Income of every kind which is not to be excluded from the total income under this Act shall be chargeable to income-tax under the head “Income from other sources”, if it is not chargeable to income-tax under any of the heads specified in section 14, items A to E.
Section 14: Save as otherwise provided by this Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income:—
B.—Income from house property.
C.—Profits and gains of business or profession.
E.—Income from other sources.
In other words, the following conditions must be satisfied before an income can be taxed under the head “Income from Other Sources”:
- there must be an income;
- such income is not exempt under the provisions of this Act;
- such income is not chargeable to tax under any first four heads viz., “Income from Salary”, “Income from House Property”, “Profits and Gains of Business or Profession” and “Income from Capital Gain”.
Income from other sources is, therefore, a residuary head of income
All receipts are not income, similarly all capital
receipts are not subject to capital gains tax. (Cadell Wearing Mills Co. Pvt. Ltd v. CIT (2001) ITR 265 (Bom.). However, if the capital receipt is not taxable under section 45 of the Act the same cannot brought to tax under residency head of ‘Income from other sources’.
The Apex court in the case of CIT v. D.P. Sandu Bros. Chembur Pvt. Ltd. (2005) 273 ITR 1 (SC.) at page 7 has observed that “There is no dispute that a tenancy right is a capital asset the surrender of which would attract section 45 so that the value received would be a capital receipt and assessable if at all only under item E of section 14. That being so, it cannot be treated as a casual or non-recurring receipt under section 10(3) and be subjected to tax under section 56. The argument of the appellant that even if the income cannot be chargeable under section 45, because of the inapplicability of the computation provided under section 48, it could still impose tax under the residuary head is thus unacceptable. If the income cannot be taxed under section 45, it cannot be taxed at all. (See S.G. Mercantile Corporation Pvt. Ltd. v. CIT  83 ITR 700 (SC.))
Furthermore, it would be illogical and against the language of section 56 to hold that everything that is exempted from capital gains by the statute could be taxed as a casual or non-recurring receipt under section 10(3) read with section 56. We are fortified in our view by a similar argument being rejected in Nalinikant Ambalal Mody v. S.A.L. Narayan Row, CIT  61 ITR 428 (Sc.), 432, 435.
Where an income can appropriately fall under section 28 as business income or any other specific head of income, no resort can be made to section 56 (Mercantile Corpn. (P) Ltd. v. CIT 83 ITR 700 (SC)).
Instances of Classification of Certain Incomes:
Different kind of Income calls for different types of classification. Few examples being:
- Pension vs. Family Pension: Pension will be taxable under the Head “Salary”, however, Family Pension will be taxable under the Head “Income from Other Sources”.
- Rent Income vs. Sub-letting Income: Rent Income from Owned House shall be taxable under the Head “House Property” whereas Sub-letting of a Rented Premises shall be taxable under the Head “Income from Other Sources”.
- Interest Income: Interest earned from loans lended from regular Business Sources shall be taxable under the Head “Business / Profession”. In case, the Interest is earned out of regular savings, then it is taxable under the Head “Income from Other Sources”.
- Director’s Sitting Fees: Sitting Fees paid to Directors is neither in the nature of Salary nor Business. Hence, it is taxable under the Head “Income from Other Sources”.
Method of accounting for computing the Income under the head “Income from Other Sources”
- Section 145: income chargeable under this head, is to be computed in accordance with the method of the accounting regularly employed by the assessee. If the books of account are maintained on mercantile system, the income is to be computed on due basis. On the other hand, if books of account are maintained on cash system,
income is taxable on receipt basis and expenditure shall be allowed as a deduction on payment basis.
- Juggilal Kamlapat Bankers v. CIT (1975 101 ITR 40 (All); J.K. Bankers v. CIT (1974) 94 ITR 107 (All) : The option regarding adoption of a system of accounting is with the assessee and not with the department. The department cannot compel an assessee to adopt the mercantile system of accounting. If the assessee chooses to adopt cash system of accounting under section 56, he cannot be assessed on the accrual basis.
The income chargeable under the head “Income from other sources” shall be computed after making the following deductions, namely :—
- in the case of dividends, or interest on securities, any reasonable sum paid by way of commission or remuneration to a banker or any other person for the purpose of realising such dividend or interest on behalf of the assessee;
(ia) in the case of income of the nature referred to in sub-clause (x) of clause (24) of section 2 which is chargeable to income-tax under the head “Income from other sources”, deductions, so far as may be, in accordance with the provisions of clause (va) of sub- section (1) of section 36;
- in the case of income of the nature referred to in clauses (ii) and (iii) of sub-section (2) of section 56, deductions, so far as may be, in accordance with the provisions of sub-clause of clause (a) and clause (c) of section 30, section 31 and sub-sections (1) and (2) of section 32 and subject to the provisions of section 38;
(iia) in the case of income in the nature of family pension, a deduction of a sum equal to thirty-three and one-third per cent of such income or fifteen thousand rupees, whichever is less.
Explanation.—For the purposes of this clause, “family pension” means a regular monthly amount payable by the employer to a person belonging to the family of an employee in the event of his death;
- any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income;
- in the case of income of the nature referred to in clause (viii) of sub-section (2) of section 56, a deduction of a sum equal to fifty per cent of such income and no deduction shall be allowed under any other clause of this section:
Provided that no deduction shall be allowed from the dividend income, or income in respect of units of a Mutual Fund specified under clause (23D) of section 10 or income in respect of units from a specified company defined in the Explanation to clause (35) of section 10, other than deduction on account of interest expense, and in any previous year such deduction shall not exceed twenty per cent of the dividend income, or income in respect of such units, included in the total income for that year, without deduction under this section.
Clauses (i), (ia), (ii) & (iia) of section 57 specifically mention to deductions available while computing the income chargeable under the head ‘Income from other sources’. Clause (iii) to section 57 makes admissible the deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income (income chargeable under the head “income from other sources“).
Section 57(iii) of the Act is in line with the section 37(1) of the Act which in general (subject to its Explanation) makes available deduction of any expenditure (not being expenditure of the nature described in sections 30 to 36 of the Act and not being in the nature of capital expenditure or personal expenses of the assessee) laid down or expended wholly and exclusively for the purposes of the business or profession while computing the income chargeable under the head “Profit and gains of business or profession.
It may be pertinent to mention the distinction in the language used by the legislature in section 37(1) of the Act and 57(iii) of the Act. Section 37 provides for deduction of expenditure incurred wholly and exclusively “for the purpose of business” whereas section 57(iii) provides for deduction only of expenditure incurred wholly and exclusively “for the purpose of making or earning such income”. “Such income” refers to “income from other sources”.
Pre-requisites for claiming Deduction u/s 57(iii)
The Gujarat High Court in Virmati Ramkrishna
- CIT (1981) 131 ITR 659, has observed the following propositions in respect of deduction of an expenditure under sec. 57(iii) of the Act (See also Eastern Investments Ltd. v. CIT (1951) 20 ITR 1 (SC), Seth R. Dalmia vs. CIT (1977) Taxation 49(3)-57, 110 ITR 644 (SC):
- In order to decide whether an expenditure is a permissible deduction u/s 57(iii), the nature of the expenditure must be examined.
- The expenditure must not be in the nature of capital expenditure or personal expenses of the assessee;
- The expenditure must have been laid out or expended wholly and exclusively for the purpose of making of earning “income from other sources”;
- The purpose of making or earning such income must be the sole purpose for which the expenditure must have been incurred, that is to say, the expenditure should not have been incurred for such purpose as also for another purpose, or for a mixed purpose;
- The distinction between purpose and motive must always be borne in mind in this connection, for, what is relevant is the manifest and immediate purpose and not the motive or personal considerations weighing the mind of the assessee in incurring the expenditure;
- If the assessee has no option except to incur the expenditure in order to make the earning of the income possible, such as when he has to incur legal expenses for preserving and maintaining the source of income, then undoubtedly, such expenditure would be an allowable deduction; however, where the assessee has an option and the option which he exercises has no connection with the making or earning of the income and the option depends upon personal considerations or motives of the assessee, the expenditure incurred in consequence of the exercise of such option cannot be treated as an allowable deduction;
- It is not necessary, however, that the expenditure incurred must have been obligatory; it is enough to show that the money was expended not of necessity and with a view to an immediate benefit to the assessee but voluntarily and on the ground of commercial expediency and in order indirectly to facilitate the making or earning of the income;
- If, therefore, it is found on application of the principles of ordinary commercial trading that there is some connection, direct or indirect, but not remote, between the expenditure incurred and the income earned, the expenditure must be treated as an allowable deduction;
It would not, however, suffice to establish merely that the expenditure was incurred in order indirectly to facilitate the carryingon of the activity which is the source of the income; and nexus must necessarily be nexus must necessarily be between the expenditure incurred and the income earned;
- It is not necessary to show that the expenditure was a profitable one or that in fact income was earned;
- The test is not whether the assessee benefited thereby or whether it was a prudent expenditure which resulted in ultimate gain to the assessee but whether it was incurred legitimately and bonafide for making or earning the income;
- The question whether the expenditure was laid out or expended for making or earning the income must be decided on the facts of each case, the final conclusion being on of law.
Case Law References
- Interest paid on the loan obtained for acquiring the shares – not allowed in absence of Nexus:
CIT v. Smt. Amirtaben R. Shah (1999) 152 Taxation 721 (Bom.): Under section 57(iii), deduction will not be allowed if the expenditure is not incurred for the purpose of earning income falling under the head “income from other sources”. the expenditure incurred by way of interest on the loan taken by the assessee for the said purpose cannot be held to be an expenditure incurred wholly and exclusively for the purpose of earning income by way of dividends. From the nature of transaction, it is clear that the expenditure was not for the purpose of earning income by way of dividends but for the purpose of acquiring controlling interest in the company and, therefore, it would not be allowable as a deduction under Section 57(iii) of the Act.
Sri Saytasai Properties and Investment P. Ltd. Y CIT (2014) 361 ITR 641 (Cal)
The interest which the assessee is liable to pay on the amount borrowed by him for the purpose of making investments is undoubtedly an expenditure laid out or expended wholly and exclusively for the purpose of making or earning income chargeable under the head “Income from Other sources”
Jaswantrai P. Mehta v CIT (1991) 192 ITR 577(Guj)
The interest which the assessee has become liable to pay on account of his failure to pay interest cannot be said to be an expenditure laid out or expended wholly and exclusively for the purpose of earning such income. The assessee is entitled of only the interest payable on the principal amount, but not the additional interest on the overdue interest.
Mathew Joseph v ACIT (2017) 87 ITR 317 (Kerala)
Without obtaining consent of bank, a part of loan taken for promotion of export was diverted to sister concern which was doing a different business, though interest was earned by assessee from sister concern at same rate it paid interest to bank, income could not be said to have exclusive nexus with expenditure; interest so earned could not be set off against interest expenditure paid to bank.
- Expenditure in issuing the circulars to indirectly facilitate the earning of the director’s fees is allowable as it has direct nexus with earning Director’s Fees; however, expenditure incurred in collecting the proxies from the shareholders cannot be regarded as expenditure, even indirectly connected with the earning of the director’s fees:
Kasturbhai Lalbhai (1968) 70 ITR 267 (Guj.): The assessee was director of A & Co. Ltd., of which K. N. Co. Ltd. was the managing agent. Due to certain mismanagement and change in the directorate of K. N. Co. Ltd., there were difference between the assessees and the other directors of A & Co. Ltd. The assessees therefore sent out two circulars to the shareholders pointing out the mismanagement. They also collected proxies for a meeting of A & Co. Ltd. requisitioned in the meantime. Before the said meeting could be held, the differences were settled and ultimately the first assessee was elected chairman of the board of directors of A & Co. Ltd. The assessees jointly spent about Rs. 33,299 for sending out the circulars and collecting the proxies and claimed to deduct this amount in their respective assessment both under section 10(2)(xv) and under section 12(2) of I. T. Act, 1922 (which corresponds to section 37(1) & 57 of I. T. Act, 1961, respectively). The departmental authorities negatived this claim, but the Tribunal allowed the expenditure as a permissible deduction under section 12(2). The Tribunal, however, rejected the contention of allowability under section 10(2)(xv). On a reference to the Gujarat High Court, it held as follows:
- as the assessees had incurred the expenditure in issuing the circulars on the ground of commercial expediency in order to indirectly facilitate the earning of the director’s fees, the expenditure relating thereto was an expenditure incurred solely for earning the director’s fees and hence was allowable under sec. 12(2).
- The expenditure incurred in collecting the proxies from the shareholders cannot be regarded as expenditure, even indirectly connected with the earning of the director’s fees and, hence, was not allowable under section 12(2).
- Expenditure for deduction u/s 57(iii) does with relation to any income is made or earned:
CIT v. Rajendra Prasad Moody (1978), Taxation 51 (3)-52, 115 ITR 519 (SC) : CIT vs. Murli Manohar (1998) IX SITC 673 (All) : CIT vs. Rampur Timber & Turney Co. Ltd. (1981) 129 ITR 58 (All.) : CIT vs. Administrator General of Madras (1998) 142 Taxation 85 (Mad.): The plain natural construction of the language of section 57(iii) of the Act, irresistibly leads to the conclusions that to bring a case within that section it is not necessary that any income should in fact have been earned as a result of the expenditure. What section 57(iii) requires is that the expenditure must be laid out or expended wholly and exclusively for the purpose of making or earning income. The section does not require that this purpose must be fulfilled in order to qualify the expenditure for deduction it does not say that the expenditure shall be deductible only if any income is made or earned.
West Palm Developments LLP (Formerly West Palm Developments Pvt. Ltd.) v. ACIT (Karnataka High Court): Section 57(iii) of the Act does not require that the expenditure incurred is deductible only if expenditure has resulted in actual income. As long as the purpose of incurring expenditure is to earn income, the expenditure would have to be allowed as a deduction under Section 57(iii) of the Act. Under Section 57(iii) of the Act a nexus between the expenditure and income has to be ascertained. The assessee was therefore, entitled to deduction under Section 57(iii) of the Act.
CIT v. Sujani Textiles P. Ltd (1985) 151 IT 653 (Mad).
Where there is no possibility of income from a particular source, expenditure incurred in relation to such investment cannot be allowed as a deduction.
- Interest payment on overdrafts to meet the personal liability is not allowable: H. H. Maharaja Martand Singh Ju Deo v. CIT (1989) Taxation 92(3)-199, 174 ITR 515 (MP): Padmavati Jai Krishna v. Addl. CIT (1987) Taxation 86(2)-1: 166 ITR 176 (SC): Where the dominant purpose of the assessee in taking overdrafts was not to earn income but to meet the personal liability, interest payment on overdrafts was held to be not allowable deduction under section 57(iii) of the Act.
- There should be some nexus, either direct or indirect, between the expenditure and the earning of the income: Addl. CIT v. Madras Fertilisers Ltd. (1980) 122 ITR 139 (Mad.) : Vijaya Laxmi Sugar Mills Ltd. v. CIT (1991) 191 ITR 641 (SC): CIT v. Dwaraka Chit Funds Pvt. Ltd. (1996) 132 Taxation 109 (Mad.): Connection between the expenditure and earning of income need not be direct and it may be indirect. But, since the expenditure must have been incurred for the purpose of earning that income, there should be some nexus between the expenditure and the earning of the income.
As discussed, Section 56(1) seeks to bring all the Residuary Income which cannot be classified under other Heads of Income within the ambit of the Income Tax Act, 1961. The provisions of the Income-tax Act state that the expenditure sought to be deducted should have a nexus to the Income earned. The allowable expenditure as envisaged by Section 57(iii) of the Act should not be in the nature of capital or personal expenditure and it should have been incurred wholly and exclusively for the purpose of making or earning the income which is chargeable under the head “Income from Other Sources” under Section 56 of the Act.