What is tax?

Tax means “a financial charge or other levy” upon a person (taxpayer) by a government.

A tax is not optional payment, but an enforced contribution.

Purposes of tax

Taxes are the main source of revenue for every type of government. Governments use tax revenue (money) to carry out many of its functions. Some of these include

  • expenditures on war,
  • the enforcement of law and public order,
  • protection of property,
  • economic infrastructure (roads, legal tender, enforcement of contracts, etc.),
  • public works and
  • the operation of government itself.

Governments also use taxes to fund welfare and public services. A portion of taxes also go to pay off the state’s debt.

Types of taxes

  • Direct taxes like House Tax, Income tax, wealth tax etc.
  • Indirect taxes like sales tax, service tax, custom, excise etc.
  • Various kinds of cesses

What is Direct tax?

  • The direct tax generally means a tax paid directly to the government by the persons on whom it is imposed. Here the burden of tax bears the person on whom it is imposed. Thus direct tax is borne entirely and directly by the person who pays it.

What is Indirect tax?

  • The indirect tax generally means a tax paid indirectly to the government by the persons who avails services or buys products. It is imposed on, and paid by, the persons providing services or goods but recovered by the buyer or consumers of such goods and services.

 

What is cess?

Cess is a kind of small tax imposed and collected for the specific purpose like Primary education cess/ Secondary Higher education cess/ Krishi Cess/ Swach Bharat Cess Etc.

Constitutional Provisions regarding Income Tax

 

Seventh Schedule to Article 246 of the Indian constitution distributes the power of levy of taxes amongst the State and central government via three lists:-

  1. List I – Union List – States matter on which Central Government can create Law.
  2. List II – State List – States matter on which State Government can create Law.
  3. List III- Concurrent List – Both Central Government and state Government can create Law.

There in 1961, Income Tax Act was passed by parliament to levy taxes on the income of persons. Income Tax Act, 1961 contains provisions for determination of taxable income and tax liability, procedure for assessment, appeals, penalties and prosecutions.

 

Central Board of Direct Taxes (CBDT)

Generally every Act gives power to an authority (Board) for proper implementation and administration of the provisions of the Act. Section 295 of the Income Tax Act, 1961 has given powers to “Central Board of Direct Taxes” to implement the provisions of this Act properly and to make various rules under this Act (subject to the control of Central Government). Further, this Act prescribes powers and duties of various income tax authorities and officers.

CBDT issues notifications from time to time. These notifications become rules and are collectively known as Income Tax Rules, 1962.

Further, CBDT issues circulars from time to time for the purpose of clarifications regarding various provisions of this Act. These circulars work as guidance for income tax authorities and officer and binds income tax department only. They are not binding upon assessees but assessees can take benefits of these circulars.

Note: CBDT has no powers to amend Income Tax Act, 1961.

Amendment in Income Tax Act, 1961

Income Tax Act, 1961 is a law related to income of the various persons and revenue of the government. Therefore it changes time to time according to the various market conditions and government needs. Such amendments are introduced every year in the form of Financial Act.

Every year a budget is presented before the parliament by finance minister and one of the most important components of the budget is financial bill. This bill contains various amendments which are proposed to be made in the direct taxes and indirect taxes.

This bill also mentions the rate of income tax. Schedule I to this bill provides rates of income tax in 3 parts:

PART 1

It gives the rates of income tax for various assessees for the current assessment year. Means it provides the rates of income tax for the income earned during the previous year.

  • For example, the Finance Act, 2015 has given the rates of income tax for assessment year 2015-16 (1st April, 2015 to 31st March, 2016). Here the previous year is 2014-15

PART 2

It gives the rates of deduction of tax at source (TDS) from the income earned in the current financial year.

  • For example, the Finance Act, 2015 has given the rates at which tax is to be deducted at source from the income earned during financial year 2014-15 (1st April, 2014 to 31st March, 2015). Here the previous year is 2014-15.

PART 3

It gives the rates of deduction of tax from the income chargeable under the head “salaries”.

These rates are applicable for the computation of advance tax to be paid in the current financial year.

  • For example, the Finance Act, 2015 has given the rates for the computation of advance tax for the assessment year 2016-17 (1st April, 2016 to 31st March, 2017). Here the previous year is 2015-16.

Note:

  • Generally Part 3 of the Schedule I of a particular Finance Act becomes Part 1 of the subsequent Finance Act.

 

INCOME-TAX ACT, 1961

[43 OF 1961]

Short title, extent and commencement (Section 1)

  • This Act may be called the Income-tax Act, 1961.
  • It extends to the whole of India.
  • Save as otherwise provided in this Act, it shall come into force on the 1st day of April, 1962.

Certain Definitions (Section 2)

 

ASSESSEE [Clause (7)]

Assessee means a person by whom any tax or any other sum of money (like fine, interest, penalty etc.) is payable under this Act, and includes—

  • every person in respect of whom any proceeding under this Act has been taken for the
    • assessment of his income or
    • assessment of the income of any other person in respect of which he is assessable, or
    • assessment of the loss sustained by him or by such other person, or
    • assessment of the amount of refund due to him or to such other person ;
  • every person who is deemed to be
    • an assessee under any provision of this Act ;
    • an “assessee in default” under any provision of this Act ;

Accordingly, assessee is a person by whom tax or any other sum is payable under the Act or any refund is due under the Act.

 

 

Note:

  • The proceedings must be initiated under the provisions of the Act. A single enquiry letter issued by the Income-tax Department without reference to any specific provision of the Act does not constitute proceeding under the Act and, as such, till proceedings are initiated under the Act, the person may not become an assessee within the ambit of Section 2(7) of the Act.

PERSON [Clause (31)]

Person includes—

  • an individual (male, female, minor, lunatic etc.)
  • a Hindu undivided family (HUF),
  • a company,
  • a partnership firm (whether registered or not),
  • an association of persons (AOP) or a body of individuals (BOI) (whether incorporated or not)
  • a local authority (like municipal committee, district board etc.) and
  • every other artificial juridical person (like deity, unregistered charitable trusts, unregistered clubs, religious body etc.)

Note:

  • an AOP or a BOI or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains;
  • HUF consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters.
  • The difference between Association of persons and body of individuals is that whereas an association implies a voluntary getting together for a definite purpose, a body of individuals would be just a body without an intention to get-together. Moreover, the members of body of individuals can be individuals only whereas the members of an association of persons can be individual or non-individuals (i.e. artificial persons).
  • an association of persons or a body of individuals or a local authority or an artificial juridical person shall be deemed to be a person, whether or not such person or body or authority or juridical person was formed or established or incorporated with the object of deriving income, profits or gains.

 

PRINCIPAL OFFICER [Clause (35)]

Principal officer, used with reference to a local authority or a company or any other public body or any association of persons or any body of individuals, means—

  • the secretary, treasurer, manager or agent of the authority, company, association or body, or
  • any person connected with the management or administration of the local authority, company, association or body
    • upon whom the Assessing Officer has served a notice of his intention of treating him as the principal officer thereof

Note:

  • In order to make a person the principal officer, the connection must be with the management or administration of the company.
  • It is not necessary that the person concerned should be actually managing or administering the company. It is sufficient that the person is connected with such management or administration.
  • What is important is that the person so connected must be served by the Assessing Officer with a notice setting out his intention to treat such person as the principal officer of the company.
  • Therefore, the requirements of law are fulfilled if the person concerned can be treated as the principal officer, the Assessing Officer indicates his intention to him, treating him as the principal officer.

ASSESSMENT YEAR [Clause (9)] 

Assessment year means the period of twelve months commencing on the 1st day of April every year;

(Income of previous year of an assessee is taxed during the following assessment year at the rates prescribed by the relevant Finance Act.)

 

PREVIOUS YEAR (SECTION 3)

For the purposes of this Act, “previous year” means the financial year immediately preceding the assessment year.

Previous year in case of new business or new source of income

In the case of

  • a business or profession newly set up or
  • a source of income newly coming into existence,

the previous year shall be the period

  • beginning with the date of setting up of the business or profession or the date on which the source of income newly comes into existence and
  • ending with the end of financial year.

Kind of companies under Income Tax Act, 1961

COMPANY [SECTION 2(17)]

Company means—

  • any Indian company, or
  • any body corporate incorporated by or under the laws outside India, or
  • any institution, association or body
    • which is or was assessable or was assessed as a company for any assessment year under the Indian Income-tax Act, 1922, or
    • which is or was assessable or was assessed under this Act as a company for any assessment year commencing on or before the 1st day of April, 1970, or
  • any institution, association or body, whether incorporated or not and whether Indian or on-Indian, which is declared by general or special order of the Board to be a company.

ote: Such institution, association or body shall be deemed to be a company only for such assessment year or assessment years as may be specified in the declaration

DOMESTIC COMPANY [SECTION 2(22A)]

Domestic company means

  • an Indian company, or any other company which, has made the prescribed arrangements for the declaration and payment of the dividends within India (including dividends on preference shares) payable out of income liable to tax under this Act

Prescribed arrangement of Dividend

  • Share register of the company for the shareholders shall be regularly maintained at its principal place of business within India in respect of any assessment year form a date not later than 1st April of such year.
  • The AGM for passing the accounts and for declaring the dividends shall be held only at a place within India.
  • The dividend declared shall be payable only within India to all shareholders.

FOREIGN COMPANY [SECTION 2(23A)]

Foreign company means a company which is not a domestic company.

INDIAN COMPANY [SECTION 2(26)]

Indian company means a company formed and registered under the Companies Act, 1956 (now Companies Act, 2013), and includes—

  • a company formed and registered under any law relating to companies formerly in force in any part of India (other than the State of Jammu and Kashmir and the Union territories specified in sub-clause (v) below);
  • a corporation (like LIC, UTI etc.) established by or under a Central, State or Provincial Act
  • any institution, association or body which is declared by the Board to be a company under clause (17);
  • in the case of the State of Jammu and Kashmir, a company formed and registered under any law for the time being in force in that State ;
  • in the case of any of the Union territories of Dadra and Nagar Haveli, Goa, Daman and Diu, and Pondicherry, a company formed and registered under any law for the time being in force in that Union territory.

Note:

In all the above cases, to be an Indian company, the registered or principal office of the company, corporation, institution, association or body shall be in India.

COMPANY IN WHICH THE PUBLIC ARE SUBSTANTIALLY INTERESTED

(Widely held company) [Section 2(18)]

 

A company is said to be a company in which the public are substantially interested—

  • if it is a company
    • owned by the Government or the RBI or
    • in which not less than 40% of the shares are held by the Government or the RBI or a corporation owned by RBI; or
  • section 25 companies (non profit companies); or
  • if it is a company
    • having no share capital and
    • it is declared by order of the Board to be a company in which the public are substantially interested.
  • Nidhi company or Mutual Benefit Society ; or
  • if it is a company,
    • wherein shares (not being preference shares) carrying not less than 50% of the voting power have been allotted unconditionally to or have been acquired unconditionally by, and were throughout the relevant previous year beneficially held by, one or more co-operative societies ;
  • if it is a company which is not a private company as defined in the Companies Act, 1956, and the conditions specified either in item (A) or in item (B) are fulfilled, namely :—
  • it is listed company on the last day of the relevant previous year;
  • shares in the company (not being preference shares) carrying not less than 50% of the voting power have been allotted or acquired by, and were throughout the relevant previous year beneficially held by—
  • the Government, or
  • a corporation established by a Central, State or Provincial Act, or
  • any widely held company or any subsidiary company of such widely held company if the whole of the share capital of such subsidiary company has been held by the parent company or by its nominees throughout the previous year.

 

 

Note:

In case of an Indian company whose business consists mainly

  • in the construction of ships or
  • in the manufacture or processing of goods or
  • in mining or
  • in the generation or distribution of electricity or any other form of power,

item (B) shall have effect as if for the words “not less than 50%”, the words “not less than 40%” had been substituted.

CONCEPT OF INCOME

 

Income Tax is a financial charge on the income of a person. So the question is that what income will be considered as “income” for tax purposes?

Income Tax Act, 1961 defines income u/s 2(24). The said definition is an inclusive definition and not an exhaustive one. It includes a big list of incomes. But any kind of receipt can be taxed under this act (whether such kind of receipt is included in the list or not) if such receipt comes within the general meaning of the term “Income”.

According to Section 14, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following 5 heads of income:—

  1. Salaries
  2. Income from house property
  • Profits and gains of business or profession
  1. Capital gains
  2. Income from other sources

Points to remember

  • Income may be in cash or in kind
  • Income may be on receipt basis or on accrual basis. Accrual basis means where income is not actually received but right to receive income arises.
  • Both legal and illegal income stands on the same footing from tax point of view. Means even illegal income is taxable.
  • Income may be temporary or permanent
  • Income may be lump sum or in installments
  • Income may be in the nature of revenue receipt or in the nature of capital receipt
    • Revenue receipts are generally taxable unless they are exempted under any specific provisions of this act.
    • Capital receipts are generally exempted unless they are taxable under any specific provisions of this act.
  • Income includes loss. Thus to carry forward loss, one must file return of losses.
  • Generally the word “income” connotes a periodical receipt with some sort of regularity from some definite source. Mere windfalls unexpected receipts do not constitute income. But from assessment year 1972-73, certain casual and non recurring receipts are also covered under the term income like income from lotteries, gambling, betting, card-games, crossword puzzles etc.

 

Accrue/Arise or Due

  • Accrue refers to the right to receive income, whereas due refers to the right to enforce payment of the accrued income. Therefore, income can be said to be accrue when it becomes due. For example salary for work done in December will accrue throughout the month, day to day, but will become due on the salary bill being passed on 31st December or 1st Similarly, on Government securities, interest payable on specified dates arise during the period of holding, day to day, but will become due for payment on the specified dates.
  • Accrual of business or profession income depends upon the method of accounting employed by the assessee during the previous year- [CIT v. Ashokbhai Chimanbhai [1965] (SC]).
  • It must be noted that income which has been taxed on accrual basis cannot be assessed again on receipt basis, as it will amount to double taxation.

Charge of income-tax (Section 4)

Sub-Section (1)

Where any Central Act (financial act) enacts that

  • income-tax shall be charged for any assessment year at any rate or rates, than
    • income-tax shall be charged for that assessment year at the rates prescribed in such financial act;
    • such income-tax shall be charged in accordance with the provisions of this Act (Income Tax Act, 1961);
    • income-tax shall be charged in respect of the total income of the previous year of every

Where by virtue of any provision of this Act

  • income-tax is to be charged in respect of the income of a period other than the previous year,
    • income-tax shall be charged accordingly.

Sub-Section (2)

In respect of income chargeable under sub-section (1),

  • income-tax shall be deducted at the source or paid in advance, where it is so deductible or payable under any provision of this Act.

Exceptions of Section 4

Thus according to Section 4, income-tax shall be charged in respect of the total income of the previous year of every person. But there are some exceptions to this rule. In certain cases, income shall be charged within the same assessment year. These cases are:

  • In case of shipping business by non-resident (Section 172)

In this ships are allowed to leave the port only after paying taxes or after making proper arrangements for payment of taxes. (here 7.5% of the amount paid or payable on account of carriage (whether living or non living) will be deemed to be the taxable income).

  • In case of a person leaving India for uncertain period (Section 174)

When it appears to the Assessing Officer that any individual may leave India during the current assessment year or shortly after its expiry and that he has no present intention of returning to India,

  • the total income of such individual (for the period from the expiry of the previous year) for that assessment year up to the probable date of his departure from India shall be chargeable to tax in that assessment year.

The total income of each completed previous year or part of any previous year included in such period shall be chargeable to tax at the rate or rates in force in that assessment year, and separate assessments shall be made in respect of each such completed previous year or part of any previous year.

  • Assessment of association of persons or body of individuals or artificial juridical person formed for a particular event or purpose (Section 174A)

Where it appears to the Assessing Officer that any AOP or a BOI or an artificial juridical person (formed or established or incorporated for a particular event or purpose) is likely to be dissolved in the assessment year in which such AOP or a BOI or an artificial juridical person was formed or established or incorporated or immediately after such assessment year,

  • the total income of such association or body or juridical person (for the period from the expiry of the previous year) for that assessment year up to the date of its dissolution shall be chargeable to tax in that assessment year.
  • Assessment of persons likely to transfer property to avoid tax (Section 175)

If it appears to the Assessing Officer during any current assessment year that any person is likely to charge, sell, transfer, dispose of or otherwise part with any of his assets with a view to avoiding payment of any liability under the provisions of this Act,

  • the total income of such person (for the period from the expiry of the previous year) for that assessment year to the date when the Assessing Officer commences proceedings under this section shall be chargeable to tax in that assessment year.
  • In case of discontinued business (Section 176)

Where any business or profession is discontinued in any assessment year, the income of the period from the expiry of the previous year for that assessment year up to the date of such discontinuance may, at the discretion of the Assessing Officer, be charged to tax in that assessment year.

Any person discontinuing any business or profession shall give to the Assessing Officer notice of such discontinuance within fifteen days thereof.