Forfeited advance money

A seller in the middle of negotiating a sale often takes an advance, a token payment showing the buyer means business. Sometimes the deal falls through anyway, and the seller keeps the advance.

The workbook is direct about what happens next: that forfeited advance is taxable income, taxed under income from other sources, in the year it is forfeited.

The rule applies specifically where the advance was received in the course of negotiating the transfer of a capital asset, and the negotiations then do not result in a transfer. Two conditions have to both hold: a genuine negotiation for a capital asset, and a failure of that negotiation.

The workbook lists this as one of the items always charged under income from other sources, alongside dividend income and interest on securities — it does not wait to be picked up as a residual item; it is a named, standing entry in the list.

The workbook does not give this item its own worked example or a numeric threshold of its own — there is no Rs 50,000-style floor here, unlike the gift-of-securities rule in the same chapter. Whatever is forfeited is taxable in full, in the year forfeited.

Illustrative figures. Mrs Nair agrees, in principle, to sell a flat for Rs 80,00,000 and takes an advance of Rs 5,00,000 from a prospective buyer. The buyer later backs out, and under the terms of their negotiation, Mrs Nair keeps the Rs 5,00,000.

Because the negotiation was for the transfer of a capital asset — the flat — and it did not result in a transfer, the entire Rs 5,00,000 is taxable in Mrs Nair's hands as income from other sources in the year she forfeits it, added to her other income and taxed at her slab rate. This is so whether or not she ever finds another buyer for the flat.

Chapter 9 (Income from Other Sources), section 9.1, lists forfeited advance money for a capital asset among the incomes always taxable under this head, immediately alongside dividend income and interest on securities. Expect a question that asks which head of income a forfeited advance falls under, or one that tests it against the alternative of the advance being adjusted against the cost of a later transfer.

• The asset itself must be a capital asset, and the failed negotiation must genuinely be for its transfer — advance money in an ordinary trading or business transaction follows different rules.
• The tax falls in the year of forfeiture, not the year the advance was originally received, if the two years differ.
• This does not reduce the cost of acquisition of the asset later sold to someone else. The forfeited amount is taxed as income in its own right, a separate event from any eventual sale.