Section 56 of Income Tax Act, 1961: An Explanation of Key & Specific Clauses

The Income Tax Act, 1961, categorizes income into five heads, with "Income from Other Sources" being the residuary category. Section 56 ensures that earnings from diverse and unconventional sources, such as gifts, lottery winnings and interest on deposits, are accounted for in a taxpayer's annual income. This provision helps prevent tax evasion through non-traditional income streams and is particularly relevant for individuals, Hindu Undivided Families (HUFs), companies, and other entities.

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What is Section 56 of Income Tax Act, 1961?

Section 56 of the Income Tax Act, 1961, is a critical provision that addresses "Income from Other Sources," ensuring that all forms of income, particularly those not classified under the primary heads such as salary, house property, business or profession, and capital gains, are taxed appropriately. This section is essential for maintaining the integrity of the tax system by capturing miscellaneous or residuary incomes. Below, we provide a comprehensive breakdown of its provisions, including key clauses, taxation rules, thresholds and exemptions.

Key Clauses under Section 56(2)

Section 56(2) of the Income Tax Act, 1961, outlines specific incomes taxable under "Income from Other Sources." Below is a detailed explanation of each clause in paragraph form, covering the description, key details or thresholds, tax implications, and exemptions or notes.

Clause (i): Dividends

This covers money earned from dividends, which are payments from companies to shareholders. No specific limits apply. Dividends are taxed based on whether the company is based in India or abroad. All dividends are taxed under "Income from Other Sources" with no exemptions.

Clause (id): Interest on Securities

This includes earnings from interest on securities, like bonds. There’s no minimum amount; all interest is taxable under "Income from Other Sources." The tax depends on your income slab rate, and no exemptions are available.

Clause (ii): Renting Out Equipment or Furniture

This applies to income from renting out things like machinery or furniture. Any amount earned is taxable under "Income from Other Sources." There are no specific limits or exemptions, so all rental income is taxed.

Clause (iii): Renting Equipment with Buildings

This covers income from renting machinery or furniture along with a building, if they can’t be separated. All such income is taxable under "Income from Other Sources," with no specific limits or exemptions.

Clause (iv): Keyman Insurance Policy

This includes money received from a Keyman insurance policy, including bonuses. All amounts are taxable under "Income from Other Sources," with no specific limits or exemptions.

Clause (viib): Shares Above Market Value

This applies when private companies sell shares at a price higher than their fair market value (FMV). The extra amount above FMV is taxed for both Indian and foreign recipients. Startups registered with DPIIT and filing Form 2 are exempt, helping new businesses avoid this tax.

Clause (x): Gifts

This covers gifts in cash, property, or other forms. If the total value of gifts in a year exceeds Rs 50,000, the entire amount is taxed under "Income from Other Sources." For example, if you receive Rs 55,000 in gifts, all of it is taxable. Exemptions include gifts from family (like parents or siblings), gifts on marriage, gifts through a will, gifts for Covid-19 treatment (unlimited from employers, up to Rs 10 lakh from others), gifts from local authorities or certain institutions, and specific transactions like asset transfers during marriage.

Clause (xi): Job Termination Compensation

This includes money received for losing a job. All such compensation is taxable under "Income from Other Sources," with no specific limits or exemptions.

Clause (xiii): Life Insurance Policy

This covers money from life insurance policies that exceeds the premiums you paid. The excess is taxed under "Income from Other Sources," but amounts exempt under Section 10(10D) are not taxed. No other exemptions apply.

Clause (xii): Business Trust Debt Repayment

This applies to money received as debt repayment from business trusts, like REITs or InVITs. The amount above the purchase price, after accounting for certain debt repayments, is taxed under "Income from Other Sources." No exemptions are available.

Read Section 147 of Income Tax Act, 1961.

Detailed Analysis of Specific Clauses of Section 56 of Income Tax Act, 1961

This clause aims to prevent tax evasion through gifts, particularly from non-relatives, while allowing for socially and legally recognized exemptions.

1. Gifts (Section 56(2)(x))

This clause is particularly significant for taxpayers, as it addresses the taxation of gifts received in cash, property (movable or immovable) or in-kind. The rule states that if the aggregate value of such gifts exceeds Rs 50,000 in a financial year, the entire amount is taxable under "Income from Other Sources." For example, if a taxpayer receives gifts totaling Rs 55,000, the entire Rs 55,000 is taxable, not just the excess over Rs 50,000.

• Exemptions: Several categories are exempt from taxation, including:

1. Gifts from relatives, defined as spouse, siblings, parents, children, and other close family members.

2. Gifts received on occasions like marriage, which are considered socially acceptable and not subject to tax.

3. Gifts received under a will or by inheritance, which are covered under separate provisions.

4. Gifts for Covid-19 treatment, with an unlimited exemption if received from an employer, and up to Rs 10 lakh if received from others, reflecting special considerations during the pandemic.

5. Gifts from local authorities, educational or medical institutions, or trusts registered under specific sections like 10(20), 10(23), 12A, 12AA, 12AB, and 10(23C).

6. Transactions covered under Section 47, such as transfers of assets on marriage, which are not treated as taxable income.

2. Property Transactions (Section 56(2)(x))

Property transactions are another critical area under Section 56(2)(x), where the difference between the stamp duty value and the consideration paid can be taxable. Specifically:

• If the stamp duty value exceeds the consideration by more than 10%, the difference is taxable as income from other sources.

• For residential properties up to Rs 2 crore, a special rule applied between November 12, 2020, and June 30, 2021, where the threshold was 20% instead of 10%.

For example, if a property is purchased for Rs 50,00,000, but its stamp duty value is Rs 60,00,000, the difference of Rs 10,00,000 is taxable. This provision ensures that undervalued property transactions are captured for tax purposes along with exemptions for gifts from relatives or other exempt categories as outlined above.

3. Lotteries, Crossword Puzzles, Races, Gambling, Betting

Winnings from lotteries, crossword puzzles, races (including horse races), card games, gambling, or betting are taxed at a flat rate of 30%, with an additional 4% cess, resulting in an effective tax rate of 31.2%. This high rate reflects the government's approach to taxing windfall gains, and there are no specific exemptions mentioned for these categories, making them fully taxable under "Income from Other Sources."

4. Shares Issued at Higher than Fair Market Value (Section 56(2)(viib))

This clause addresses situations where a privately held company issues shares at a price higher than their Fair Market Value (FMV). The excess amount is taxable and this provision applies to both residents and non-residents. However, an exemption is available for companies registered under Startup India, provided they have valid DPIIT registration and have filed Form 2, encouraging entrepreneurial activities while preventing tax evasion through inflated share pricing.

5. Other Incomes

Other clauses, such as interest on securities, income from letting out plant or machinery, and compensation for termination of employment, are also taxable under "Income from Other Sources," with no specific thresholds or exemptions mentioned beyond standard tax rules.

Summary

Section 56 of the Income Tax Act, 1961covers taxes "Income from Other Sources," including gifts exceeding Rs 50,000, dividends, lottery winnings and property transactions where stamp duty value exceeds consideration by over 10%. Exemptions apply for gifts from relatives, on marriage, or under wills. Startups issuing shares above fair market value are taxed, but DPIIT-registered startups are exempt. This provision ensures miscellaneous incomes are taxed, preventing evasion through non-traditional sources.

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Section 56 of Income Tax Act: FAQs

Q1. What is Section 56 exemption of Income Tax Act?

Exemptions under Section 56 include gifts from relatives, gifts on marriage, inheritances, Covid-19 treatment amounts (unlimited from employer, up to Rs 10 lakh from others), and gifts from specified institutions or trusts.

Q2. What is taxable income under Section 56?

Taxable income includes dividends, interest on securities, lottery winnings (taxed at 30% + 4% cess), gifts exceeding Rs 50,000, property transactions with stamp duty value exceeding consideration by over 10%, and share issues above fair market value.

Q3. What is Section 56 of Income Tax Act startup?

Section 56(2)(viib) taxes privately held companies issuing shares above fair market value. Startups registered with DPIIT and filing Form 2 are exempt.

Q4. How much money can you gift to a family member tax-free in India?

Gifts to relatives (e.g., spouse, siblings, parents, children) are tax-free under Section 56, with no monetary limit, regardless of the amount.

Q5. What is Section 56 of the Indian Contract Act?

Section 56 of the Indian Contract Act, 1872, deals with agreements void due to impossibility of performance, either initially or subsequently, and is unrelated to the Income Tax Act.