Tax (Amendment) Act, 1947. The question arose if enlarging definition of term income in section 2(6C) of 1922 Act and introducing a new head of income in section 6 of 1922 Act and inserting new section 12B, was within powers of Central Legislature acting under entry 54 in List I of Seventh Schedule of Government of India Act, 1935. This matter was dealt by Privy Council in the case of Navin Chandra Mafatlal Vs. CIT (1954) 26 ITR 758 (SC). Before discussing this case law, it would be important to go into the legislative powers conferred to bring Income to tax. Prior to the adoption of the Constitution of India, the power to legislate on Income Tax was conferred by the Government of India Act, 1935 which as per List 1 conferred powers on Viceroy with his council and Central Legislative Assembly to legislate on Taxes on Income which was enumerated in Entry 54. Entry 54 and 55 read thus:
“54 Taxes on income other than agricultural income.
55 Taxes on the capital value of the assets, exclusive of agricultural land, of individuals and companies, and taxes on the capital of companies”
The broad scheme of taxation on this aspect, post-adoption of Constitution remains similar to the Government of India Act, 1935.
The matter under dispute was what constituted ‘Income’ enumerated in entry 54 above. The Judgement of the Supreme Court in this case Navinchandra Mafatlal Vs. CIT is a great read for all those interested in Fiscal Laws and Constitutional law. The issue involved interpreting the same term in two different contexts. Whether the precedents cited by the appellants on the contours of Income under the Income Tax law can be used to restrict its meaning in the constitution law conferring powers to tax Income. The arguments of the appellants could be summed up as follows:
a) entry 54 which deals with “taxes on income ” does not embrace within its scope tax on capital gains.
b) “Income” does not signify capital gains either according to its natural import or common usage or according to judicial interpretation of relevant legislation both in England and in India.
c) there was a clear line of demarcation that had always been observed by English lawyers and English jurists between income and capital, that the English legislative practice had always recognised this difference and that as the word had come to acquire a certain meaning and a certain connotation by reason of such legislative practice in England, the British Parliament which enacted the Government of India Act, 1935, must be regarded as having understood and used that word ”income” in entry 54 in that sense.
The Supreme Court negatived these averments of the appellants and upheld the view of the department on the following premises:
a) The precedents cited by the appellants related to the term “income” or “proft” as used in the Incometax Act and that there is no warrant for saying that these observations cut down the natural meaning of the ordinary English word ” income” in any way.
b) While income tax legislation adopts an inclusive definition of the word “income” the scheme of such legislation is to bring to charge only such income as falls under certain specified heads (e.g., the 5 Schedules of the English Act of 1918 and our Section 6 read with the following sections) and as arises or accrues or is received or is deemed to arise or accrue or to be received as mentioned in the statute. The Courts have striven to ascertain the meaning of the word “income “in the context of this scheme.
c) The question before us relates to the correct interpretation of a word appearing in a Constitution Act which as’ has been said, must not be construed in any narrow and pedantic sense.
d) The cardinal rule of interpretation however, is that words should be read in their ordinary, natural and grammatical meaning subject to this rider that in construing words in a Constitutional enactment conferring legislative power the most liberal construction should be put upon the words so that the same may have effect in their widest amplitude.
After detailed discussion the Supreme Court concluded that Act XXII of 1947 which amended the Indian Income tax Act by enlarging the definition of the income in Section 2 (6C) and introducing .a new head in Section 6 and inserting the new Section 12B were intra vires the of power Legislature acting under entry 54 in List I of the Seventh Schedule of the Government of India Act, 1935. Now this establishes that there is no bar on bringing Capital Receipts to tax under Income Tax. Then what differentiates Capital from Revenue. There is a clue in the decision under discussion that while interpreting the term “Income” in the Tax legislation there is a natural restriction to the meaning. So how does the taxation of such items resorted to in the tax legislation? Normally such items of Income are added as one of the clauses in the inclusive definition of Income.
What is the difference in treatment between items of Income which are naturally understood as such and those which are deemed as income by insertion in the inclusive definition of “Income” ? That shall form part of the long story for the next episode of this Soap.