INCOME TAX

Why Tax is required?

Funds are required by the Government for discharging its duties. Some of the important duties are:a) Protecting the country against external aggression financing & maintaining Defence. b) Maintaining Law & order within the society. c) Looking after the general welfare of the people education, health care, public works department etc. d) Maintaining cordial relations with various countries and posting diplomats and consulates. In order to efficiently & effectively discharge these duties and functions, huge funds would be required by a government. One of the primary and most important sources is through Tax. The solution is to compel people who enjoy the benefits of protection & welfare to contribute for the satisfaction of the collective wants. This compulsory contribution is called Tax. In other words Tax is the price which we have to pay for civilization. Definition The word tax has been derived from Latin expression taxo which means to estimate or to value or compute. In Mathews vs Chicory Marketing Board, Latham CJ of the High Court of Australia has defined the term tax as follows :-

A tax is a compulsory exaction of money by public authority for public purposes enforceable by law and is not payment for services rendered.

The essential characteristics of Tax are:-

a) Compulsion Tax is paid by the people under compulsion. It is not a voluntary payment or donation. It is exacted pursuant to legislative authority in the exercise of taxing power.

b) No quid pro quo :Tax is collected for public purpose & the tax payer will not get any special benefit. There is no quid pro quo between the tax payer and the public authority that collect the money.

c) Tax is payable in money :Tax is payable only in money & it is collected under authority of law.

d) Public Purpose :Tax is collected for the purpose of revenue. The tax collected will be used for public welfare & public purposes. The tax payer will also get benefit along with others.

Principles of Tax According to Adam Smith there are four principles of taxation. In the enactment of a taxing statute, the legislative should be guided by the following:1) Equality & Ability This means that the subjects of every state should be compelled to contribute towards the support of government in proportion to their income & abilities. In the matter of taxation the principle of equality should be observed ie equals should be taxed alike. One who could earn more at the protection of the state should be compelled to contribute more towards the support of Government. 2) Certainty The Tax each individual is bound to pay should be certain. The time of payment, the manner of payment, the quantity to be paid is all to be unambiguous and certain. It should be made known to the persons who have to contribute. 3) Convenience

Tax should be levied at the time which is more convenient to the contributors. A person should not be directed to pay several taxes at a time. 4) Economy The purpose of taxation is to collect revenue for public purpose. The expenditure for collecting tax should not be greater than the tax collected.

DIRECT & INDIRECT TAX

Direct Tax is one which is to be directly paid by the person bound to make payment to the authority competent to collect tax. Direct tax is one which is demanded from every person who should pay it. Income tax & Wealth tax are the examples of direct taxes. In the case of Indirect tax the initial burden will be on one person and the ultimate burden will be on another person. In indirect tax there will be shifting of burden. Sale tax is an example of indirect tax. The dealer is under an obligation to pay tax on sale of goods and he can collect the tax from the buyer. He will be liable to pay tax even though he has not collected the tax from the person on whom the ultimate burden falls. Thus the initial burden is on the dealer and the ultimate burden is on the buyer. Indirect tax is collected through an intermediary. The person, who has initial burden, acts as an agent for collection.

Methods of Taxation There are different methods of taxation. They are the following:a) Proportional Method of Taxation In this method tax is imposed at same rate for taxable income. If tax at the rate of 10% or 20% or 30% is imposed on the income, it is proportionate method of taxation. There will be no slabs. Same rate of tax is applicable to all persons irrespective of the income they get.

b) Progressive Method of Taxation In this method, tax at a higher rate is imposed on the higher income. On the basis of income different slabs will be fixed, and an increased rate will be fixed on higher income slabs. India is following this method. Example Income Rate of Tax Upto Rs. 1 Lakh 10% Rs. 1 to 2 Lakh 20% Rs. 2 to 3 Lakh 30% Rs. 3 to 4 Lakh 40% and so on.

c) Regressive Method of Taxation It is the opposite of progressive method of taxation. In regressive method of taxation, the rate of tax falls with the rise in income. Income Upto Rs. 1 Lakh Rs. 1 to 2 Lakh Rs. 2 to 3 Lakh Rs. 3 to 4 Lakh Rate of Tax 40% 30% 20% 10%

d) Degressive Method of Taxation In degressive method of taxation, rate of tax increases with the rise in income but the increase in rate of tax will not be in proportion to the rise in income. Example Income Upto Rs. 1 Lakh Rs. 1 to 2 Lakh Rs. 2 to 3 Lakh Rs. 3 to 4 Lakh Rate of Tax 10% 15% 18% 20%

THE INCOME TAX ACT, 1961

In India tax on income other than agricultural income is levied and collected under the Income Tax Act 1961. The Parliament enacted the Income Tax Act, 1961 in exercise of its powers conferred under Article 246 with entry 82 of List 1 of the Seventh Schedule to the Constitution of India. By Article 270 taxes on income other than agricultural income shall be levied and collected by the Government of India and distributed between the Union and the States as per the recommendation of the Finance Commission. The law relating to Income Tax is contained in :1) The Income Tax, 1961 2) The Income Tax Rules, 1962 3) The Annual Finance Act 4) Circulars, Notifications & Orders of the Central Board of Direct Taxes. 5) Executive instructions of the Department regarding the procedural aspects of collection of tax. 6) The Judgments rendered by competent Courts of Law. On every year the Parliament passes the Finance Act. It fixes the rates of tax for the relevant assessment year, rates for the deduction of tax as source and advance payment of tax.

Assessment Year & Previous Year Assessment year means the period of twelve months commencing on the first of April every year and ending on the 31st March. It is also called the financial year. The current assessment year is 2013 14. The current assessment will begin on 1st April, 2013 and it would end on 31st March, 2014. Previous year means the financial year immediately preceding the assessment year. The previous year of the current assessment year is 2012 13. An assessees income of previous year is taxed during the following assessment year at the rates prescribed for such assessment year by the relevant Finance Act. The income earned in a financial year is taxable in the next financial year. The year in which the income is earned is known as previous year and the next year in which the income is taxable is known as assessment year. Who is liable to pay tax under The Income Tax Act? An assessee is a person who is liable to pay income tax or any other sum of money payable under IT Act 1961. Every person whose total income exceeds the non-taxable limit is an assessee under the IT Act 1961. The following persons are liable to pay Income Tax under the IT Act 1961:1) Individuals 2) Hindu Undivided Family (HUF)

3) Company 4) Firm 5) Association of persons or body of individuals, whether incorporated or not. 6) Local authority 7) Every Artificial Judicial person.

Define Income as defined in the Income Tax Act 1961? Section 2 (24) of the IT Act defines Income as Income Tax is an annual tax on the income of the assesses. Income of the previous year is charged to tax in the next following assessment year @ tax applicable for that assessment year.

Residential Status and its effect on liability to pay tax Section 6 to 9 deal with residential status and its relation with liability to pay tax. The incidence of tax or liability of an assesses to pay tax depends upon his residential status. The following are the principles which are to be followed while deciding RS of an assesses. All taxable entities are divided into the following categories for the purpose of determining RS. 1) 2) 3) 4) 5) Individual HUF Firm or an association of persons Joint Stock Companies Every other persons

An individual HUF can either be 1) Resident and ordinarily resident or 2) resident but not ordinarily resident 3) nonresident in India. All other assesses can either be 1) resident in India or nonresident in India. RS of an assessee is to be determined in respect of each previous year. Determination of RS of an Individual 1) Resident and ordinarily resident or 2) resident but not ordinarily resident 3) nonresident in India.

Resident & ordinarily resident in India An individual is said to be a resident in India in the previous year if he satisfy any one of the following basic conditions:1) He is in India in the previous year for a period of 182 days or more or 2) He is in India for a period of 60 days or more during the previous year and 365 days or more during the 4 years preceding the previous year. A resident individual is treated as a resident and an ordinarily resident in India if he satisfies both the following two conditions:1) He has been resident in India at least 9 out of 10 previous years preceding the relevant previous year.

2) He has been in India for a total period of 730 days or more during 7 years preceding the relevant previous year. In brief it can be said that an individual becomes and ordinarily resident in India if he satisfies one of the basic conditions and the two additional conditions. Resident but not ordinarily resident An individual who satisfies one of the basic conditions is treated as a resident but not ordinarily resident in India. Non Resident An individual is a non resident of India if he satisfies none of the basic conditions. Determination of RS of HUF A HUF is said to be resident in India of the control and management of its affairs is wholly or partly situated in India. A HUF is a non resident in India if the control and management of its affairs is wholly situated outside India. A resident HUF will be treated as resident and ordinarily resident in India if the Karta or manager of the family satisfies the following conditions:1) He has been resident in India for 9 out of 10 previous years preceding the relevant previous year. 2) He has been present in India for a period of 730 days or more during 7 years preceding the previous years.

Determination of RS of Firms and Associations of persons A partnership and an AOP are said to be resident in India if control and management of their affairs are wholly or partly situated within India during the relevant previous year. They are treated as nonresident if control and management of their affairs are situated wholly outside India. RS of Company An Indian company is always a resident in India. A foreign company is resident in India only if controlled and management of its affairs is situated in India wholly during the previous year. A foreign company is treated as nonresident in India if the control and management of its affairs is either wholly or partly situated outside India during the previous year. Tax treatment of income Under Section 14 of the IT Act, all class of income has been classified under the following 5 heads of incomes for the charge of Income Tax and computation of total taxable income. 1) Salaries 2) Income from House property 3) Profits & gain of business or profession 4) Capital gains 5) Income from other sources If an assesse has different sources of income, each income is to be treated separately for the purpose of tax. Taxable income under each head is to computed first and then total taxable income is to be ascertained by aggregating the taxable income of different

heads. The taxable salary income is to be computed as per the provisions Section 15 to 17 of the Act under the head Salaries. Taxable income from house property is to be computed as per the provisions of Section 22 to 27 of the Act under the head income from house property. Taxable income from business or profession is to be computed as per the provisions of Section 28 to 44 of the Act under the head profits and gains of business or profession. Profits or gains derived from the transfer of the capital asset are to be charged to tax as per the provisions of Section 45 to 55 of the Act under the head Capital Gains. Those income which do not fall under the above four heads is to be computed for taxation as per the provisions of Sections 56 to 59 of the Act under the head Income from Other Sources. After computing the taxable income under each head the total taxable income is to be ascertained by aggregating the income under different heads. Income tax is to be levied on the aggregate of income. Permissible deductions from gross total income An assessee who is liable to pay income tax has to first calculate the taxable income under different heads of income. At that time he can deduct certain items of expenditures, standard deductions from each head of income. After arriving at taxable income under different heads of income, he has to add the taxable income calculated under different heads and pay tax for the aggregate income. Eg suppose X has a taxable salary of 80000 income

from house property of 30000 and income from other sources 40000. Here X has to pay tax for 150000. The amount so arrived at by adding taxable income under different heads of income is known as gross total income. It is to be noted that an assessee need not pay tax for the gross total income under all circumstances. He can deduct some more items from the gross total income to arrive at net taxable income. Section 80 CCC to 80 U of the IT Act 1961 deal with such permissible deductions. It can be seen that the deductions permitted under these sections are indented to encourage savings, donations, industrialization, foreign earning and to assist tax payers in meeting their essential expenditures. The following are permissible deductions:1) Deduction in respect of Pension Fund 2) Deduction in respect of Medical Insurance Premium 3) Deduction in respect of maintenance and medical treatment of a dependent person with disability (Sec 80 DD) 4) Deduction in respect of medical treatment (Sec 80 DDB) 5) Deduction in respect of repayment of loan taken for higher education ( Sec 80 E) 6) Deduction in respect of donations to certain funds, charitable institutions etc 7) Deduction in respect of rent paid 8) Deduction in respect of donations for scientific research or rural development 9) Deduction of profits and gains from projects outside India

10) Deduction of profits and gains from housing projects aided by World Bank. 11) Deduction of profits and gains derived from export of goods. 12) Deduction in respect of profits and gains from industrial undertaking engaged in infra structure development , telecommunication services, industrial park and power generations 13) Deduction in respect of profits and gains from business of processing of bio degradable waste. 14) Deduction in case of totally blind or person with disability. Computation of Taxable income under the Head Salaries Salary includes the following:Wages Any annuity or pension Any gratuity Any fees or commission or perquisites or profits in lieu of addition to any salary or wages. Any advance salary Any payment received by an employee in respect of any period of leave not availed by him (Leave Salary) Payment would fall under the head Salary only if there is relationship of employer and employee between the payer and payee.

The fees received by a director of a company or the fees received by the lawyer from his client cannot be chargeable to tax under the income from salary. It is because that there is no relationship of employer and employee between the company and the director or client and lawyer. The fees received by the director can be charged to tax under the head Income from Other sources. The fees received by an advocate can be charged to tax under the head Profits and gains of business or profession. Salaries of MP and State Legislatures are not chargeable to tax under the head Salaries but it is to be charged under the head Income from other sources. It is because the employees of Central or State Governments. If an employee does any work of his employer which is not connected with his service then the remuneration for such work will not be treated as Salary. E.g. Remuneration received by a government college lecturer from the University for the Paper Valuation Work is not chargeable to tax under the head Salaries. Computation of Income under the Head House Property Chargeability of income from House Property is subject to the satisfaction of the following conditions:1) Property should consist of any building or land appurtenant thereto. 2) The assessee should be the owner of the property. 3) Property should not be used by the owner for any business or profession carried on by him.

Computation of Income under the Head Profits & Gains of Business or Profession Following are the general principles 1) Business or profession should be carried on by the assessee. 2) Business or profession should be carried on during the previous year. 3) Income of the previous year is taxable during following assessment year. 4) Profits or gains of different business or profession carried on by the assessee are not separately chargeable to tax. 5) The Income Tax law is not concerned with a legality or illegality of a business or profession. 6) Capital receipts are not taxable. Income under the Head Capital Gains Capital Gains Tax liability arises only when the following conditions are satisfied. 1) 2) 3) 4) There should be a capital asset. The capital asset is transferred by the assessee. Such transfer should take place during the previous year. Profit or gain should have arisen as a result of the transfer.

Income under the Head Income from Other Sources The following incomes are chargeable to tax under the head Income from Other Sources:1) Dividend

2) Any winnings from lottery, crossword puzzle, races including horse races, card games and other games of any sort or gambling or betting of any form or nature whatsoever. 3) Interest on securities. 4) Income from machinery, plant or furniture let on hire. 5) Income from letting of plant, machinery or furniture along with the building. 6) Income from sub letting. 7) Interest on bank deposits and loans 8) Income from royalty 9) Ground rent 10) Agricultural income from outside India 11) Examination fee received by a teacher 12) Insurance commission 13) Directors fees 14) Salaries & allowances payable to MPs & MLAs. 15) Family pension. INDIRECT TAXES Salient Features of Maharashtra Value Added Tax (MVAT) Act 2002 Introduction MVAT has been introduced with effect from 01.04.2005. The original bill was passed in 2002. Due to political reasons its implementation was postponed. Maharashtra Government made modification in the said Act of 2002 and given its effect from 01.04.2005. Thus its name MVAT 2002 and not 2005.

MVAT is a form of Sales Tax collected by Maharashtra Government from consumers within the State. It is collected through business transactions involving sales of goods within state. In a chain of distribution goods moved from manufacturer to wholesaler, semi wholesaler, retailer to consumer. In every stage there is value addition tax collected. It is multi point tax. It is collected on value addition made by every person. VAT is adopted in 130 countries in the world, 21 states in India. This is the most important tax reform in India. Computation of VAT VAT is the tax levied on the goods or service of each point of value addition. Under the VAT system tax is levied on the value added to a commodity or service as it passes through different stages of production and distribution until it reaches the final consumer. In this scheme of taxation, tax is payable by each link in the supply chain on the value addition made by it on the product or service. The burden of tax is ultimately borne by the consumer of goods. The consumer may have goods at cheaper price under VAT. This can be understood with the following example. Assuming a 10 % Sales Tax in the sales tax regime and the same rate under VAT the benefit to the customer for a shirt will be as under:-

Pre VAT System Vat System Stage 1 A sells a fabric to tailor B- For Fabric For Tax Total Stage 2 B stitches the shirt & sells to C For Shirt For Tax Total Stage 3 Consumer buys shirt from C For Shirt For Tax Total 400.00 40.00 440.00 400.00 20.00 420.00 200.00 20.00 220.00 200.00 10.00 210.00 100.00 10.00 110.00 100.00 10.00 110.00

The consumer gets a net benefit of Rs. 20/- i.e. (440 420) on 1 shirt. Assuming that the trader will pass on the benefit to the consumer. Input Tax and Output Tax Under the VAT system a dealer can collect tax at the specified rate on the goods sold by him. He has to collect the tax on the sale price. He need not remit to the government the whole tax collected by him from the customer. He can deduct the tax aid by him at the time of purchase of goods. The tax paid by him at the time of purchase of goods is called Input tax. The tax collected by him at the time of sale of goods is called

Output tax. He can deduct the input tax paid by him from the output tax. The tax payable by a dealer under the VAT system is calculated by using the input tax credit method. The following illustration will make the point more clear. A is a registered dealer of Home appliances. In the month of April, he purchased 10 sewing machines each for Rs. 1000/-. He has paid 4 % tax on the total purchase price of Rs. 10000/-. Thus he has paid Rs. 400/towards tax. The tax paid by him is called input tax i.e. Rs. 400/-. In the month of April he has sold all the sewing machines each for Rs. 1200/-. He has collected 4 % tax on the total sale price. Thus he has collected Rs. 480/- towards tax i.e. 12000*4/100 towards Output tax. He has to remit Rs. 80/- to the government. It is arrived at by deducting Input Tax from the Output Tax (480 400).