Direct Tax

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Unit-I

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 Introduction

Tax is a fee charged by a Government on a product, income or activity. If tax is levied (imposed)
directly on personal or corporate income, then it is a direct tax. If tax is levied on the price of a
good or service, then it is called an indirect tax.
The purpose of taxation is to finance public goods and services, such as street lighting, street
cleaning, road, dams, utility services etc. Since public goods and services do not allow a non-
payer to be excluded, or allow exclusion by a consumer, there cannot be a market in the goods or
services, and so they need to be provided by the Government or a quasi- Government agency,
which tend to finance themselves largely through taxes. The word tax is derived from the Latin
word ‘taxare’ which means ‘to estimate’.
“A tax is not a voluntary payment or donation, but an enforced contribution, exactly pursuant
to legislative authority" and is any contribution imposed by Government whether under the
name of toll, tribute, impost, duty, custom, Excise, subsidy, aid, supply, or other name.”
(Black’s Law Dictionary)
In India, the tradition of taxation has been in force from ancient times. It finds its references in
many ancient books like 'Manu Smriti' and 'Arthasastra'.

Definitions
There is no precise and accurate definition for the tax and, the concept of tax has been defined
differently by different economists. So there are a lot of definitions of taxes, and some
definitions go back to the oldest sciences Economists in the world like Prof. Seligman, Bastable,
Deviti de Marco and Hugh Dalton and so on.
 According to Prof Seligman: A tax is compulsory contribution from the person to the
government to defray (Discharge) the expense incurred in the common interest of all
without reference to special benefits conferred.
 Bastable defines it as: A tax as a compulsory contribution of the wealth of a person, or
body of persons for the service of public powers
"Taxation is the act of levying a tax, i.e. the process or means by which the sovereign,
through its law making body, raises income to defray the necessary expenses of
government. It is merely a way of apportioning, the cost of government among those who
in some measure are privilege to enjoy its benefits, therefore must bear its burden"
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  Deviti De Marco defines: A tax as a share of the income of citizens which the state
appropriate in order to procure for itself the means necessary for the production of
general public services.
 Hugh Dalton: A tax is a compulsory charges imposed by a public authority irrespective
of the exact amount of service rendered to the tax payer in return and not imposed as a
penalty for legal offence
 Jom Bouvier defined: a tax as "A pecuniary burden imposed for support of the
government, the enforced proportional contribution of persons and property of the
government and for all public needs"

Characteristics of Taxes
As we know Public revenue is divided into:
 tax revenue and;
 Non tax revenue.
Non-tax revenue like revenue comes from administrative activities like fines, fees, gifts & grants,
Surplus from Public Enterprises, Special assessment of betterment levy, and deficit financing,
but tax revenue has some other characteristics. We will discuss it in this section.
1. A Tax is compulsory.
A tax is imposition by law, the law practice in the societies becomes an important thing, hence
compulsory element existed by legislation. So tax is compulsory payment to the governments
from its citizens. Tax is duty from every citizen to bear his share for supporting the government.
The tax is compulsory payment; refusal or objection for paying tax due leads to punishment or is
an offence of the court of law. All the people like minors and aliens are taxed. Government
imposes when somebody buys commodities, or when uses services then the condition of
compulsion is found. The government practices its sovereign when levying the tax from its
citizens.
2. Tax is contribution.
Contribute Means order to help or provide something. Tax is contribution from members of
community to the Government. A tax is the duty of every citizen to bear their due share for
support of government; these contribute to help the government to face its expenditures.

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 3. Tax is for public benefit.
Tax is levied for the common good of society without regard to benefit to special individual.
Government proceeds are spent to extend common benefits to all the people such as natural
disaster - like floods, famine - defense of the country, maintenance of law and establish
infrastructure and order. Such benefits are given to all people.
4. No direct benefit
Government is compulsorily collecting all types of taxes and does not give any direct benefits to
the tax payer for taxes paid. Tax is different from another government charges, which gives no
direct benefits to taxpayers, another charges like prices, fees, fines; hence the direct benefits are
available. They are common benefits to all the members of the society.
5. Tax is paid out of income or wealth of the tax payer.
Income means money received, especially on regular basis, for work or through investment. Tax
is paid out of income as long as the income becomes realized, here the tax is imposed. Income
owner has profit from any business, so he should pay his share for support the government.
6. Government is levying the taxes.
Government is levying the tax; Governments are practicing sovereign authority upon its citizens
through levying of taxes, because the tax is sovereign revenue. Nobody can collect tax from the
people but the government because it has all power for that. Tax is transferring resources from
the private sector to the public sector. Government is levying the tax to cover its expenditures.
The government targets for this expenditures for increase of social welfare, economy
development and stabilization.
7. Tax is not the cost of the benefit.
Tax is not the cost of benefit conferred by the government on the public, Benefit and taxpayer
are independent of each other, and payment of taxation is of course designed for conferring of
benefits on general public.
8. A tax is for the economic growth and public welfare.
Major objectives for the government are to maximizing economic growth and also maximize
social welfare. Development activities of nations generally involve two operations, theraising of
revenue and the spending of revenue, so the government spent taxes for economic benefit, for
entire community, for aggregate welfare of the society.

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 General Rules/Principle’s of Taxation
Principles of taxation refer to the administrative aspect of a tax. They are related to the rate,
amount, method of levy, and collection of a tax.
1. Principle of equity:
This principle implies that any tax system should be based on the principle of social justice.
Equity refers to both horizontal and vertical equity.
2. Certainty:
The tax rules should clearly specify when the tax is to be paid, how it is to be paid, and how the
amount to be paid is to be determined. This principle is made trust between two parties, first
party taxpayer who is pay the tax and second party the authority whom receipt tax. If taxpayers
have difficulty measuring the tax base or determining the applicable tax rate or the tax
consequences of a transaction, then certainty doesn‘t exist. Certainty might also be viewed as the
level of confidence a person has that the tax is being calculated correctly
3. Convenience of Payment:
A tax should be due at a time or in a manner that is most likely to be convenient for the
taxpayer. Convenience in paying a tax helps ensure compliance. The appropriate payment
mechanism depends on the amount of the liability and the how easy or difficult it is to collect.
This principle in designing a particular rule or tax system would focus on whether it is best to
collect the tax from the manufacturer, wholesaler, retailer or customer, as well as the frequency
of collection.
4. Economy in Collection:
This principle implies that decreasing the administrative cost of collection of the tax at the lowest
level. The costs to collect a tax should be kept to a minimum for both the government and
taxpayers. This principle considers the number of revenue officers needed to administer tax.
Compliance costs for taxpayers should also be considered. This principle is closely related to the
following principle of simplicity.
5. Simplicity:
The tax law should be simple so that taxpayers can understand the rules and comply with them
correctly and in a cost-efficient manner. A tax should be simple in nature so that the tax-payer is
able to calculate it and pay it conveniently. Simplicity in a tax system reduces the number of
errors. Simplicity increases respect for the system and therefore improves compliance. A simple

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tax system better enables taxpayers to understand the tax consequences of their actual and
planned transactions. Simplicity includes a clear understanding of the time of payment, the mode
of payment, the place of payment and the amount to be paid.
6. Transparency and Visibility:
Taxpayers should know that a tax exists and how and when it is imposed upon them and others.
Transparency and visibility in a tax system enable taxpayers to know the true cost of
transactions. These features enable taxpayers to know when a tax is being assessed or paid and to
whom. This principle relates to fairness because taxpayers should be able to, Know what type of
taxes they are paying and how much. On the other hand, consumers indirectly pay various excise
taxes when they buy gasoline, but they typically do not know how much of the total amount paid
represents excise taxes. Consumers would most likely perceive that the price of gas had
increased rather than realizing that the manufacturer‘s excise tax had increased.
7. Neutrality:
The effect of the tax law on a taxpayer‘s decisions as to how to carry out a particular transaction
or whether to engage in a transaction should be kept to a minimum. The principle of neutrality
stands for the proposition, that taxpayers should not be unduly encouraged or discouraged from
engaging in certain activities due to the tax law.
8. Appropriate Government Revenues:
The tax system should enable the government to determine how much tax revenue will likely be
collected and when. A tax system should have some level of predictability and reliabilityto
enable governments to know how much revenue will be collected and when. Generally, a
government realizes better stability with a mix of taxes.
9. Canon of co-ordination.
In Some countries taxes are imposed by central and state governments, it is therefore, very much
desirable that, there must be co-ordination between different taxes that are imposed by different
tax authorities. From the data, the researcher found out that, any tax system should include all
those tax canons till become plentiful revenue, easy to apply, clear in the procedures, simply for
understanding. Governments should incorporate those canons for increase taxes revenue. We
have to mention that those canons are not enough to structure good tax system, but there are
some other factors, like political system, stability of economics as well.

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 Objectives of Taxation
Objectives of taxes have been developed when the functions of the Government are developed.
In the primitive communities a member was to pay his share to the Head of the tribe, who in
return provided them with administration, security from foreign aggression and other civic
amenities.
But today taxation besides being the main resource for supporting government has became a tool
for economic growth, social welfare; attract foreigner investment, economic stability, and
income distribution.
Objectives of taxes in brief:
A. Revenue:
This objective is the oldest, uppermost and primary objective, so the taxes are imposed so as to
produce the necessary amount of revenue to meet the requirement of the government since the
public expenditures is increasing in scope and size day by day. So the main objective of taxes is
to raise revenue to meet the expenditures adequately. The provision of public services and
infrastructure is a key for economic development and growth, so the Government seeks to secure
a huge amount for protection, education, public health, etc.
B. Social objectives:
Taxes became as main goal for some of social objectives. The objectives as follows
a. Redistribution of income and wealth Income is deferent from one person to another in the
society, inequity in income leads to many evils, and the government aims to reduction of
inequalities between members of the society to secure social justice, so tax is a means of
ensuring the redistribution of income and wealth in order to reduce poverty and promote
social welfare, For the achievement of these goals government follows these ways:
 Imposition of high rate tax upon luxury commodities.
 Applying progressive tax system when levying taxes from taxpayers.
 Imposition of tax exemption to basic goods.
b. Social welfare: Social welfare is the basic need of the society in the modern age. The
government functions have become very important to the society, because the society
needs saving, protection, education, health, and so on. All these functions are necessary
to make social welfare, so the government levies revenue from tax, and expends it for
that function. Therefore revenue from taxes is fuel to the government for social welfare.

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 Social welfare is indicator of development of the countries, so almost all the countries
have competition to introduce these services in the societies.
c. Safety of society from bad and injurious customs Fighting the bad customs in the society
is the primary task of the government, so tax is a tool for fighting some of those customs.
From this angle tax imposition of very high percentage on the goods like tobacco and
alcohol is an effort to reduce. Those habits have reaction on the health of people in the
society its use because those goods are main reasons to some diseases.
C. Economic significance of taxes:
Taxes are used from economic point of view, so taxation helps to encourage some economic
activities, and as a tool to solve some economics problems. Tax is also a means for directing of
scarce economic activities. Taxation helps to accelerate economic growth, and taxation plays
very important role in case of economic stability.
a. Economic growth Taxes are considered as a tool for economic growth and it helps at to
accelerate growth of economic development. Economic development has placed
considerable emphasis on objectives of taxation policy. Economic development is the
main objective in all the countries of the world. Economic development depends on
mobilization of resources and efficient use of such resources between different sectors of
the economy activities. Tax policy must be designed so as to mobilize the internal
resources and avoid use of theses resource in the un-useful filed. Taxation policy helps to
increase production through raising the rate of capital formation, so it helps improve the
economic welfare through better distribution of income and it becomes an important
instrument for regional inequalities through imposition rate of tax from regional to
another. Tax policy may serve directly to mobilize resources for capital formation in the
public sector and indirectly to promote private saving and investment.
b. Enforcing government policy: Government policy can be easily enforced by adoption of
suitable tax policy, The Government can encourage investment, saving, consumption,
export, protection of home industry, employment, production, protection of society from
harmful customs, and economic stability through suitable tax policy. Therefore, the
government gives tax exemption to the investment and saving.
c. Direction limited scarce resources into effective and essential channels Tax policy plays
crucial role for direction scarce resources into essential commodities. This is achieved by

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 giving tax exemption to certain industries and imposition of heavy duties on other
industries, so with the adoption of suitable tax policy, economic resources may be
diverted to the production of necessary articles and investors will go to the exemption
industries.
d. Economic stability To maintain economic stability is one of the tax objectives, Economic
stability is a very important factor for the government‘s economic growth. Government
can use taxes in the case of inflation and depression. Here taxation has different roles in
times of inflation and depression, in the case of inflation when the prices are rising. Tax
can play very important role, which the government reduces, the purchasing power in the
hands of people. Thus arise in the rates of existing taxes and the imposition of new taxes
would check consumption, decrease the level of effective demand and therefore help in
bringing up stability in prices. Heavy taxation transfer purchasing power from the hand of
people to the government which if used for productive purpose will increase the level of
economic activity and employment In the case of depression taxes play a different role
Purchasing power in the hand of people is reduced and they are able to spend less and the
demand for commodities and services is reduced. All these lead to a shrinkage of
business activity and employment. In this case government should increase the
purchasing power in the hand of public through reducing the burden of taxation on the
people and impose tax upon saving and hoarding so that people may be encouraged to
spend more and thus help to create more demand for goods and more business activity
and employment.

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 Income Tax in India
Income-tax is a tax of Central Government which is collected by taxing income earned by the
persons. For the purpose, the Central Government has passed a separate Act i.e. Income-Tax Act,
1961 under which the procedures of taxing the incomes of the persons and collection of income-
tax has been envisaged.
The Act gives definition of ‘person’ and explains how its residential status should be decided.
Tax incidence on an assessee depends on his residential status. The Central Government under
its yearly financial budget decides the rates of income-tax to be charged on taxable income of
‘person’.
For the proper administration and collection of income-tax, the government has formed a
separate department known as Income-Tax Department which is solely responsible for collection
of income-tax and completing all the procedures in this regard.

Indian Tax System

India has a well developed three tired tax structure. It comprises of the Central Government, the
State Governments and Local Bodies (includes Gram-Panchayat, Municipal Corporations, and
Corporations). In accordance with the provisions of Indian Constitution the power to levy and
collect taxes is entrusted to these bodies. Accordingly these bodies are empowered to levy and
collect following taxes.
 Central Government:
 Income-Tax (except agricultural income-tax)
 Corporate Tax
 Custom Duties
 Central Excise Duty
 Sales Tax
 Value Added Tax (on inter-state sale of goods)
 Service Tax
 Tax on Capital Gain
 Securities Transaction Tax
 Service Tax

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  State Governments:
 Sales Tax (on inside state sale of goods)
 Land Revenue
 Taxes on Agricultural Income
 Stamp Duty (on transfer of property)
 State Excise (on manufacture of alcohol)
 Duty on Entertainment
 Profession Tax
 Local Bodies -
 Property Tax or Building Tax
 Octroi
 Tax on Markets
 Tax or user charges for utilities (e.g. water supply, drainage, etc.)

Historical Review
India is presumed to be one of the oldest civilizations of the world. Various references from the
Hindu dharmashastra and its literature has shown that there was a taxation in one or another form
from very beginning of the civilization, though the nature, scope and objectives were different at
different stages of its development. The evaluation of income-tax in India can be studied in the
following stages:
1. Ancient Period
There is enough evidence to show that taxes on income in some form or the other were levied
even in primitive and ancient communities. References to taxes in ancient India are found in
“Manusmriti” and “Kautilya‟s Arthashastra”. Manu the ancient sage and law giver stated that
king should levy taxes according to sastras. He advised that taxes should be related to income
and should not be excessive. He laid down that traders and artisans should pay 1/5th of their
profits in gold and silver, while the agriculturists were to pay 1/6th, 1/8th and 1/10th of their
produce depending upon their circumstances. The detailed analysis given by Manu on the subject
clearly shows the existence of a well planned taxation system, even in ancient times. Kautilya‟s
Arthasastra was the first authoritative text on public finance, administration and the fiscal laws.
Collection of income tax was well organized during Mauryan Empire. Schedule of tax payment,

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time of payment, manner and quantity were fixed according to Arthasastra. It is remarkable that
the present day system of taxation is in many ways similar to the system of taxation given by
Kautilya 2300 years ago.
2. Initial Period (1860-1886)
Income tax in its modern form was introduced in India for first time in 1860 by the British
Government to overcome the financial crisis following the events of 1857. Initially Government
introduced it as a temporary measure of raising revenue under the Income Tax Act 1860 for a
period of five years. Different tax rates were prescribed for different heads of income. In the year
1867, it was transformed as licence tax on trade and profession. In the year 1869, the licence tax
was replaced by Income Tax again. The assessments were made on arbitrary basis leading to
inequality, unpopularity and widespread tax evasion. Income Tax was withdrawn in the year
1874. After the great famine of 1876-78, the Government introduced local Acts for income tax in
different provinces. With several amendments these Acts remained in force till 1886. Thus, the
period from 1860 to 1886 was a period of experiments in the context of income tax in India.
3. Pre Independence Period (1886-1947)
In 1886, a new Income Tax Act was passed with great improvements than the previous Acts.
This Act with several amendments in different years continued till 1918. In 1918, a new Act was
passed repealing all the previous Acts. For the first time, this Act introduced the concept of
aggregating income under different heads for charging tax.
In 1921, the Government constituted All India Income Tax Committee‟ and on the basis of
recommendation of this committee a new Act (Act XI of 1922) was enacted. This Act is a
landmark in the history of Indian Income Tax system. This Act made income tax a central
subject by shifting the tax administration from the Provincial Governments to the Central
Government. During this period the Board of Revenue (Central Board of Revenue) and
Income Tax Department with defined administrative structure came into existence.
4. Post Independence Period
The Income Tax Act 1922 continued to be applicable to independent India. During the early post
independence period, the Income Tax legislation had become very complicated on account of
innumerable changes. During this period tax evasion was wide spread and tax collection was
very expensive. In 1956, the Government of India referred the Act to a Law Commission to
make the Income Tax Act simpler, logical and revenue oriented. The Law Commission

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submitted its report in September 1958 and in the meantime the Govt. also appointed a Direct
Taxes Administration Enquiry Committee to suggest the measures for minimizing the
inconvenience to the assessees and prevention of tax evasion. This committee submitted its
report in 1959. The recommendations of the Law Commission and the Enquiry Committee were
examined and extensive tax reform programme was undertaken by the Government of India
under the supervision of Prof. Nicholas Kaldor. The Income Tax Bill 1961, prepared on the basis
of the Committee‟s recommendations and suggestions from Chamber of Commerce, was
introduced in the Lok Sabha on 24.4.1961. It was passed in September 1961 by Lok Sabha. The
Income Tax Act 1961 came into force on April 1, 1962. It applies to whole of India including the
state of Jammu and Kashmir. It is a comprehensive piece of legislation having 23 Chapters, 298
Sections, various sub sections and 14 schedules. Since 1962, it has been subjected to numerous
amendments by the Finance Act of each year to cope with changing scenario of India and its
economy. Moreover the Central Board of Direct Taxes is empowered to amend rules and to
clarify instructions as and when it becomes necessary.
Besides this, amendments have also been made by various Amendment Acts e.g. Taxation Laws
Amendment Act 1984, Direct Taxes Amendment Act 1987, Direct Taxes Law (Amendment)
Acts of 1988 and 1989, Direct Taxes Law (Second Amendment) Act 1989 and at last the
Taxation Law (Amendment) Act 1991. As a matter of fact, the Income Tax Act 1961 has been
amended drastically. It has therefore become very complicated both for administration and
taxpayers.
5. Recent Tax Reforms
The economic crisis of 1991 led to structural tax reforms in India with main purpose of
correcting the fiscal imbalance. Subsequently, the Tax Reforms Committee headed by Raja
Chelliah (Government of India, 1992) and Task Force on Direct Taxes headed by Vijay Kelkar
(Government of India, 2002) made several proposals for improving Income Tax System. These
recommendations have been implemented by the government in phases from time to time. As
regarding the personal income tax, the maximum marginal rate has been drastically reduced, tax
slabs have been restructured with low tax rates and exemption limit has been raised. In addition
to this, government rationalised various incentive provisions and widened TDS scope. In case of
corporate tax, the government has reduced rates applicable to both domestic and foreign
companies, introduced depreciation on intangible assets and rationalised various mincentive

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provisions. Some new taxes have been introduced such as Minimum Alternative Tax and
Dividend Distribution Tax, Securities Transaction Tax, Fringe Benefit Tax and Banking Cash
Transaction Tax. However, Fringe Benefit Tax and Banking Cash Transaction Tax were
withdrawn by Finance Act, 2009.
The Income tax administration was restructured with effect from August 1, 2001 to facilitate the
introduction of computer technology. Further, keeping in mind the global developments, the
department has made considerable efforts for reforming the tax administration in recent years.
Some important measures in this direction are introduction of mandatory quoting of Permanent
Account Number (PAN), e-filing of returns, e-TDS, e-payment, Tax Information Network (TIN),
Annual Information Return (AIR) for high value transaction, Integrated Taxpayer Profiling
System (ITPS), Refund Banker Scheme in certain cities etc. The main objective of these reforms
has been to enhance tax revenue by expanding the taxpayer base, improving operational
efficiency of the tax administration, encouraging voluntary tax compliance, creating a taxpayer
friendly atmosphere and simplifying procedural rules.

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 Constitutional Provisions
The constitution of India is the supreme law; it is foundation and source of power to all laws in
India. Power to levy and collect tax by union or state is derive from constitution, articles 245 to
255 provide for the distribution of taxation powers between the union and the states. It may be
recalled at this stage that India is having a quasi-federal Constitution in which the powers of
legislation are shared between the union and the states. In briefly, the parliament has exclusive
power to make laws with respect to any of the matters enumerated in list I in the seventh
Schedule of the constitution; this list is referred to usually as union list. The legislature of every
state has exclusive power to make laws for such state or any part thereof with respect to any of
the matters enumerated in list II in the seventh schedule to the constitution. This list is popularly
called as state list. Both the parliament and the legislature of any state have power to make laws
with respect to any of the matters enumerated in list III in the seventh schedule to the
constitution. This list is referred to as the concurrent list.
Or
India is a federal union of states with distribution of powers. Articles 245 to 255 of the
Constitution of India relate to legislative relations between the Union and the States in the form
of federal distribution of legislative powers between the Parliament and the Legislature of a
State. These powers to make laws are conferred by Articles 245, 246 and 248 whereas the
subject matters of laws to be made by the Parliament and the legislatures of States are listed in
Schedule VII to the Constitution.
There is a threefold distribution of legislative powers as stipulated in Article 246 read with
Schedule VII.
 List I of the Union list in Schedule VII comprises of 99 items or subjects over which the
Union shall have the exclusive powers of legislation.
 List II of the State list comprises of 61 items over which the State Legislature shall have
the exclusive powers of legislation.
 List III of the concurrent list comprises of 52 items over which the Parliament and the
Legislatures of States shall have concurrent powers. These three lists demarcate the fields
of legislation whereas the powers of legislation are conferred by Article 246.
 The Union list includes citizenship, Railways, major ports and airways, trade and
commerce with foreign countries, defense, foreign affairs, banking, insurance, currency

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 and coin-age, taxes on income other than agricultural income, duties of customs, duties of
excise on tobacco and other goods manufactured or produced in India except alcoholic
liquor for human consumption, opium (Drug) etc. Corporation tax, taxes on capital value
of assets other than agricultural land, taxes on the capital of companies, estate duty in
respect of property other than agricultural land etc.
 The State list includes public order and police, local government, public health and
sanitation, agriculture, forests and fisheries, education, taxes on agricultural income
duties in respect of succession to agricultural land, taxes on lands and buildings, taxes on
sale and purchase of goods other than newspapers, toll taxes on professions, trades,
callings and employments taxes on luxuries including taxes on entertainment,
amusement, betting and gambling.
 The Concurrent list includes Civil and Criminal law and procedure, marriage, contracts,
trusts, labour welfare, education, charities and charitable institutions, price control,
electricity etc.

The distribution of fields of taxes duties etc. between the Union and the States as earmarked in
Schedule VII is summarized hereunder:

Union List:

 Taxes on income other than agricultural income;

 Corporation tax;
 Custom duties;
 Excise duties except on alcoholic liquors and narcotics not contained in toilet and
medical preparations;
 Estate and succession duties other than on agricultural land;
 Taxes on the capital value of the assets; except agricultural land’ of individual and
companies;
 Rates of stamp duties on financial documents;
 Taxes other than stamp duties on transactions in stock exchanges and future markets;
 Taxes on sale or purchase of newspapers and on advertisements published therein;
 Taxes on railway freight and fares;

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  Terminal taxes on goods or passengers carried by railways, sea or air; and
 Taxes on the sale or purchase of goods in the course of inter-State trade.

State List:

 Land revenue;
 Taxes on the sale and purchase of goods, except newspapers;
 Taxes on agricultural income;
 Taxes on land and buildings;
 Succession and estate duties on agricultural land;
 Excise on alcoholic liquors and narcotics;
 Taxes on the entry of goods into a local area;
 Taxes on mineral rights, subject to any limitations imposed by Parliament;
 Taxes on consumption and sale of electricity;
 Taxes on vehicles, animals and boats;
 Stamp duties except those on financial documents;
 Taxes on goods and passengers carried by road or inland water ways;
 Taxes on luxuries including entertainment, betting and gambling;
 Tolls;
 Taxes on professions, trades, callings and employment;
 Capitation taxes; and
 Taxes on advertisement other than those contained in newspapers.

The Central Government has exclusive power to impose taxes which are not specifically
mentioned in the State or Concurrent lists. The Union and the State Governments have
concurrent powers to fix the principles on which taxes on motor vehicles shall be levied and to
impose stamp duties on non-judicial stamps. The property of the Central Government is
exempted from State taxation and the property and income of the States are exempted from
Union taxation.

Article 265: provides that no tax shall be levied or collected except by authority of law. Thus,
the tax proposed to be levied or collected must be within the legislative competence of the

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legislature imposing the tax. Tax includes duties, cesses (Tax) or fees by way of general, special
or local imposts. The law imposing the tax, like other laws, must not violate any fundamental
right or contravene any specific provision relating to particular matters.

A law to levy or collect any tax or duty or cess or fees does not include an executive order or a
rule without express statutory authority. A Money Bill, which includes a bill to impose, abolish,
remit, alter or regulate any tax, shall not be introduced in Rajya Sabha or a legislative council.
Such a Bill shall not be moved or introduced except as the recommendations of the President or
the Governor, as the case may be.

Articles 268 to 281 relate to the distribution of revenues between the Union and States. Stamp
duties like those on financial documents and excise or medicinal or toilet preparations as
mentioned in the Union list are to be levied by the Government of India but are to be collected
by the States (Article 268).

Taxes on inter-State trade or commerce by way of sale or purchase of goods and taxes on the
consignment of goods are to be levied and collected by the Government of India but are to be
assigned to the States (Article 269).

All taxes and duties referred to in the Union list, except those referred to in Articles 268 and 269,
surcharge on taxes and duties, for the purposes of the Union and any cess levied by the
Parliament for specific purposes are to be collected by the Government of India and are to be
distributed between the Union and the States in the manner prescribed by the President by order
until a Finance Commission has been constituted and after its constitution, as prescribed by the
President by order after considering the recommendations of the Finance Commission.

Article 274 stipulates that prior recommendation of President is required to Bills affecting
taxation in which States are interested. “No bill or amendment which imposes or varies any tax
or duty in which States are interested, or which varies the meaning of the expression
“agricultural income” as defined for the purposes of the enactments relating to Indian Income
Tax, or which affects the principles on which under any of the foregoing provisions of this
Chapter, moneys are or may be distributable to States, or which imposes any such surcharge for
the purposes of the Union as is mentioned in the foregoing provisions of this Chapter, shall be

19
introduced or moved in either House of Parliament except on the recommendation of the
President. The expression tax or duty in which States are interested in this Article means:

 a tax or duty the whole or part of the net proceeds whereof are assigned to any State, or
 A tax or duty by reference to the net proceeds were of sums are for the time being
payable out the Consolidated Fund of India to any State.”

The plain reading of above Article 274 clearly stipulates that before any Finance Bill can be
moved in either House of Parliament, a prior recommendation from President is required.
Income tax being direct tax happens to be the major source of revenue for the Central
Government. The entire amount of income tax collected by the Central Government is classified
under the head:

 Corporation Tax (Tax on the income of the companies) and

 Income Tax (Tax on income of the non-corporate tax assessees).

This classification of Income Tax in to: (a) Corporation Tax; and (b) Income Tax, is of great
assistance to the Central Government while preparing budget estimates and setting the target.
The classification of Income Tax in to above two categories is also important for easy division of
income tax between the Central and State Governments as the proceeds from Corporation Tax
are not divisible with the States [Article 270(1) read with Article (4)(a)].

Municipality or other local authority or body for the purposes of the State, district or other local
area may, notwithstanding that those taxes, duties, cesses or fees are mentioned in the Union
List, continue to be levied and to be applied to the same purposes until provision to the contrary
is made by Parliament by law.”

As per recommendations of the Eleventh Finance Commission duly accepted by the

Government, in the overall scheme of transfer of funds, 37.5% of the gross revenue receipts is
the ceiling for such transfer of funds to the States. This includes (i) 28% of the net proceeds of
shareable central taxes and duties to the States; (ii) 1.5% of the net proceeds of shareable Central
taxes in lien of sales tax on sugar, tobacco and textiles, and (iii) grant-in-aid to States facing
revenue deficits after devolution, grants, meant for local bodies and grants for calamity relief. It

20
has also laid down the criteria for determining relative shares of States in central pool of taxes
and duties which is based on the weight age given to population area index of infrastructure, tax
effort and fiscal discipline.

Taxes levied and collected by the Union but assigned to the States
Article 269 deals with the taxes, which are levied and collected by the Union but assigned to the
States. Originally, Article 269 contained six types of taxes and duties, which were to be levied by
the Union Government. Consequent to the decision in 'Bengal immunity Case’ Constitution
(Sixth Amendment) Act, 1956 was passed by the Parliament whereby substantial amendments
were brought with regard to the taxing power of the State on the sale or purchase of goods.
Article 269 was amended by the above constitutional amendment and clause (1) (g) was inserted
Clause (I) (g) of Article 269 prescribed that tax on the sale or purchase of goods other than
newspapers where such sale or purchase takes place in the course of interstate trade or commerce
shall be levied by the Union but the same shall be assigned to the By the Constitution (Forty
Sixth Amendment) Act, 1982, clause (1) (h) was inserted in Article 269. Clause (I) (h) provided
for taxes on the consignment of goods (whether such consignment is to the person making it or
to ;my other person), where such consignment takes place in the course of inter-state trade or
commerce. After the Constitution (Forty Sixth Amendment) Act, 1982, the following eight types
of taxes and duties were to be levied by the Union Government the proceeds of which were
entitled to the States.
 duties in respect of succession to property other than agricultural land
 estate duty in respect c f property other than agricultural land
 terminal taxes on goods or passengers carried by railway, sea or air
 taxes on railway fares and freights
 taxes other than stami duties on transactions in stock exchanges and future markets
taxes on the sale or purchase of newspapers and on advertisements published therein
 taxes on the sale or purchase on goods other than newspapers where such sale or
purchase takes place in the course on interstate trade or commerce
 Taxes on the consignment of goods (whether such consignment is to the person making it
or to any other person), where such consignment takes place in the course of inter-state
trade or commerce.

21
The duties mentioned under Article 269 (1) (a) and (b) pertained to estate duty, and succession
duty in respect of property other than agricultural land. The incidence of duty in both the cases
was List succession to the property on the death of the owner and the only difference was that in
the case of estate duty, the value of the whole estate, even if situated in more than one State, was
taken as the base for assessment whereas the succession duty was computed on the value of
individual shares passing oil to the successors. Estate Duty was levied under the Estate Duty Act,
1953 on the capital value of all property passing on the death of any person on or after October
15, 1953.
However, Estate duty was abolished with effect from March 16, 198550 following the
recommendations of the Economic Administration Reforms Commission, 1981 -83.
Article 269(1) (c) pertained to terminal taxes on goods and passengers carried by railways, a or
air and correspond to entry 89 of List I. Clause (1) (d) pertained to tax on the railway fares and
freights. Under the provisions of the': Railway Passenger Fares Tax Act, 1957, tax on railway
fares was levied. The Second Finance Commission observed that the proceeds of this tax should
be distributed to the States on the principles that each State should be enabled to get as nearly as
possible the share of the net proceeds on account of the actual passengers travel on railways
within its limits. It recommended that each state should be allocated on the basis of the passenger
earnings from non-suburban services for each gauge of each railway zone separately among the
states covered by it according to the route length falling within each state. The basis was
accepted by the Government of India. However, on the basis of recommendation by the Railway
Convention Committee, the Railway Passenger Fares Tax Act was repealed in 196 1 and the t ix
was merged in the basic fares with effect from April 1, 196 1. Arrangement was made to
compensate the states for the losses suffered by them from 1 96 1-62 to 1965-66. The railways
agreed to make an ad hoc grant of Rs. 12.5 crores a year to States in lieu of the tax for a period of
five years from 196 1-62 to 1965-66. The successive Finance Commissions have recommended
for the amount to be distributed among the states and have laid down the basis of distribution.
Article 269(1) (e) related to 'taxes other than stamp duties on transactions in stock exchanges and
future markets' that corresponded to entry 90 of List I. This subject was with significant revenue
potential Finance Commission opined against the levy of taxes on transactions in stock exchange
and future markets.

22
Article 269 (1) (f) referred to 'taxes on the sale or purchase of newspapers and on achievements
published therein', which corresponded to entry 92 of List I. Though a tax on the sale or purchase
of newspapers is generally not appreciated, the advertisements Published therein could be taxed
without public protest. Fifth and Eighth Finance Commissions also had recommend for tax on
advertisements published i I newspapers. Clause (1) (g) deals verity the tax on the sale or
purchase of goods other than newspapers where such sale or purchase is in the course of
interstate trade or commerce:
Article 269(1) (h), corresponding to entry 92B of List I, referred to taxes on consignment of
goods in the course of inter-State trade.
Since the Central Sales Tax Act, 1956 (74 of 1956) does not seek to tax interstate movement of
goods, which is not as a result of sale, it has helped the tax evaders to show sale of goods as
consignment from one State to another. Constitution (Forty sixth Amendment) Act, 1982
empowered the Parliament to levy 'taxes on consignment of goods (whether the consignment is
to the person making it or to any other person), where such consignment takes place in the course
of inter-State trade or Commerce.' by inserting entry 92B in List I of the Seventh Schedule and
simultaneously amending Article 269 by inserting sub-clause 269(1) (h) Ever since, the States
have been pressing the Centre to levy the tax, the net proceeds of which were entirely assignable
to States. The Commission on Centre-State Relations, 1988, also impressed upon the
Government to "bring in suitable legislation in this regard without further loss of The
Amendment Act, 2000 amended Article 269 radically. The provisions relating to taxes, which
are levied by the Union but assigned to the States, were deleted except the provisions relating to
the Central Sales Tax and Consignment Tax. In these cases also the Union Parliament has
enacted the law to levy tax on the interstate sale of goods. In the case of tax on consignment,
there is no levy in the absence of central legislation. Prior to the Amendment Act, 2000, the
States were entitled to the proceeds of these taxes and duties whereas the Constitution
amendment converted these taxes and duties except Central Sales Tax and Consignment Tax,
entirely as Union Taxes and Duties and since they form Jart of the divisible pool of the Union
Taxes and Duties, the States are eligible only for a share of it.

23
 Taxes and Duties Levied and Collected by Union but Shared with the States
Prior to the Constitution Eightieth Amendment, tax on income other than agricultural income
was compulsorily shareable 55 and duties of Union Excise were shareable optionally if the
Parliament by law so provided. This system was totally altered by the Amendment Act,
2000 and the separation of taxes and duties as compulsory sharing and optional sharing was done
away with. The Constitution eightieth amendment introduced a system of a single divisible pool
and mandatory sharing of it between the Union and State Governments.
Article 270 of the Constitution makes provision for the sharing of taxes, which are levied ant1
collected by the Union, between the Union Government and the State Governments. Taxes,
which are assigned to be shared, were different prior to and after the Amendment Act, 2000.

Sharing of Taxes and Duties Prior to Constitution Eightieth Amendment

As per the pre-amended Article 270, tax on income other than agricultural income was levied
and collected by the Government of India and the same was distributed between the Union and
the States. Prescribed percentage of; he net proceeds of such tax in any financial year were
assigned to the States within which that tax was leviable. The Finance Commissions when:
assigned the responsibility to recommend the share of income tax that was to be transferred to
the States.
However, a tax on income did not include corporation tax. The proceeds attributable to Union
Territories, taxes payable in respect of Union emoluments and any surcharge, which might be
levied for the purpose of the Union, were also kept out of the divisible pool.
Under the pre-amended Article 272, Union Excise Duties were shareable between the Union and
the State Governments if the Parliament by law provided for it. Though sharing of this duty was
permissive in nature, all the Finance Commissions had recommended for including a portion of it
in the shareable resources, of course, under various criteria.
The share in net proceeds of income tax and excise duties assigned to the states, as recommended
by various Finance Commissions, are given in Table. 1.3. Two basic problems existed in relation
to the sharing of income tax between the Union and the State Governments. One was the
continuation of Union surcharge on a permanent basis, the proceeds of which were not shareable.
The other problem was that the income tax paid by the companies in the corporation tax, was not
shareable with the Despite persistent demands by the States, these problems were never solved.

24
In the case of Excise Duties, the First Commission fixed the share of the States at 40 percent of
the net proceeds of duty on tobacco, 51 Sub- matches, and vegetable products. Gradually the
number of articles considered for the purpose of the divisible pool was increased and the share
was consequently enlarged. The Fourth Finance Commission, for the first time, recommended
for assigning 20% of the net proceeds of the excise duty collected on all articles. The Seventh
Finance Commission enhanced the share of the states to 40 percent of the net proceeds of duties
on all commodities excepting the duty on the generation of electricity.

Sharing of Taxes and Duties Subsequent to Constitution Eightieth Amendment

The Amendment Act, 2000 radically altered Article 270 and repealed Article 272.60 Subsequent
to this amendment, the system followed till then for the sharing of taxes and duties was
fundamentally changed. Present system of sharing of taxes between the Union and
State Governments is discussed below.
All taxes and duties referred to in the Union List shall be levied and collected by the Union
Government and the same shall be distributed between the Union and the State Governments.
However, the sharable taxes and duties do not include duties and taxes referred to in Articles 268
and 269 respectively and surcharge on taxes and duties referred to in Article 271 and any cess
levied for any specific purposes under any law made by the Parliament. The net proceeds of
sharable taxes and duties shall be distributed between the Union and State Governments at
prescribed percentage by the President of India after considering the recommendations of the
Finance Commission. Sharing of the net proceeds of all taxes and duties levied and collected by
the Union Government was proposed by the Tenth Finance Commission. The Commission
recommended that 29 percent of the gross receipts of the Union Government should be
transferred to the states' Eleventh Finance Commission recommended for the sharing of the net
proceeds of all shareable taxes and duties levied and collected by the Union Government with
the States. It recommended for the devolution of 28 percent of the net proceeds of all shareable
Union taxes and duties for each of the five years starting from 2000-01 and ending in 2004-05.
The Commission further recommended for the devolution of 1.5 percent of the net proceeds of
all shareable Union taxes and duties as a compensation for not levying sales tax on sugar, textiles
and tobacco by the States. The original constitutional scheme of sharing of Personal Income

25
Tax with the States compulsorily and sharing of Union Excise Duties with the States optionally
is; no more available. The divisible pool of the Central taxes and duties now include all those
taxes and duties, which were exclusively assigned to the Union Government. All though the
divisible pool is widened, the shares of the States have not increased considerably for the reason
that the recommended percentage share of the States in the divisible patrol was accordingly
adjusted. The surcharge on taxes and duties under Articles 268 and 269 and cess on any central
subject are still kept for the exclusive use of the Union Government.

26
 Financial Relation between the Center and State

The distribution of powers in countries adopting the federal system of government defines the
financial relations between the Central and State governments. However, there are some special
problems that have to be solved within the federal financial system in determining the basis of
division and the amount that should he divided between the Centre and the State. The financial
Relation between the central (union) and the state is provided in the constitutional. The
constitution gives a detailed scheme of distribution of financial resources between union and
states. The India constitution makes a board distribution between the power to levy a tax and the
power to appropriate the proceeds of a tax. Thus, the legislature which levies a tax is not
necessarily the authority which retains the proceeds of a tax levied. The constitution grants the
union parliament exclusive power to levy taxes on several items. The state, legislature enjoys
similar power with regard to other specified items. In general the union parliament levies tax on
items mentioned in the union list while the state legislatures levy taxes on items mentioned in
state list. The Constitution of India, being federal in structure, divides all power (legislative,
executive and financial) between the center and the states. However, there is no division of
judicial power as the constitution has established an integrated judicial system to enforce both
the central laws as well as state law.
Or

Financial relations are the most important aspect of Centre-State relations. No system of
federation can be successful unless both the Union and the States have at their disposal adequate
financial resources to enable them to discharge their respective responsibilities under the
Constitution.

To achieve this object, Indian Constitution has made elaborate provisions, relating to the
distribution of the taxes as well as non-tax revenues and the power of borrowing, supplemented
by provisions for grants-in-aid by the Union to the States. It is to be noted that Indian
Constitution makes a distinction between the legislative power to levy a tax and power to
appropriate the proceeds of a tax so levied.

The legislative power to make a law for imposing a tax is divided as between the Union and
States by means of specific Entries in the Union and State Legislative Lists in Schedule VIII.

27
Thus, while the State's Legislative has the power to levy an estate duty in respect of agricultural
lands, the power to levy an estate duty in respect of non-agricultural land belongs to Parliament.

Similarly, it is the State Legislature which is competent to levy a tax on agricultural income,
while Parliament has the power to levy income-tax on all incomes other than agricultural
income.

The distribution of the tax-revenue between the Union and the States stands as follows.

1. Taxes exclusively assigned to the Union:

In this category, certain items of revenue have been exclusively assigned to the Union. These
include customs and export duties, income tax, excise duties on tobacco, jute, etc., corporation
tax on capital value of assets of individuals and companies; estate duty and succession duty in
respect of property other than agricultural land; and income from the earning departments like
the Railway and Postal departments.

2. Taxes exclusively assigned to the states under Article 269:

This category contains items of revenue which fall under the exclusive jurisdiction of the state.
These are: land revenue; stamp duty (except on documents included in the Union List);
succession duty and estate duty; taxes on goods and passengers carried by road or inland waters;
consumption or sale of electricity; tolls; taxes on employment; duties on alcoholic liquors for
human consumption, opium, India hemp and other narcotic drugs; taxes on the entry of goods
into local area; taxes on luxuries, entertainments, amusements, betting and gambling, etc.

3. Taxes leviable by Union but collected and appropriated by states under Article 268:

The revenue from the following items is collected and appropriated by the states. Stamp duties
on bills of exchange, cheques, promissory notes, bills of lading, letters of credit, policies of
insurance, transfer of shares, etc. Excise duties on medicinal, toilet preparations containing
alcohol or opium of Indian hemp or other narcotic drugs. Though all the above items are
included in the Union List and the Union government can levy taxes on them, yet all these duties
are collected by the states and form part of the revenue of the state that collects them.

28
 4. Taxes levied and collected by Union but assigned to states under Article 269:
The taxes on the following items are levied and collected by the Union but wholly assigned to the states
within which they are levied.

 Duties in respect of succession to property other than agricultural land;

 Estate duty in respect of property other than agricultural land;
 Terminal taxes on goods or passengers carried by rail, sea, or air;
 Taxes on railway freights and fares;
 Taxes other than stamp duties on transactions in stock exchanges and future markets; and
 Taxes on the sale or purchase of newspapers and on advertisements published therein.

5. Taxes levied and collected by Union and shared with states:

The taxes from the following items are levied and collected by the Union government but shared
with the states in certain proportion with a view to securing an equitable distribution of the
financial resources:
 Taxes on income other than agricultural income;
 Excise duties, other than those on medicinal and toilet preparations.

The Constitution provides that the Parliament may by law give grants-in-aid to the needy states
out of the revenue of the Central government. The amount of such grants is determined by the
Parliament in accordance with the needs aim to help such states which need Centre’s special
support for special kinds of needs and calamities. Knowing well the inelasticity of state’s
resources and the pressure of development on state exchequers the provision of grants in aid by
the Centre seems justified.

This need necessitated the provision of a Finance Commission which the President of India
appoints every fifth year:
 To assess and fix the allocation of revenue to the Central and state governments, and
 To determine the principles and proportions on which the grants in aid can compensate
the revenues of the states.

This ongoing arrangement and distribution of resources by an expert economic body with the
approval of the Parliament presents a democratic solution of the question. If it does not work

29
well, then Article 360 of the Constitution empowers the President to make a declaration of
emergency stating that a situation has arisen whereby the financial stability or credit of India is
threatened.

The consequences of this declaration are:

 During the period, the executive authority of the Union shall extend to the giving of
directions to any state to observe such canons of propriety as may be specified in the
directions.
 These directions may include: A provision requiring all Money Bills or other Financial
Bills to be reserved for the consideration of the President. A provision to issue directions
for the reduction of salaries and allowances of all or any class of persons serving in
connection with the affairs of the Union and states including the judges of the Supreme
Court and the High Court.

The duration of such proclamation will be a period of two months; unless before the expiry of
that period, it is approved by resolutions of both houses of Parliament. If the House of the People
is dissolved within the aforesaid period of two months, the proclamation shall cease to operate on
the expiry of 30 days from the date on which the House of the People first sits after its
reconstitution, unless before the expiry of that period of 30 days it has been approved by both
houses of Parliament. It may be revoked by the President at any time, by making another
proclamation.

A. Towards Centralization:
This prescribed union-state relationship of the Constitution has passed through very many
vicissitudes and strains since 1950. The dependence syndrome of state on the Union government
has caused flutter if not open protests. Several committees and commissions were appointed even
during Nehru era when the governments in most of the states belonged to the ruling Congress
party.

The Planning Commission and its role as an extra constitutional body generated a debate but the
issue could be resolved within the framework of the Constitution. In six years of working of the

30
Constitution, the India polity witnessed three constitutional amendments Third, Sixth and
seventh which have a direct bearing on union-state relations.

 The Third Amendment Act:

The Third Amendment Act modified item 33 of the Concurrent List and increased the power of
the Union government over the production, distribution, and prices of many commodities
including the food grains in 1954.

 The Sixth Amendment Act:

The Sixth Amendment Act 1956 added a new item 9-A to the Union List and thereby reduced
the powers of the state legislature with regard to imposition of sales tax by states.

 The Seventh Amendment Act:

The Seventh Amendment Act added Section 350-A to the Constitution whereby special powers
were given to the Centre to give primary education to the linguistic minority groups in their own
language. Under this amendment, the Central government was authorised to appoint a special
officer to look after the special interests of the linguistic groups. It also transferred ‘industries’
from the State List to the Union List.

Even during Nehru period, the Supreme Court of India following the American convention of
doctrine of implied powers interpreted the Constitution on the assumption that whatever is not
clearly given or assigned to the states may be taken as implied with the centre.

The Supreme Court held in a number of cases that the Central government was competent to levy
taxes on all those goods and things which were manufactured by the state government. An
autonomous corporation created and controlled by the state government is liable to the payment
of income tax as imposed by the Central government.

It is the jurisdiction of the state government to decide as to which medium of instructions should
be used in the affiliated colleges, but at the same time, this power of the state will become invalid
if it lowers the standard of an institution of higher learning as higher education is in the domain
of the Central government.

31
Thus, the Supreme Court has taken a stand which has led to the increase of the Central
government’s powers at the cost of state activity. The Indian Constitution lays down the rules of
comity, which the units have to observe in their horizontal and vertical relationships. These rules
and agencies relate to matters such as recognition of the public acts, records and proceedings of
each other, extra-judicial settlement of disputes, coordination between states and freedom of
inter-state trade and commerce. It has contributed to the growth of centralization in Indian polity.

B. The Pinpricks and Protest:

In the post-Nehru era, the non-Congress coalitions at Centre and states disturbed this union-state
equilibrium with a political jolt. The states mounted their campaigns for increased autonomy.
The Administrative Reforms Commission constituted in 1967 asked the Setalvad Study Team to
make a comprehensive analysis of union-state relations for their recommendations. It was the
beginning of identification of the problem.

Following the ARC report 1969, the Tamil Nadu government constituted a commission to
examine intergovernmental relations under the chairmanship of Justice P.V. Rajamannar in 1969.
The provision of President’s rule under Article 356 was the real hub of controversy when eleven
instances of President’s rule were witnessed in four years time from 1967 to 1971.

The M.C. Setalvad study team of ARC recommended the following:

 An inter-state council with five representatives one each from five zonal councils may be
set up.
 The office of the Governor be filled by a person having ability, objectivity and
independence and the incumbent must regard himself a creation of the Constitution.
 An inter-state council is composed of the Prime Minister and other central ministers
holding key portfolio and chief ministers and others may be invited or co-opted.
 Guidelines for the Governor to regulate the exercise of discretionary powers may be
detailed.
 The relationship between the Finance Commission and the Planning Commission should
be rationalized.

32
The Tamil Nadu Rajmannar report of 1971 is another comprehensive document of 282
pages wherein Justice Rajmannar reopened some of these perennial issues and suggested:
 An inter-state council, consisting of chief ministers with Prime Minister as chairman be
set up to resolve inter-state disputes.
 The Governor of a state should be appointed in consultation with the state government
and should be ineligible for second term.
 The jurisdiction of Article 356 pertaining to President’s rule be restricted to avoid its
abuse by the Centre.
 Some subjects from Union List be transferred to the State List and a redefinition of items
in Union List be attempted.
 The residuary powers of legislation and taxation should be vested in the state legislature.

This crystallization of issues in union-state relation in the year 1977 promoted the West Bengal
Marxist government to articulate the need for redefinition and a document was prepared as a
charter of demands against the Union government. It picked up specific articles of the
Constitution and suggested varieties of amendment to extend the sphere of state autonomy.

Some of the major recommendations of West Bengal document on Centre-state relations

are appended below:
 The state legislature should have exclusive power to legislate on matters not enumerated
in Union or Concurrent List. For this Article 248 be suitably amended.
 The preamble should describe India a ‘Federation of state’ and the term Union should be
deleted.
 Rajya Sabha should be directly elected with equal representation of states and its powers
should be equal with that of Lok Sabha.
 Article 302 which restricts states trade and commerce should be deleted.
 Article 368 should be so amended as to ensure that no amendment of the Constitution
was possible without the concurrence of two-thirds of the members present and voting in
each house of Parliament.
 Languages mentioned in the Eighth Schedule should be allowed in the work of the
Central government and the state governments at all levels. English should continue to be

33
 used for all the official purposes of the Union along with Hindi as long as the people of
the non-Hindi regions so desire.
 Article 249 is an encroachment upon state autonomy and should be deleted.
 All India services (IAS and IPS) should be abolished and there should be only Union and
state services and Centre should have no jurisdiction over the personnel of state services.
 Article 3 of the Constitution should be suitably amended so as to ensure that the name
and area of a state cannot be changed by Parliament to prevent specific conflict between
two or more states in respect to territory.
 The special status of Kashmir within the Indian Union, as laid down in Article 370 of the
Constitution should be retained.
 Articles pertaining to President’s Rule, Financial Emergency and Reservation of Bills for
President’s assent should be done away with.
 The Seventh Schedule and its lists should be reformulated and states should have
exclusive control over police, law and order, CRPF, certain categories of industries, etc.
 A separate article should be included in the Constitution to constitutionalise the existence
and operations of Planning Commission and National Development Council. The Centre
supervise these organizations to play its role as a coordination agency.
 States must be accorded more powers for improving tax on their own and to determine
the units of public borrowings.

C. The Sarkaria Effort:

This West Bengal Document was a well thought out and precisely drafted memorandum and it
aimed to arrest the increasing tendency of centralization. It went much beyond Article 356 and
its implications but covered several maiden areas like all India services, Seventh and Eighth
Schedules and problems of union policy through CRPF. The roles of Governor, Planning
Commission, Finance Commissions, and NDC were viewed from the state’s angle.

The memorandum goes to the extent of suggesting that Union List should contain only five
subjects, namely, (1) Foreign Relations, (2) Defence, (3) Currency, (4) Communications, and (5)
Economic Coordination. The radical suggestions to delete several articles go a long way to
change the basic nature and structure of the Indian Constitution. But the demand for restructuring

34
Centre-state relations continued unabated by Non-congress States like Andhra Pradesh,
Karnataka, West Bengal, Kerala, Assam, Tripura, Tamil Nadu and Jammu & Kashmir.

This forced Government of India to set up a commission under the chairmanship of Justice R.S.
Sarkaria to go into the question and recommend appropriate changes within the constitutional
framework in August 1983. The Commission took four years to complete its deliberations and
submitted its report on October 27, 1987. The Commission made a total of 247 recommendations
of which 24 were rejected, 10 were not considered wholly relevant and 36 accepted with
modifications. One hundred and nineteen recommendations are reported to have won the
government’s full acceptance.

The centrist tendency and the office of the Governor in union-state relations dominated the
Sarkaria findings and recommendations.

The Commission felt that:

 The chief minister of a state should be chosen by the Governor according to a four-step
formula.
 Article 356 should be retained but should sparingly be used after due warning to erring
state.
 State legislature should not be dissolve before the Presidential proclamation.
 Leader of the pre-election alliance.
 Leader of the largest single party.
 Leader proving his or her majority in front of the Governor.
 Leader whom the Governor thinks the House will support or accept.

The other recommendations pertain to more all India services in technical fields and inter-
governmental councils to sort out Centre-state disputes. The dynamics democracy and devel-
opment has significantly changed the framework in which the states now find themselves
operating.

It signifies a need for a wide ranging re-examination of Centre-state relations so that they are
enabled to have adequate powers as well as resources to meet their growing patterns of needs.

35
This should be possible without weakening the Centre. The problems call for greater bi-level or
tri-level sensitivity to the need for sound political processes and conventions in the land.

With the constitutionalisation of the Panchayati Raj in 1993, federalism has become a three-tier
governmental arrangement, and the needs and aspirations of the community-level government
must also be constitutionally monitored. For this, the Constitution has already created an
institutional framework of zonal councils and control boards. Then, there are informal
consultation devices through conferences.

36
 Finance Commission of India

Establishment of Finance Commission of India of 1951 was an important step by the

Government to enforce Article 280 of Indian Constitution as part of an important role to enrich
the country’s economy. The purpose of establishing this Commission was mainly to evaluate and
define finance related relations between the Central and respective state governments.

According to Finance Commission Act of 1951, Finance Commission of India was to be

established through assessing the need, qualifications, and disqualifications for the appointment
of Core Committee of Commission by keeping of view related aspects such as each
Commission’s term, power and role as an important body.

Constitution of India approves for the appointment of Finance Commission of India every five
years for a team comprising of Commission’s Chairman and four key members to work
according to roles defined by the law. This Commission has by now suggested many
recommendations ever since first Commission was set by keeping of view drastic changes of
India’s economy. Such recommendations have been implemented over the period with five
yearly Commission appointments.

Need of Finance Commission

By now Indian government has appointed thirteen Finance Commissions who have played
crucial roles and submitted reports to Central Government over the period.

As a democratic governance system, India witnessed many political and economic ups and
downs. Cases of economic imbalances were there due to differences of the system of governance
with Central and states. The law of the country bounds the states to take certain important
responsibilities for sustainable growth of country with the view to strengthen economy. States
are advised to incur expenditures and balance sources of avenues for that Finance Commission of
India play major role.

37
 Centre and State Financial Relations

One of the important roles of Finance Commission of India is to evaluate multiple factors related
to states concerned by keeping of consideration historic background of states and union
territories. This Commission takes crucial steps to evaluate the resource endowments differences
if any and crosscheck imbalances if they occur.

Major Objectives

Indian constitution bounds Finance Commission of India to look into affairs of the Central and
state governments of terms of financial issues by proper recognition of factors. This Commission
has made several key provisions to ensure gaps between the Central and state governments are
bridged through effective solutions. Issues are handled under following laws:-

Article 268 facilitates levying Center’s duties while states equip for retention

 Articles 269, 270, 275, 282 and 293 are meant to specify various ways to share resources
between Centre and State governments
 Constitution of India also offers institutional framework for Centre-State transfer
facilitation

Role of Finance Commission of India

According to Article 280, the Finance Commission has to make recommendations to the
President on two specific matters and on "any other matter referred to the Commission by the
President in the interests of sound finance."

The two specific matters are:

 The distribution between the Union and the States of the net proceeds of taxes which are
to be, or may be, divided between them and the allocation between the States of the
respective shares of such proceeds; and

 The principles which should govern the grant-in-aid of the revenues of the States out of
the Consolidation Fund of India.

38
The Constitution makes it mandatory under Article 270 to divide taxes on income other than
agricultural income between the Union and the States. For this purpose, taxes on income exclude
corporation tax and any surcharge which may be levied for Union purposes.

To the extent that the proceeds of taxes in income represent proceeds attributable to Union
Territories or to taxes payable in respect of Union emoluments, they are retained by the Union.

The Constitution also contains in Article 272 an enabling provision under which, if Parliament so
prescribes by law, Union duties of excise other than duties of excise on medicinal and toilet
preparations may be divided.

The President, after considering the recommendations of the Finance Commission with regard to
income-tax, prescribes by order the percentages and the manner of distribution. Parliament is not
a directly concerned with the assignment and distribution of income-tax.

Article 275 deals with the grants-in-aid of the revenues of the State. These grants-in-aid are to be
provided by law of Parliament; but clause (2) of this Article states that until provision is made by
law, the President may exercise this power by order.

His power is, however, conditioned by the proviso "that after a Finance Commission has been
constituted no order shall be made under this clause by the President except after considering the
recommendations of the Finance Commission."

No reference to the Commission is necessary, if the grants-in-aid are provided by the law of
Parliament or if the President considers that no State is in need of assistance. The President did,
however, refer the matter to all the Finance Commissions for their recommendations.

Under Article 280(3) (b) the Finance Commission has the duty of making recommendations "to
the principles which should govern the grants-in-aid of the revenues of the States out of the
Consolidated Fund of India."

Under Article 280(3) (c) the President may refer to the Commission any matter which he
considers to be in the interests of sound finance. Under this provision, they were asked to make
recommendations as to the principles which should govern the distribution, among the States, of
the net proceeds in any financial year of

 The estate duty in respect of property other than agricultural land;

39
  The tax on railway fares; and

 The additional duties of excise on mill-made textiles, sugar and tobacco (including
manufactured tobacco), to be levied in replacement of the sales taxes and those articles.

In case of the last item, the Commission had been asked to recommend the amount which should
be assured to each State as the income now derived by it from the levy of the sales taxes on these
commodities.

The importance of the Finance Commission as a constitutional instrument capable of settling

many complicated financial problems that affect the relationship of the Union and the States may
be seen from the recommendations of the last eleven Commissions.

The present system of allocation of finance between the Union and the States is almost entirely
the result of these recommendations,

The chief merit of the work of the Commission lies in its impartial and objective outlook as a
steadying force in the finances of the federal system and its ability to take the question of
distribution of finances out of the vortex of federal State political pressures and controversies.

In fact, the Commission acts as a buffer between the Union and the States, checking the
clamorous, finance- hungry States bent upon applying their political pressure on the Union, and,
at the same time, ma'' the latter give as much as possible to the needy States. It will be almost
impossible for the Union to go against the recommendations of the Commission.

The Constitution also embodies a number of special provisions which seek to establish a certain
amount of immunity from taxation by the State Governments on the income and property of the
Union and vice versa. Further it contains several detailed provisions dealing with miscellaneous
financial matters.

To examine the financial relations between the Union and the States is indeed to traverse
difficult terrain. The provisions are detailed, often expressed in difficult and clumsy legal
terminology. Moreover, almost every general proposition is qualified or modified by exceptions
or limitations.

Nevertheless, these detailed provisions have one solid merit, that of eliminating the possibility of
much litigation which has been the bane of the older federations.
40
Critics of the bulkiness of the Constitution should take special note of this. It is a striking feature
of the working of the Constitution that the volume of litigation in this field has been negligible.

Thus, the financial provisions of the Constitution have on the whole avoided the pitfalls of other
federal Constitutions. This has been achieved by sharply demarcating the tax jurisdictions of
each authority Union and State in order that conflicts in the concurrent zone of tax jurisdiction
may not arise.

The Constitution has not followed the simple dichotomy of direct and indirect tax commonly
followed in some federations. Both direct and indirect taxes have been allocated to the Union and
the States.

The rationale of the division is the fundamental principles of federal finance, namely, efficiency
and suitability. The principle of adequacy has been met by the provision dealing with federal
grants- in-aid.

The framework of the entire financial fabric is based upon the assumption of Union-State co-
ordination, so that the fiscal relations between the Union and the States may be harmonious.

Viewing the Union-State relationship in the financial field as a whole, one finds that it is in
harmony with the general nature of Indian federalism, namely, the tendency for centralisation.

The Union Government is financially stable and stronger than the State Governments. This was
necessary to facilitate the planned development of the country as a whole and to check parochial
and even separatist tendencies in the economic activities within individual States.

As it is, the States are, in view of their limited resources, bound to look up to the Union for
financial aid for most if not all developmental projects. Naturally, they will have to follow the
lead of the Union and often even submit to its dictation.

This is not a happy situation from the point of view of the States. Perhaps in the initial stages of
development of India as a new politically independent country (after 1947) this was necessary
both to ensure the unity of the nation and the balanced development of the different regions.

But during the last five decades the pattern of Indian economy has undergone considerable
change. The States today feel that if they have to pursue their developmental objectives
satisfactorily, they should have greater financial resources.

41
And this is possible only if either the Centre gives them a larger share of the Central revenues or
allowing them to have more taxation powers, if necessary, through constitutional amendment.

It is not likely that the Centre would agree with either of these demands readily. But there is
indication to believe that these demands are bound to gather momentum and strength in the days
to come.

Financial relations between the Union and the States, especially in a developing economy,
cannot remain static for long. Adjustments will have to be made in the light of the changing
pattern of the economy.

Legislative enactments on taxation cannot be made for all time to come. After all, the
relationship between the Central Government and the States in a federal system is a dynamic
one; and the problems arising out of this relationship cannot be solved once for all any more than
the problems of life itself.

The appointment of the Sarkaria Commission, (1983) to go into the entire question of Centre-
State relations and make appropriate recommendations is significant in this context and was a
step in the right direction.

The Commission's recommendations have been widely welcomed by different sections of public
opinion in the country but not much has yet been done to implement them.

42
 Important Concepts and Definitions:

1. Assessment Year:

Assessment year means a period of 12 months commencing on 1st April and ending on 31st March of the
subsequent year. Income earned in financial year is taxed in assessment year. Assessment year succeeds
the financial year.

2. Accounting Year / Financial year / Previous Year:

Accounting Year or Financial year is also known as ‘previous year’. It means the year immediately
proceeding the assessment year.

Generally previous year consists period of 12 months, only in case of newly set up during the financial
year business, this period shall be beginning on the date of setting up of the business and ending with the
said financial year.

3. ‘Assessee’ :

An ‘assessee’ is a person:

 From whom any tax is payable under the Act

 From whom any other sum of money (such as interest or penalty) is payable under the Act
 Against whom any proceedings under the Act have been initiated for the assessment of his
income or loss or of amount of refund due to him
 Who is deemed to be an assessee i.e. representative assessee such as guardian of a minor or
manager of a lunatic or agent of a nonresident
 Who is deemed to be an assessee in default i.e. a person who has failed to discharge any
obligation under the Act e.g. deduction of tax at source, payment of advance tax etc.

In simple terms an ‘assessee’ is a person who is liable to pay income-tax, interest and / or penalty for his
own income or income of other person. The term ‘assessee’ also includes the person whoever failed to
follow any obligation under the Act.

4. Assessment:

The Term ‘assessment’ is not defined in Income-Tax Act, 1961. The Act only states that it includes ‘re-
assessment’. Assessment means computation of total income earned or loss suffered by the assessee
during the financial year and the amount of tax payable by him or refund payable to him.

43
 5. ‘Income’:

According to section 2(24) of the Income-Tax Act, 1961 ‘income’ includes:

 Profit and gains

 Dividend
 Voluntary contributions received by charitable institutions, religious trusts, research associations
etc.
 Any allowance granted to employees
 The value of any perquisite or profit in lieu of salary taxable under the ‘salaries’
 The value of benefit or perquisite obtained by a director or a person substantially interested in a
company
 Income chargeable under the head ‘profits and gains of business or profession’
 Capital gain
 Profit and gains of insurance carried on by Mutual Insurance Company or by a co-operative
society, computed in accordance with provisions of section 44 of the Act.
 Winning from lotteries, betting, cross-word puzzles, gambling, horse race etc. It includes prizes
won in TV / game shows
 Employer’s contribution to provident fund or super-annuation fund or other such fluidsxii. Any
sum received under Keyman Insurance Scheme including bonus
 The contribution made by the central government in the previous year to the account of
employees under a pension scheme referred to in section 80 CCD
 Cash gifts received from non-relatives exceeding Rs. 50000/-. From 01-10-2009 immovable
property, movable property transferred without or with inadequate consideration is taxable in the
hands of recipient (donee)

The definition of ‘income’ lists the items which are treated as income. This definition is not an
exhaustive, but an inclusive one. It means any other kind of earnings not mentioned in the list of income
is also to be included and to be treated as income.

6. ‘Person’:
 The term ‘person’ includes -
 An Individual
 A Hindu Undivided Family
 Partnership Firm

44
  A Company
 An Association of Persons
 A Local Authority
 Every Artificial Judicial Person

The definition of ‘person’ given by the Act is very simple. It includes natural human beings as
‘individuals’ and other persons who are established under various Acts.

Legal status of the assessee i.e. whether the assessee is a firm or company or artificial judicial person etc.,
is very important in determining assessee’s tax liability. The tax rates are different for different legal
status of the assessees.

7. Total Income:

According to Income-Tax Act, incomes earned are classified and assessed under five heads viz;

 Income from salary

 Income from house property
 Profits and gains from business or profession
 Capital gain and
 Income from other sources

Total of these five income heads is called as ‘Gross Total Income’.

8. Taxable Income:

After claiming deductions under chapter VI-A from gross total income, ‘Taxable Income’ of the assessee
is arrived at.

45
 Introduction

The double taxation avoidance agreement is an agreement which helps the taxpayer to get relief
from double taxation on the same income. If India has signed any double taxation agreement
with any foreign country; it’s meant that the taxpayer of those countries does not have to pay the
tax on the same income in both the countries. So, double taxation avoidance agreement is a
useful tool which helps the taxpayer to avoid “double taxation”. In case of claiming relief under
double taxation avoidance agreement two important things are needed to find out.

These are:

 The country of residence.

 The source country.

Here “the country of residence” means where the assessee resides and the source country is any
foreign country other than where he resides, but the asseesee earn some income from that foreign
state. In that case if the two countries does not sign any DTAA then the assess has to pay tax in
both the state i.e. the country of his residence as well as the source country, this is why double
taxation avoidance is so much important.

Double Taxation Avoidance Agreement: An Analysis

Hypothetical example:

If there is a double taxation avoidance agreement between India and other foreign country then it
restricts taxation of the same income in both countries. India has double taxation avoidance
agreement with 84 countries. It means a person does not give tax of the same income in India or
any of those countries. DTAA is an essential tool to avoid double taxation of the same income in
different countries. The effectiveness of DTAA can be explained by using a hypothetical
example:

Hypothetical example:

A person who lives in a foreign country and maintains an NRO account (non resident ordinary
account) in India; so the interest he gets from this NRO account is appearing as “NRIs income
originated in India”. If India and this foreign country where the person lives are binding with a

46
Double taxation avoidance agreement then this income will be taxed according to the specified
rate prescribed in the DTAA. So the main purpose of the DTAA is to provide benefit to the
assesses. when two countries entering into Double taxation avoidance agreement then the
provisions which are laid down in DTAA overrides the provisions of Tax Law of particular
country. In India also the provision of DTAA overrides the income tax provisions.

According to section 90 (2) of the income tax act, assessee can choose whether he will go with
the DTAA provisions or with the Income Tax act. Assessee can decide whichever is more
beneficial.

Article 265 of the Indian constitution stated that “no tax shall be levied or collected except by
authority of law”. To avoid any confusion The Income Tax Act, 1961 enacted clear provisions to
confer “the power of the central government to enter into agreements with foreign countries for
the avoidance of Double taxation as contained in Chapter 9 of the Income tax Act.” Section 90
and section 91 of the income tax act, 1961, these two provisions deals with double taxation.
Section 90 and section 91 are very helpful provision in this regards which save taxpayers from
double taxation. Section 90 of the Income Tax Act, 1961 talking about “those taxpayers who
have paid the tax to a country with which India has signed DTAA”.

On the other hand section 91 is talking about “those taxpayers who have paid tax to a country
which does not have any double taxation avoidance agreement with India. That is how Indian
income tax act takes care of these two different types of taxpayers. When India enters into a
double taxation avoidance agreement with any foreign country, by such agreement they mutually
determined the tax rate. It protects the interest of taxpayers.

Double Taxation Avoidance Agreement And The Income Tax Act: A Study

The main aim of double taxation avoidance agreement is to provide relief to the taxpayer from
double taxation. A country entered into a DTAA with a foreign state so that; by this agreement it
can prevent double taxation of same income in different country. In India, section 90 and section
91 of the income tax act deals with the double taxation avoidance agreement. Now in this chapter
I will try to find out what happened when any of the provisions of the Double taxation avoidance
agreement clash with any section of the Income tax act and which provisions should prevail over
another? Section 90 (2) of the Income Tax Act, 1961 explain that if India has a DTAA with any

47
other foreign country then it is the assessee who will decide that which provision is more
beneficial for them and that provision will apply accordingly.

In the famous case CIT vs. Visakhapatnam Port Trust first time “the rule under section 90 (2)”
was recognized by Andhra Pradesh High Court. After that in the famous case Union of India vs.
Azadi Bachao Andolon, the supreme court of India recognized the same. Now here the main
issue comes. According to sec 90 (2) the provisions which are beneficial for the assessee will
apply on him then the question is whether an assessee can choose income tax act for his one
types of income and DTAA for another types of income?

Hypothetical Example:

If MR. A has a certain amount of income which is derived from business and he wants to pay tax
on this particular income according to the provision of income tax law and also MR A has to
give tax for his another types of income i.e. capital gain. In this case if he chooses to follow the
provisions of DTAA.

Here the question comes is it possible? It can be argued that if we follow the language of the
section 90 (2) of income tax act then it should be allowed a person to go with income tax act for
a certain types of income and also can go with DTAA provision for another types of income.

DTAA and Jurisdictional Issue

The main jurisdictional issue regarding double taxation avoidance agreement comes when the
question arises that “who can tax the income”? It means it is essential first to find out which
country should tax a particular income. If one country has entered into a double taxation
avoidance agreement with another foreign country then the question is who will tax the particular
income:

 The country from where the income comes.

 The country where the taxpayer resides.

If it is provided in the DTAA that in case of immovable property; the country where the property
was located, has the right to tax. Here the question comes that the country where the owner lives

48
can also tax the same income. In such case the owner of the property shall have to claim “credit
in the country where he resides for the tax paid in the country where the property is located”.

In case of “business profits”, “the country of residence” has a right to tax the profit which is
derived from the business house; unless it is doing business in other source state and having a
permanent established located therein.

The Madras high court in CIT vs. V.R.S.R.M Firm & Others and the Karnataka High Court in
the case CIT vs. R. M. Muthaiah in both these cases it was held that when it is stated that tax can
be charged for a certain income by one state then the other contracting state has no right to tax on
the same income.

In general case both the contracting state has a right to tax income in respect of “dividend and
interest”; but the taxation right is vested in the state where the party resides but it’s also stated
that such income “also” be taxed in the source state. In OECD model convention there are two
articles 23A and 23B in this regard.

Double Taxation Avoidance Agreement in India: How Its Work: An Analysis

In this chapter I will discuss how double taxation avoidance agreement works in the Indian
context. To save a taxpayer from being doubly taxed in respect of the same income, the concept
of double taxation avoidance agreement got introduced. If two countries have signed in double
taxation avoidance agreement both countries tax payers get benefit from it. India is not an
exception to it. Currently India has signed double taxation avoidance agreement with 87
countries. This agreement is very effective for the taxpayer who has income in another foreign
country other than where he resides. By the help of this agreement taxpayer can be protected
from giving tax of the same income in two times. The double taxation can be avoided by
following manners:

 The country where the taxpayer resides, can exempt the income which is coming from
foreign countries.22 Or,
 The country where the taxpayer resides, “grant the credit for the tax paid in another
foreign country”.

49
The rules of the agreement depend on the mutual agreement of the two states, so the DTAA
provision will apply in the countries who have signed the same agreement. DTAA can be
different from one country to another.

In the general case when two countries have signed the Double Taxation Avoidance Agreement
then the “source country” gets the right to tax by using the relevant provisions of the taxation law
of that country and thereafter “the country of residence” grants “credit” for tax also apply low tax
rate.

Hypothetical example:

Suppose in our country (India) the tax rate applies on the long term capital gain is 20% and the
tax rate of the country where the assesee resides is 30% then in that case only 10% tax will be
charged on that income. Procedure for claiming relief from double taxation:

The procedures which are required to follow for claiming relief from double taxation are stated
below:

 Firstly it is necessary to find out “the country of residence” then the next step is to find
out that which provisions are there in the DTAA between the two countries.
 Then it is needed to check that the person who claims “tax exemption” and taxcredit”
whether he paid tax in “the source country”. For this he has to submit the following
documents to the tax-authorities as evidence.

These are:

 Tax Residency Certificate

 Self-attested Xerox of Pan Card.
 Self-declaration & identity form.
 Self-attested Xerox of passport & visa.

In short to get the benefits of the DTAA, a person who lives outside of India; i.e. any foreign
country should apply for “tax residency certificate” from “tax authorities”. Finally he/she has to
submit “a self declaration form” and also Xerox of PAN, TRC, PASSPORT, VISA to the “tax
authorities.”

50
 Double Non Taxation and Treaty Shopping: The Misuse Of Double Taxation Avoidance
Agreement: An Analysis

In this chapter I will analyze the negative effect of double taxation avoidance agreement. DTAA
can be misuse by two ways, these are:

 Double Non Taxation

 Treaty Shopping
1. Double Non Taxation

Firstly I would like to discuss about the double non taxation. In case double non taxation a
specific income is not taxed in the source country, because of “an incentive”, “exemption” or
“prevailing” in that country.

Hypothetical Example:

If a person who lives in India has an immovable property in country X. In country X the income
which comes from immovable property “may be” tax in accordance with the DTAA but the law
of country X does not provide for any tax of the income from such immovable property for some
specific reason, then such income will be “untaxed”; because of this reason that country X does
not impose any tax on the immovable property. But DTAA should not be interpreted in such way
that it allows double non taxation; because the purpose of DTAA is to avoid double taxation not
to promote double non taxation.

So it can be said that the country of the resident has “inherent right” to tax the income of the
resident. If it is so then in the above example country X does not impose tax on the income from
immovable property; in that case India can tax the same income as it is the country of residence.

But situation is not as easy as it seems. A DTAA should be interpreted according to its own term
even it is “result in double non taxation”. The Supreme Court also stated that the double non
taxation possibility is not relevant.28In the famous case CTI v. Laxmi Textile Exporters Ltd29,
the assessee is the Indian resident and in Srilanka he owns a business which is a permanent
establishment. That income is not considered as taxable income in Sri-lanka. The Mardas High
Court held that India would not tax this income as it is a country of resident.

51
 2. Treaty Shopping

Treaty shopping is another example of misuse of DTAA. It means when an assessee wants to do
“a transaction through another country which has most beneficial treaty with India in order to
reduce his tax liability.”

Example: Indo-Mauritius Treaty.

In India 40% of the total FDI comes through Mauritius, because according to the Indo Mauritius
DTAA, tax levied on capital gain as per the law of the country of the residence of the assessee.
But according to the tax law on Mauritius there is no tax imposed on capital gains; because of
which all the investment in India from the different country comes through the Mauritius.

In the famous case Union of India v. Azadi Bachao Andolan; it was held that if the aim of the
DTAA was not to include a person of third country and restricts him/her from taking “the benefit
out of the favourable terms”, then there should be an another provision about it.

Parliament has a duty to take care of it in this regard; and if there is no specific provision and
limitation mentioning DTAA; then “no one can be denied benefit of the favorable tax provision
in the belief that treaty shopping is prohibited.”

Example: In the Indo-US DTAA Art 24 deals with treaty shopping.

Conclusion

So from the above study it can be said Double Taxation Avoidance Agreement is very much
helpful for avoiding double taxation not only that double taxation avoidance agreement can over
ride the Income Tax act; if it is beneficial for the assessee. But it should not be used in wrong
manners like to promote double non taxation or to unnecessarily or illegally reduce the tax
liability or treaty shopping. It is essential that the Double Taxation Avoidance Agreements
should have a clear provision which prevent DTAA from misuse (example: provision for anti
treaty shopping etc).

So to conclude it can be said the Double taxation avoidance agreement should be used for good
purpose like for the beneficial of the assessee or to prevent a person from being taxed twice for
the same income it should not be misused.

52
Unit-II

53
 Definitions/Basic Terms of Income Tax

1. Assessee: Section 2(7):

‘Assessee’ means a person by whom any tax or any other sum of money is payable under this
Act and includes:

Every person in respect of whom any proceedings under this Act have been taken for the
assessment of his income pr of the income of any other person in respect of which he is
assessable or loss sustained by him or by such other person or of the amount of refund due to
him or to such person;

 Every person who is deemed to be an assessee under any provision of this Act;
 Every person who is deemed to be an assessee-in-default under any provision of this Act;

The above definition divides various types of assessees into three categories:

 Ordinary assessee it includes:

 any person against whom some proceedings under this Act are going on. It is
immaterial whether any tax or other amount is payable by him or not;
 any person who has sustained loss and filed return of loss u/s 139(3);
 any person by whom some amount of interest, tax or penalty is payable under this
Act; or
 Any person who is entitled to refund of tax under this Act.
 Representative assessee or deemed assessee:

A person may not be liable only for his own income or loss but also on the income or loss of
other persons e.g. agent of a non-resident, guardian of minor or lunatic etc. In such cases, the
person responsible for the assessment of income of such person is called representative assesses.
Such person is deemed to be an assessee.

Deemed Assessee:

 In case of a deceased person who dies after writing his will the executors of the
property of deceased are deemed as assessees.

54
  In case a person dies intestate (without writing his will) his eldest son or other
legal heirs are deemed as assesses.
 In case of a minor, lunatic or idiot having income taxable under Income-tax Act,
their guardian is deemed as assessee.
 In case of a non-resident having income in India, any person acting on his behalf
is deemed as asseessee.
 Assessee-in-default:

A person is deemed to be an assessee-in-default if he fails to fulfill his statutory obligations. In

case of an employer paying salary or a person who is paying interest it is their duty to deduct tax
at source and deposit the amount of tax so collected in Government treasury. If he fails to deduct
tax at source or deducts tax but does not deposit it in the treasury, he is known as assessee-in-
default.

2. Person: Section 2(31):

Person includes:

 An Individual;
 A Hindu Undivided Family;
 A Company;
 A Firm;
 An association of persons or a body of individuals, whether incorporated or not;
 A Local Authority, and
 Every artificial juridical person not falling within any of the proceedings sub-clauses.

Association of Person or Body of Individual or a Local authority or Artificial Juridical Persons

shall be deemed to be a person whether or not, such persons are formed or established or
incorporated with the object of deriving profits or gains or income. This amendment has been
i9nserted with effect from 1-4-2002 i.e. from assessment year 2002-03.

55
 Concept of Income under the Income Tax Act

The word income is very important concept. It is very much essential to a person, Business
organization and also to the Government in order to meet the regular and routine expenditure. If
there is no income, the question of meeting the expenditure becomes very difficult. In such cases,
we have to go for the loans. And now the question arises about the loan repayment. Even to
repay the loan, one should plan for the income resource, It all applicable to the person, business
organization, and also to the Government.

Now, let us discuss, the term “income” from the Governments point of view. The Government is
going to get the income by imposing the various taxes. One among the various taxes is income
tax. Every Government activity depends upon the “income of the Government”.

An individual a firm, a business organization is going to earn the income through one or the
other activity. So, it is quite clear that, the income is going to play a predominant role in the
society with all the above stated reasons. Hence, it is a must for us to know about the meaning
and definition of the income.

Since, income tax is a tax on income, it becomes very important to understand the concept of
income. Meaning of Income: In general tem “income” means any monetary gain either in the
form of money or money’s worth coming from a certain source with some sort of regularity.

In another sense, the income means the return on investment (ROI). In Oxford Dictionary
meaning of the term “income” is “periodical receipts from one’s business, land, work,
investments, etc.” Important features of Income:

 Income is linked with the source.

 Income must come from outside.

For example:

 income received from transactions between a Branch office and

 Head Office and subscriptions received by a club from its members is not
income.

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  Income is being received by any source whether legal or illegal and taxable over the
income ceiling.
 The income may be received either in the form of money or money’s worth. Definition of
Income:

Income Tax Act 1961, Section 2(24) defines the term “Income” as: “Income includes”

 Profit and gains

 Dividend
 Voluntary contributions received by charitable institutions, religious trusts, research associations
etc.
 Any allowance granted to employees
 The value of any perquisite or profit in lieu of salary taxable under the ‘salaries’
 The value of benefit or perquisite obtained by a director or a person substantially interested in a
company
 Income chargeable under the head ‘profits and gains of business or profession’
 Capital gain
 Profit and gains of insurance carried on by Mutual Insurance Company or by a co-operative
society, computed in accordance with provisions of section 44 of the Act.
 Winning from lotteries, betting, cross-word puzzles, gambling, horse race etc. It includes prizes
won in TV / game shows
 Employer’s contribution to provident fund or super-annuation fund or other such fluidsxii. Any
sum received under Keyman Insurance Scheme including bonus
 The contribution made by the central government in the previous year to the account of
employees under a pension scheme referred to in section 80 CCD
 Cash gifts received from non-relatives exceeding Rs. 50000/-. From 01-10-2009 immovable
property, movable property transferred without or with inadequate consideration is taxable in the
hands of recipient (donee)

The above mentioned definition does not give its definition but widens the scope of the term
“income”. It simply tells us the sources and the income of which is included in the scope of
income chargeable to tax.

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According to the decision of the Privy Council, in Commissioner of Income Tax, Bengal vs.
Shaw Wallace & Co. Ltd., “income” can notes a periodical monetary return coming in with
some sort of regularity or expected regularity from definite sources which need not be
continuously productive, but their object must be the production of a definite return as
distinguished from a mere windfall. Thus, the meaning and definition of the income is very
broad, like a fruit of a tree or crop of the field where the source is a must in both the cases alike.

Gross Total Income

Gross total income of an assessee consists of:

 Income from salaries (section’s 15 to 17).

 Income from House property (section’s 22 to 27).
 Profits and Gains of Business or Profession (section’s 28 to 44).
 Capital Gains (section’s 45 to 55) and
 Income from other sources (section’s 56 to 59) of Income Tax Act, 1961. First of all, we
have to compute the taxable income of an assessee under Head wise separately.

In order to calculate the taxable income under each head certain deductions have to be made
from the Gross income of that head. These deductions are different for each head. Then, after
computing the head wise income separately, these incomes should be added together to find out
the Gross Total Income of the Assessee.

Gross total = (income from salaries + Income from House Property + Income from profits &
gains of business or profession + Income from capital gains + Income from other sources +
Income of other persons to be included in Assessess income).

Thus, the gross income of an assessee may be calculated.

Total Income

Total Income = (Gross Total Income – Deduction Allowed under Section 80D to 80U Section
14 of the Income-Tax Act, 1961 deals with the total income of an Assessee.)

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 In order to derive the total income of an Assessee the following steps are to be followed.

 Head-wise income should be computed.

 Admissible head-wise deductions are to be considered.
 Add together all the Head-wise incomes to get Gross Total income.
 From the gross total Income certain deductions are to be allowed under section 80D to
80U.
 The Net-amount, thus arrived, is a total income of an Assessee. It should be rounded off
to the nearest multiple of Rs.10/-.

Taxable Income

The income of an assessee should fall under any of the below stated heads for the computation of
taxable income.

 Income from salaries

 Income from House property
 Profits and Gains of Business or Profession
 Capital gains
 Income from other sources.

Any income which cannot come and to be included under any of the above first four heads
should be included under “Income from other sources”.

First we have to find out the total income of an assessee head wise, separately, by allowing
certain deductions admissible under each head from the Gross income of that head. In addition,
to those certain deductions are also allowed under section 10, to compute the taxable income
under different heads. After computing the head wise income separately, these should be added
together to find out the Gross Total income of the Assessee.

Afterwards, again certain other deductions are allowed under section 80D to 80U from this Gross
total income. The net amount thus arrived at, after those deductions from the Gross total income
are known as “Taxable Income”. Thus, the taxable income may be calculated of an assessee.

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 Residential Status and Its Importance Under It Act, 1961

Introduction:

Justice Oliver Wendell Holmes, Jr. once said that taxes are the price that we pay to live in a
civilized society. Though as individuals, we don't like the concept of parting with a share of our
hard earned money, as a member of a civil society, paying taxes is not just fulfilling our duties,
but a very important aspect of the growth of the nation, which directly or indirectly affects our
very own growth.

Not indulging himself too much into the philosophical aspects of taxation, the researcher would
now focus at the task at hand - to analyze the importance of “Residential Status” under the
Income Tax Act, 1961.

The Income Tax Act, 1961 (hereinafter referred to as the Act) is an Act to consolidate and amend
the law relating to income-tax and super-tax. However, not everyone is liable to pay taxes on
income under the Act. The Act makes certain exceptions and exempts certain kind and extent of
income from taxation. Those who are liable to pay tax and whose incomes are assessed under the
Act are known as “Assessees”. They can be either natural persons or artificial judicial persons,
including but not limited to corporations, firms, trusts, local authorities etc. The website of the
Income Tax Department lists the following kinds of assessees: -

 An individual,
 A Hindu Undivided Family,
 A corporation,
 A firm,
 An ‘association or persons' or ‘body of individuals',
 A local authority,
 Any other artificial juridicial person not falling in any of the above categories.

The Department notes that there are different sets of rules that exist for the taxation of different
kinds of the abovementioned individuals. The next basis of categorization of assessees is their
residential status. Under the Act, assesses are either resident in India or non-resident in India. It
might sound weird at first instance that an income accrued to an individual outside India would
be taxable in India or an income accrued to a foreign national in India could not be taxable in

60
India. However, the determination of tax liability under the Act is not on the basis of citizenship
but on the basis of the residential status of the person.

The Concepts of Residential Status And Income

Under the Act, assesses are either resident in India or non-resident in India. The same with
respect to an individual or an HUF can be further divided into resident and ordinarily resident or
resident but not ordinarily resident.

What do we exactly mean by these terms - resident, non-resident, resident and ordinarily
resident, resident but not ordinarily resident. Any further discussion on this issue will first
require clarification and explanation of these terms.

Residential Status

The first thing that needs to be kept in mind is that the residential status is determined with
respect to the previous financial year - hence, an assessee may be a resident in one year and a
non-resident in the next year. Attention needs to be brought to Section 6 of the Act which
mandates that a person is said to be resident in India in any previous year if he was in India in
that year for a period of 182 days or more or in the four years preceding that year, had been in
India for 365 days or more. However, the basis for determination is not the same for all kinds of
assessees. While it is the number of days spent in India for an individual, for an HUF, firm or
other association of persons, the determination is made on the basis of its control and
management. If the control and management of such assesses was outside India in a financial
year, then it was not resident in India for that year, otherwise it was.

With respect to Companies, the very fact that a company is an Indian company is enough to
establish residency in India. Even in case of foreign companies not incorporated in India, if the
control and management of its affairs is wholly situated in India, the said Company is deemed to
be resident in India.

Another concept that needs clarification before we proceed to discuss the implications of the
residential status under the Act is “not ordinarily resident in India”. As per the Act, if an
individual has been a non-resident in India in 9 out of the 10 previous years preceding that year,
or has during the 7 previous years preceding that year been in India for a period of, or periods
amounting in all to, 729 days or less or an HUF whose manager has been a non-resident in India

61
in 9 out of the 10 previous years preceding that year, or has during the 7 previous years
preceding that year been in India for a period of, or periods amounting in all to, 729 or less, then
such a person or HUF is deemed to be “not ordinarily resident in India”. However, the Finance
Act 2003 had the effect of restricting the benefit of status of “not ordinarily resident” in the case
of a non-resident Indian coming back to India or foreign citizens working in India to only a
period of two years as against the earlier benefit of nine years. Hence, non-residents coming back
to India will have to pay tax on their global income after a period of two years. Similarly, foreign
citizens working in India will be required to pay tax on their global income if they continue to be
resident in India beyond a period of 2 years. The intention of the amendment may be principally
to prevent tax avoidance by persons who arrange their affairs in such a manner as to artificially
become eligible for NOR status. However, they also note that this move could cause a lot of
hardship to a large number of people coming to India for permanent settlement and will have a
negative impact on the inflow of funds through the medium of non-residents.

Indian and Foreign Income

Indian and Foreign Income are two concepts that need to be understood before one can assess the
relationship of residential status with tax liability. The Act mandates that all incomes, whether
directly or indirectly accruing or arising in India shall be deemed to accrue or arise in India.

Certain types of income are deemed to accrue or arise in India even though they may actually
accrue or arise outside India. The categories of income which are deemed to accrue or arise in
India are:

Any income accruing or arising to an assessee in any place outside India whether directly
or indirectly

 through or from any business connection in India,

 through or from any property in India,
 through or from any asset or source of income in India or
 Through the transfer of a capital asset situated in India.
 Income, which falls under the head “Salaries”, if it is earned in India. Any income under
the head “Salaries” payable for rest period or leave period which is preceded and

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 succeeded by services rendered in India, and forms part of the service contract of
employment, shall be regarded as income earned in India.
 Income from “Salaries” which is payable by the Government to a citizen of India for
services rendered outside India. However, allowances and perquisites paid outside India
by the Government are exempt.
 Dividend paid by an Indian company outside India.
 Interest
 Royalty
 Fees for technical services

The Test for Person Nor Ordinarily Resident In India

In Pradip J. Mehta v. Commissioner of Income Tax, Ahmedabad, assessee was appointed as

Marine Engineer by Wallem Shipping Management Ltd., Hong Kong and, during the course of
his employment, he was posted to work on high seas and paid abroad for many years. The
assessee while filing his return for the assessment year 1982-83 claimed the status of “not
ordinarily resident in India” as defined in Section 6(6)(a) of the 1961 Act and to exclude income
accruing outside India under Section 5(1)(c) of the 1961 Act, which provides that in the case of a
person not ordinarily resident in India within the meaning of Sub-section (6) of Section 6, the
income which accrues or arises to him outside India shall not be so included in his total income.

The Assessing Officer refused to grant the assessee the status of "not ordinarily resident" for the
relevant year, on the ground that the assessee was a non-resident in India for only 3 years during
the last 10 years and during the past 7 years he had stayed in India for more than 730 days. He
came to the conclusion that during the last 9 previous years, the assessee was non-resident for
only three years and during the last seven previous years, he had stayed in India for a period of
1,402 days. It was held that the status claimed by the assessee of 'not ordinarily resident' was not
acceptable.

The case eventually reached the Supreme Court and the issue to be decided was whether the
status of the assessee for the year in question was not that of 'resident but not ordinarily resident'
as claimed by him?

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The Court noted that the definition of “resident” and “not ordinarily resident” was enacted by the
British Rulers, i.e., the officers of the Indian Civil Services and those in armed forces serving in
India, who were absent from India on furlough for a year out of every four years so that they
could be treated as “not ordinarily resident” and avoid tax on income in their home country,
notwithstanding continuous stay and service in India.

The Court further noted that Law Commission of India had recommended that the provisions of
Section 4B of 1922 Act defining "ordinary residence" of the taxable entities be deleted but the
suggestion was not accepted by the Legislature. Rather, on the legislative anvil, it was felt
necessary to keep Section 4B of 1922 Act intact and, accordingly, Section 6(6), which
corresponds to and is pari materia with Section 4B of 1922 Act, was enacted in 1961 Act.

The Court presumed that the legislature was in the know of the various judgments given by the
different High Courts interpreting Section 4B but still the legislature chose to enact Section 6(6)
in the 1961 Act, in its wisdom, the legislature felt necessary to keep the provisions of 4B of 1922
Act intact.

It was held that a person will become an ordinarily resident only if (a) he has been residing in
nine out of ten preceding years; and (b) he has been in India for at least 730 days in the previous
seven years.

In C.N. Townsend v. CIT, the Patna High Court has held that if any of the conditions mentioned
in Clauses (a), (b) or (c) of Section 6(1) of the 1961 Act is fulfilled, the assessee will be a
'resident' within the meaning of the 1961 Act and if he comes within the mischief of either of the
two conditions mentioned in Section 6(6) (a), he will be treated as 'not ordinarily resident'. In
that case, the assessee came to India in April, 1964, and continued to stay in India till the end of
March, 1965, and therefore, it was held that he clearly fulfilled the condition laid down in Sub-
section (6)(1)(a) of the 1961 Act and as such, was a 'resident in India' during the previous year in
question. It was held that the assessee, however, could not be treated as 'ordinarily resident' in
India as he fell within the first condition in Section 6(6)(a) namely, that he was not resident in
India in nine out of ten previous years preceding the year 1964-65 even though he did not come
within the mischief of the second condition.

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Similarly, the Travancore-Cochin High Court, in P.B.I. Bava v. CIT held that a person was not
ordinarily resident in any year unless he satisfies both of the conditions of the said provision
which make a person ordinarily resident, namely,

 the condition that he must have been resident, in nine out of ten years preceding that year,
and

 the condition that he must have been, here for periods of more than two years during the
seven years preceding that year.

It was held that a person is 'not ordinarily resident' in India in the previous year if he has not been
'resident' in nine out of the ten years preceding that year; he need not establish that he was 'not
resident' in nine out of the ten years. It was observed that 'not resident' and 'not ordinarily
resident' are not positive concepts but only the converse of 'resident' and 'ordinarily resident' and
a category of persons 'not resident and not ordinarily resident' is impossible to imagine and
unknown to the Act.

The Bombay High Court, in Manibhai S. Patel v. Commissioner of Income Tax, held that an
individual is `not ordinarily resident' in the taxable territories, he should satisfy one of the two
conditions laid down in Section 4B (a) of the Indian Income Tax Act, 1922 (which corresponded
to Section 6(6) (a) of the 1961 Act). It was held that, under Section 4B (a), what were required to
be considered were the assessee's residence in the 'taxable territories' and not his residence
outside the 'taxable territories'. If the assessee had been in the 'taxable territories' for more than
two years in the preceding seven years, then he does not satisfy the second condition laid down
in Section 4B(a) and would, therefore, not be 'not ordinarily resident' in the taxable territories. In
that case, the assessee was living in Africa for four years out of the preceding seven years and he
was in the 'taxable territories' for about three years and the question was whether he was 'not
ordinarily resident' in 'taxable territories' under the second part of Section 4B(a). It was held that,
he did not satisfy the second condition. The Court also noted that the Legislature is primarily
concerned with the residence of the assessee in the taxable territories, and in order that an
assessee should be "not ordinarily resident" in the taxable territories what has got to be
considered is his residence in the taxable territories.

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 Conclusion

In order to enjoy tax benefits through non-resident status, individuals visiting India on a business
trip should not stay for more than 181 days during one previous business year and their total stay
in the previous four years should not exceed more than 364 days.

If individuals, having been in India for more than 365 days during four years preceding the
relevant previous year, which to stay for more than 60 days, they should plan their visit to India
in such a manner that their total stay in India falls under two previous years. Such persons can
come to India any time in the first week of February and stay till May 29.

An Indian citizen or a person of Indian origin can stay for a maximum period of 181 days on a
visit to India without losing his non-resident status.

An Indian citizen leaving India will not be treated as a resident unless he has been in India in that
year for more than 181 days.

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 Tax liability- Incomes which are not included in total income
Tax is calculated on the income earned in the previous year. For providing relief to the tax payers
from payment of tax, income tax law provisions contains concept of exemption and deduction.
Exempted income means the income which does not at all charged to any taxes, while
calculating the Gross Total Income. Under Income Tax Law, section 10 provides for incomes
which are exempted from levy of income tax for example Scholarship, whereas deduction means
the amount which needs to be included in the income first then they are allowed for deduction in
full or in part on fulfillment of certain conditions.
For example, deduction for payment of donations under section 80G. This lesson deals with
incomes which do not form part of total income, covering sections 10, 10AA, 11, 12, 12A, 13
and 13A. Section 10 provides for various categories of income that are exempt from tax, Section
10AA, deals with exemption in respect of income of industrial units in special economic zones.
Section 11 provides exemption in respect of income derived from property held under trust
wholly for charitable or religious purposes and section 13A exempts income derived by a
political party.
After going through this lesson, you will learn about the income which does not form part of the
total income, the conditions to be satisfied for availing exemption under section 10, 10AA,
11,12, 12A, 12B, 13A & 13B.

General Exemption:
Under Section 10 of the Income-tax Act, various items of income are totally exempt from
income-tax. Therefore, these incomes are not included in the total income of an assessee. Section
10 provides that in computing the total income of a previous year of any person, any income falls
in its ambit shall not be included in the total income, provided the assessee proves that a
particular item of income is exempt and falls within a particular clause. The onus is on the
assessee i.e. the assssee has to prove that his income falls under Section 10.
The items of ‘exemptions’ specified in Section 10, are explained as follows:

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 1. Agricultural Income: Section 10(1)

Agricultural income as defined in Section 2(1A) is exempt from income-tax in the case of all
assesses. This exemption has been granted on account of the constitutional provisions relating to
the powers of the Central and the State Governments for levying tax on agricultural income.
Under the Constitution only the State Governments are empowered to levy tax on agricultural
income. Hence, the Central Government while imposing income-tax on incomes of various types
has specifically excluded agricultural income from the purview of Central income-tax. This
exemption would, however, be available only in cases where the income in question constitutes
agricultural income within the meaning of Section 2(1A).

2. Share of Profit from Partnership Firm: Section 10(2a)

Share income of a person being a partner of a firm (includes Limited Liability Partnerships)
which is separately assessed as such is exempt from tax. For the purposes of this clause, the
share of a partner in the total income of a firm separately assessed as such shall be an amount
which bears to the total income of the firm the same proportion as the amount of his share in the
profits of the firm in accordance with the partnership deed bears to such profits.
3. Interest Income of Non-Residents: Section 10(4)
 In the case of non-residents any income from interest on such securities or bonds as the
Central Government may by notification in the Official Gazette specify in this behalf
including income by way of premium on the redemption of such bonds.
 In the case of an individual, any income by way of interest on moneys standing to his
credit in a Non-resident (External) Account in any bank in India in accordance with the
Foreign Exchange Management Act, 1999 and the Rules made there under.
4. Interest Income Of Non-Residents From Specified Savings Certificates:
Section10(4b)
In the case of an individual being a citizen of India or a person of Indian origin, who is a non-
resident, any income from interest on notified savings certificates issued before the 1st day of
June, 2002 by the Central Government will be exempt provided he subscribes to such certificates
in foreign currency or other foreign exchange remitted from a country outside India in
accordance with the provisions of the Foreign Exchange Management Act, 1999 and any rules

68
made there under. It is important to note that the exemption will be available only to the original
subscribers to the savings certificates.
5. Exemptions to an Individual Who Is Not a Citizen of India: Section 10(6):
 Remuneration of Diplomats etc. [Section 10(6) (ii)]: The remuneration received by him
as an official, by whatever name called, of an embassy, high commission, legation,
commission, consulate or the trade representation of a foreign State, or as a member of
the staff of any of these officials, for service in such capacity:
However, the remuneration received by him as a trade commissioner or other official
representative in India of the Government of a foreign State (not holding office as such in
an honorary capacity), or as a member of the staff of any of those officials, shall be
exempt only if the remuneration of the corresponding officials or, as the case may be,
members of the staff, if any, of the Government of India, resident for similar purposes in
the country concerned enjoys a similar exemption in that country. That such members of
the staff are subjects of the country represented and are not engaged in any business or
profession or employment in India otherwise than as members of such staff.
 Remuneration received by foreign individual [Section 10(6)(iv)]: [The remuneration
received by a foreign individual in his capacity as an employee of a foreign enterprise for
the services rendered by him during his stay in India would be exempt if the following
conditions are fulfilled:
 The foreign enterprise is not engaged in any trade or business in India.
 The total period of stay of the individual in India during the previous year does
not exceed 90 days.
 Such remuneration is not liable to be deducted from the income of the employer
chargeable to tax in India under the Income-tax Act.
 Non-resident employee on a foreign ship [Section 10(6) (vii)]: Income chargeable under
the head ‘Salaries’ received by or due to any non-resident individual as remuneration for
the services rendered by him in connection with his employment on foreign ship is
exempt from tax where the total period of his stay in India does not exceed a period of 90
days during the previous year.

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  Remuneration of employee of foreign Government during his training in India
[Section 10(6) (xi)]:
The remuneration received by an individual being a foreign citizen as an employee of the
government of a foreign State during his stay in India in connection with his training in
any establishment or office of, or in any undertaking owned by:
 The government; or
 Any company in which the entire paid-up capital is held by the Central
Government, or any State Government or Governments; or partly by the Central
Government and partly by one or more State Governments; or
 Any company which is a subsidiary of a company referred to in (b); or
 Any corporation established by or under a Central, State or Provincial Act; or
 Any society registered under the Societies Registration Act, 1860, or under any
other corresponding law for the time being in force and wholly financed by the
Central Government, or any State Government or partly by the Central
Government and partly by one or more State Governments.
6. Tax Paid On Behalf Of Foreign Companies In Respect Of Certain Income: Section
10(6a)
Under clause (6A), where income is derived by a foreign company by way of royalty or fees for
technical services received from government or an Indian concern in pursuance of an agreement
made by the foreign company with government or Indian concern after March 31, 1976 which is
approved by the Central Government or where the agreement relates to matter included in the
industrial policy of the government for the time being in force and tax on such income is
payable, under the terms of such agreement by the government or the Indian concern to the
Central Government, the tax so paid will not be included in computing the total income of the
foreign company. This exemption is not available under Section 10(6A) if the agreement is
entered into on or after 1.6.2002, as amended by Finance Act, 2002. In other words, the
exemption is available for the agreements entered into up to 31.5.2002 only.
7. Income Derived By A Foreign Company: Section 10(6b)
Clause (6B) provides that where in the case of non-resident (other than a company) or of a
foreign company deriving income (other than salary, royalty or fees for technical services) from
Government or an Indian concern in pursuance of an agreement entered into by the Central

70
Government with the Government of a foreign State or an international organization, the tax on
such income is payable by Government or the Indian concern to the Central Government under
the terms of that agreement or any other related agreement approved by the Central Government,
the tax so paid shall be exempt. Finance Act, 2002 has provided that this exemption is not
available under Section 10(6A) if the agreement is entered into on or after 1.6.2002. In other
words, the exemption is available for the agreements entered into up to 31.5.2002 only.
8. Allowance Payable outside India: Section 10(7)
Allowances or perquisites paid or allowed as such outside India by the Central Government to a
citizen of India for his services rendered outside India, would be wholly exempt from income-
tax.
9. Co-Operative Technical Assistance Programmes: Section 10(8)
In the case of an individual who is assigned duties in India in connection with co-operative
technical assistance programmes and projects in accordance with an agreement entered into by
the Central Government with the Government of a foreign State, the terms of which provide for
the exemption from tax, the remuneration received by the individual directly or indirectly from
the Government of that foreign State for such duties and any other income of such individual
which accrues or arises outside India (but is not deemed to accrue or arise in India) and in respect
of which such individual is required to pay any income- tax or social security tax to the
Government of that foreign State, would be exempt from income-tax.
10. Retrenchment Compensation: Section 10(10b)
Any compensation received by a workman under the Industrial Disputes Act, 1947 or under any
other Act or rules, orders or notifications issued thereunder or under any standing orders or under
any award, contract of service or otherwise, at the time of his retrenchment. The amount is
exempt under this clause to the extent of least of the following limits:
 Actual amount received.
 Amount specified by Central Government i.e. ` 5, 00,000.
 An amount calculated in accordance with the provisions of clause (b) of Section 25F of
the Industrial Disputes Act, 1947 i.e. 15 day’s average pay for every completed years of
services or part thereof in excess of 6 months.

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 11. Awards/Rewards: Section 10(17a)
Any payments made, whether in cash or in kind, in pursuance of any award instituted in the
public interest by the Government or instituted by any other body and approved by the Central
Government or as a reward by the Government for such purposes as may be approved by the
Central Government in the public interest shall be exempt.
12. Pension: Section 10(18)
A new clause 10(18) has been inserted by Finance Act, 1999 with effect from 1.4.2000 to
provide that any income by way of pension received by an individual or family pension received
by any member of the family of such individual shall be exempt if such individual has been in
the service of Central/State Government and has been awarded Param Vir Chakra or Maha Vir
Chakra or Vir Chakra or such other gallantry award as may be notified.
13. Family Pension: Section 10(19)
Family pension received by the widow or children or nominated heirs, as the case may be, of a
member of the armed forces (including paramilitary forces) of the Union, where the death of
such member has occurred in the course of operational duties, in such circumstances and subject
to such conditions, as may be prescribed, shall be exempt from tax. However, family pension
received by others is exempt upto least of `15,000 or 1/3rd of family pension and it is taxable
under the head other sources.

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 Computation of Total Income

The taxability of income of a person depends on the chargeability of such income under the
Income tax Act 1961. The total income of an assessee (subject to statutory exemptions) is
chargeable under Section 4(1). The scope of the total income, which v aries with the residential
status, is defined in Section 5. Section 14 enumerates the heads of income under which the
income of an assessee will fall.

The rules for computing income and the permissible deductions under different heads of income,
are dealt in different sections of the Act. The heads of income, along with their corresponding set
of sections for the purpose of computation of income, are given below :

 Salaries (Sections 15 to 17);

 Income from house property (Sections 22 to 27);
 Profits and gains of business or profession (Sections 28 to 44D);
 Capital gains (Sections 45 to 55A); and
 Income from other sources (Sections 56 to 59).
PDF: Concept of Income + Computation of Income

73
Unit-III

74
 Basis of Charge

Income tax is levied on the taxable income of every person. For calculation of income tax,
taxable income is the basis. To determine taxable income, residential status of the person and
scope of total income are the initial steps. There are two types of taxpayers from residential point
of view: Resident in India and Non-resident in India. Indian income is taxable in India whether
the person earning income is resident or nonresident.

Conversely, foreign income of a person is taxable in India only if such person is resident in
India. Foreign income of a non-resident is not taxable in India. Therefore, the determination of
the residential status of a person is very significant in order to find out his tax liability.

The basis for determination of residential status vary person wise. For instance, residential status
of individual and HUF depend upon the stay in India, for corporate the residential status is
determined on the basis of control and management of its affairs situated in India or not.

Residential Status and Tax Liability: Section 6

Total income of an assessee cannot be computed unless the person’s residential status in India
during the previous year is known. According to the residential status, the assessee can either be;

 Resident in India or
 Non-resident in India

However, individual and HUF cannot be simply called resident in India. If individual or HUF is
a resident in India, they will be either;

 Resident and Ordinarily resident in India (ROR) or

 Resident but not ordinarily resident in India (RNOR).

In case of persons other than individual and HUF, he will be either resident in India or non-
resident in India.

Section 6 of the Income-tax Act prescribes the tests to be applied to determine the residential
status of all tax payers for purposes of income-tax. There are three alternative tests to be applied

75
for individuals, two for companies and Hindu Undivided Families and firms, associations of
persons, bodies of individuals and artificial juridical persons.

An assessee’s residential status must be determined with reference to the previous year in respect
of which the income is sought to be taxed (and not with reference to the assessment year).

Test for Residence of Individuals

An individual may either be a

 Resident in India or
 Non-resident in India

However, individual cannot be simply called resident in India. If individual is a resident in India
he will be either;

 Resident and Ordinarily resident in India (ROR) or

 Resident but not ordinarily resident in India (RNOR).

Basic Condition for a person to be Resident

Under Section 6(1) of the Income-tax Act, an individual is said to be resident in India in any
previous year if he:

 is in India in the previous year for a period or periods amounting in all to one hundred
and eighty-two days or more i.e., he has been in India for at least 182 days during the
previous year; or,
 has been in India for at least three hundred and sixty-five days (365 days) during the four
years preceding the previous year and has been in India for at least sixty days (60 days)
during the previous year except in following cases; where if condition (a) is satisfied then
an individual is resident otherwise he will be Non-Resident.
 Citizen of India, who leaves India in any previous year as a member of the crew
of an Indian ship, or for the purpose of employment outside India, or
 Citizen of India or Person of Indian origin engaged outside India (whether for
rendering service outside or not) and who comes on a visit to India in the any
previous year.
76
Therefore, in case of India Citizen being crew member of an Indian Ship, India Citizen going
abroad for employment purpose (other than training) or Indian Citizen/Person of Indian Origin
are coming on a visit to India during relevant previous years. Then condition (a) only needs to be
checked, if it is satisfied, then individual is treated as resident, otherwise he will be treated as
nonresident.

 Non-Resident

If an individual does not satisfy any of the above basic condition then, he will be treated as Non-
Resident.

It must be noted that the fulfillment of any one of the above conditions (a) or (b) will make an
individual resident in India for tax purposes since both these conditions are alternative and not
cumulative in their application.

 Additional Conditions for a person to be resident and ordinary resident (ROR)

An individual may become a resident and ordinarily resident in India if he has satisfy both the
following conditions given u/s 6(1)besides satisfying any one of the above mentioned conditions:

 he is a resident in atleast any two out of the ten previous years immediately preceding the
relevant previous year, and
 He has been in India for 730 days or more during the seven previous years immediately
preceding the relevant previous year.
 Resident and not ordinary resident (RNOR)

An individual is not ordinarily resident in any previous year if he has been a non-resident in
India in at least nine out of the ten previous years preceding that previous year, or has during the
seven previous years preceding that previous year been in India for a period of, or periods
amounting in all to, seven hundred and twenty-nine days (729 days) or less. In other words, if
resident individual is not able to satisfy both the additional conditions, then he will be resident
but not ordinary resident (RNOR).

77
 Important Points:
 The fact that an assessee is resident in India in respect of one year does not automatically
mean that he would be resident in the preceding or succeeding years as well.
Consequently, the residential status of the assessee should be determined for each year
separately. This is in view of the fact that a person resident in one year may become non-
resident or not ordinarily resident in another year and vice versa.
 It must also be noted that the residential status of an individual for tax purposes is neither
based upon nor determined by his citizenship, nationality and place of birth or domicile.
This is because of the fact that, for tax purposes, an individual may be resident in more
than one country in respect of the same year.
 The common feature in both the above conditions is the stay of the individual in India for
a specified period.
 The period of stay required in each of the conditions need not necessarily be continuous
or consecutive nor it is stipulated that the stay should be at the usual place of residence,
business or employment of the individual Purpose of stay is immaterial in determining
the residential status.
 The stay may be anywhere in India and for any length of time at each place in cases
where the stay in India is at more places than one, what is required is the total period of
stay should not be less than the number of days specified in each condition.
Steps to solve residential status of an Individual:
 Step 1: Determine whether the person falls under exception to basic condition;
 Step 2: If yes, apply only first basic condition, if satisfied, then he will be resident
otherwise non-resident. If no, then apply both basic conditions and Individual
becomes Resident on satisfaction of any one condition.
 Step 3: Resident Individual will be called ROR if satisfies both the additional
conditions, otherwise he will be called RNOR.
 India means territory of India, its territorial waters, continental shelf, Exclusive Economic
Zone (upto 200 nautical miles) and airspace above its territory and territorial waters.
 Where the exact arrival and departure time is not available then the day he comes to India
and the day he leaves India is counted as stay in India.

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  Tests Of Residence For Hindu Undivided Families, Firms And Other Associations
Of Persons:

The test to be applied to determine the residential status of a HUF, Firm or other Association of
Persons is based upon the control and management of the affairs of the assessee concerned. The
tests based on the period of stay in India applicable to individuals cannot be applied to these
assessees for obvious reasons.

A HUF, firm or other association of persons is said to be resident in India within the meaning of
Section 6(2) in any previous year, if during that year the control and management of its affairs is
situated wholly or partly in India. If the control and management of its affairs is situated wholly
outside India during the relevant previous year, it is considered nonresident.

 A HUF can be “not ordinarily resident”:

If manager/karta has not been a ordinarily resident in India in the previous year in accordance
with the test applicable to individuals. Where, during the last ten years the kartas of the H.U.F.
had been different from one another, the total period of stay of successive kartas of the same
family should be aggregated to determine the residential status of the karta and consequently the
H.U.F.

In other words, if Karta of Resident HUF satisfies both the following additional conditions (as
applicable in case of Individual) then Resident HUF will be ROR, otherwise it will be RNOR:

 Additional Conditions:
 Karta of Resident HUF should be resident in atleast 2 previous years out of 10 previous
years immediately preceding relevant previous year.
 Stay of Karta during 7 previous year immediately preceding relevant previous year
should be 730 days or more.

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  Important Points:
 Even if negligible portion of the control and management of the affairs is exercised from
India, it will be sufficient to make the family, firm or the association resident in India for
tax purposes. For instance, if the affairs of a firm are controlled partly from India and
partly from Bangladesh, the firm would be resident both in India.
 While the control and management of the affairs of the firm or family would necessarily
be exercised by the partners of the firm or members of the family, the residential status of
the members or partners is generally irrelevant for determining the residential status of
the firm or family. But in cases where the residential status of the partners materially
affects or determines the place of control and management of the affairs of the firm, the
residential status of the member or partners should also be taken into account in
determining the residential status of the firm or the family.
 The mere fact that all the partners are resident in India does not necessarily lead to the
conclusion that the firm is resident in India because there may be cases where even
though the partners are resident in India, control and management of the affairs of the
firm is exercised from outside India.
 A Hindu Undivided Family would generally be presumed to be resident in India unless
the assessee proves to the tax authorities that the control and management of its affairs is
situated wholly outside India during the relevant accounting year. A Resident HUF would
be either ROR if karta of HUF also satisfies both the additional condition. Otherwise
HUF would be RNOR.

 Tests Of Residence For Companies

All Indian companies within the meaning of Section 2(26) of the Act are always resident in India
regardless of the place of control and management of its affairs.

In the case of a foreign company the place of control and management of the affairs is the basis
on which the company’s residential status is determinable.

According to Section 6(3) a non-Indian company would be resident in India only if the whole of
the control and management of its affairs throughout the relevant previous year are exercised
from India. In other words, even if a negligible part of the control and management is exercised

80
from outside India the company would be a nonresident for income-tax purposes. Thus, a foreign
company with its registered office outside India could be treated as resident in India if the control
of its affairs is exercised wholly from India. Like other tax payers, a company may also be
resident in more places than one although it can have only one registered office. The residential
status of a company and the place of its control and management should not be decided by the
location of the registered office of the company.

 Important Points:
 As a rule, the direction, management and control, the head, seat and directing
power of a company’s affairs is situated at the place where the directors meetings
are held.
 Consequently a company would be resident in the country if the meetings of
directors who manage and control the business are held there. It is not what the
directors have power to do, but what they actually do, that is of importance in
determining the question of the place where the control is exercised. (Egyptian
Hotels Ltd. v. Mitchell). In this case Lord Sumner said:
 Where the directors forbore to exercise their powers, the bare possession of those
powers was not equivalent to taking part in or controlling the trading. Control
means de facto control and not merely de jure control.
 The control and management of a company’s affairs is not situated at the place
where the shareholders meetings are held, even if one shareholder, by reason of
his holding an absolute majority of shares, has a decisive voice in matters relating
to the company’s affairs.
 It should be noted that the test for ascertaining the residential status of a non-
Indian company on the basis of the control and management of its affairs is
exactly opposite to that applied in the case of firms or HUF. A company will be
resident in India only if the whole of the control of its affairs is exercised from
India while a firm will be resident even if a very small portion is exercised from
India.

81
 Meaning and Scope of Total Income: Section 5

Section 4 of the Act imposes a charge of tax on the total or taxable income of the assessee. The
meaning and scope of the expression of total income is contained in Section 5. The total income
of an assessee cannot be determined unless we know the residential status in India during the
previous year. The scope of total income and consequently the liability to income-tax also
depends upon the following facts:

 whether the income accrues or is received in India or outside,

 the exact place and point of time at which the accrual or receipt of income takes place,
and
 The residential status of the assessee.

 Scope of Total income has been defined on the basis of Residential status:
A. Resident and Ordinarily Resident Assessee:

According to Sub-section (1) of Section 5 of the Act the total income of a resident and ordinarily
resident assessee would consist of:

 income received or deemed to be received in India during the accounting year by or on

behalf of such person;
 income which accrues or arises or is deemed to accrue or arise to him in India during the
accounting year;
 Income which accrues or arises to him outside India during the accounting year.

It is important to note that under clause (iii) only income accruing or arising outside India is
included. Income deemed to accrue or arise outside India is not includible

B. Resident but Not Ordinarily Resident In India:

Proviso to section (1) of section 5 the total income in case of resident but not ordinarily resident
in India

 income received or deemed to be received in India during the accounting year by or on

behalf of such person;

82
  income which accrues or arises or is deemed to accrue or arise to him in India during the
accounting year;
 Income which accrues or arises to him outside India during the previous year if it is
derived from a business controlled in or a profession set up in India.

C. Non-Resident:

Sub-section (2) of Section 5 provides that the total income of a non-resident would comprise of:

 income received or deemed to be received in India in the accounting year by or on behalf

of such person;
 Income which accrues or arises or is deemed to accrue or arise to him in India during the
previous year.

Income received:

Income received in India is taxable regardless of the assessee residential status therefore it has
great significance.

 The receipt contemplated for this purpose refers to the first receipt of the amount in
question as the income of the assessee. For instance, if A receives his salary at Delhi and
sends the same to his father, the salary income of A is a receipt for tax purposes only in
the hands of A; his father cannot also be said to have received income when he receives a
part of the income of A. In the hands of A’s father it is only a receipt of a sum of money
but not a receipt of income.
 Method of Accounting: Although receipt of income is not the sole test of its taxability,
the receipt of income would be the primary basis for determining the taxability of the
amount in cases where the assessee follows the cash system of accounting; however,
where the assessee follows the mercantile system of accounting the income would
become taxable as the income of the accounting year in which it falls due to the assessee
regardless of the date or place of its actual receipt.
 While considering the receipt of income for tax purposes both the place and the date of its
receipt must be taken into account. The income in question should be not only received

83
 during the accounting year relevant to the assessment year but must also be received in
India in order to constitute the basis of taxation. Thus, if an item of income is first
received outside India and after a few years is brought into India the subsequent receipt
of the same amount in India should not be taken as the basis of taxing the same since the
same income cannot be received twice and it will be known as Remittances.
 For the purpose of taxation both actual and constructive receipt must be taken into
account. Receipt by some other person on behalf of the assessee should be treated as
receipt by the assessee for being taxed in his hands.
 The question of taxability of a particular income received by the assessee depends upon
the nature of income. For instance, income from salaries and interest on securities would
attract liability to tax immediately when it falls due to the assessee regardless of its actual
receipt by or on behalf of the assessee.

Place and date of receipt of income:

The place and date of receipt of income are two important factors for levying tax. When the
amount is received in cash and directly from the debtor, there is no difficulty in deciding the
place and date of receipt. But when the payment is made by cheque or by post, the place and date
of receipt is determined as follows:

1. Date of receipt when receipt is by cheque:

If the payment is made by the drawee on presentment of the cheque, the date of receipt of the
cheque and not the date of its encashment shall be the date of receipt.

2. Place of receipt when payment is made by cheque and by post:

In this case, if the Post Office is the agent of the creditor, the place of posting by the debtor shall
be regarded a place of receipt by the creditor. If, on the other hand, there is no specific
understanding that the payment is to be made by post, the place of receipt by the creditor would
be the place of receipt.

84
 3. Place of receipt when receipt is through a Postal Money Order, or by Insured Post:

In this case, the place of receipt is to be determined on the basis of who (creditor or debtor) bears
the postal expenses. If the postal expenses are borne by the creditor, the place of debtor would be
place of receipt. If, on the other hand, the debtor bears the postal expenses, the place of creditor
would be the place of receipt.

4. Date and place of receipt in case of articles sent by V.P.P.:

In this case the place of the delivery by the Post Office would be the place of receipt and the date
of receipt would be the date of payment by the buyer.

5. Payment by transfer of immovable property:

Whenever any immovable property is accepted in satisfaction of a claim, the date of receipt
would not be the date when possession is given but the date of receipt would be when a
conveyance is executed.

6. Issuing receipt in advance:

When a receipt is issued in advance but the payment is not received during the accounting year,
it cannot be treated as receipt during the accounting year when the receipt is issued.

 Income deemed to be received:

In addition to the income actually received by the assessee or on his behalf, certain other
incomes not actually received by the assessee and/or not received during the relevant previous
year, are also included in his total income for income tax purposes. Such incomes are known as
income deemed to be received. Some of the examples of such income are:

 All sums deducted by way of taxes at source (Section 198).

 Incomes of other persons which are included in the income of the assessee under Sections
60 to 64.
 The amount of unexplained or unrecorded investments (Section 69).
 The amount of unexplained or unrecorded moneys, etc. (Section 69A).

85
 The annual accretion in the previous year to the balance standing at the credit of an
employee participating in a Recognised Provident fund to the extent provided in Rule 6
of Part A of the Fourth Schedule [Section 7(i)]. The contributions made by the employer
to Recognised Provident Fund in excess of 12% of the employees salary and the interest
credited to the Provident Fund account of the employee in excess of the prescribed rate
i.e., 8.5% shall be included in the salary income of the employee. This amount is known
as annual accretion.
 The transferred balance in a Recognised Provident Fund to the extent provided in Rule
11(4) of Part A- Fourth Schedule [Section 7(ii)].
 When provident fund is recognised for the first time in a particular year, the existing
balance to the credit of an employee on the date of recognition, which is carried into the
recognised provident fund, is called the transferred balance. The amount of the
transferred balance, less the employees own contributions included therein, is deemed to
be the income of the year in which recognition takes place. The amount contributed by
the employer to the provident fund and the interest on his contribution is included in the
income under the head Salaries and the interest on the contributions made by the
employee is included in the income under the head “Income from other sources”.
 Any dividend declared by a Company or distributed or paid by it within the meaning of
Section 2(22) [Section 8(a)].
 Any interim dividend unconditionally made available by the Company to the member
who is entitled to it [Section 8(b)].
 The Supreme Court verdict in Standard Triumph Motor Co. Ltd. v. CIT (1993) 201 ITR
391, seems to have made the lot of non-residents in particular more vulnerable. The Court
in that case held that a credit entry in the books of the buyer of goods or services in
favour of the supplier of goods or services tantamount to receipt of money by the latter.
By equating credit entry with receipt itself the judgment exposes non-residents to Indian
tax liability where they were not all along liable on the basis of mer credit entry. Because
a resident is in any case liable to tax on his world income and therefore this judgment
affects a non-resident more than it affects a resident.

 Different heads of salary: Book

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  Wealth Tax in India

The wealth taxation in India is known as the wealth tax act, 1957. It applies to all the citizens of
the country. It is one of the most important direct taxes. It is paid on the property ownership
benefits. It extends to the whole of India. It shall be deemed to have come into force on the 1st
day of April, 1957. Wealth tax is an annual tax like income tax. It is charged for every
assessment year for net wealth of corresponding valuation date on every individual, Hindu
Undivided Family and company at the rate of 1% of the amount by which net wealth exceeds Rs.
15 lakhs. The Wealth Tax Act is important direct tax legislation. Wealth tax is tax on the benefits
derived from property ownership. The tax is to be paid year after year on the same property on
its market value, whether or not such property yields any income. Till a person retains the
ownership of a property, he or she has to pay wealth tax based on the prevailing market rate.
Even if the property is not yielding any income, Wealth tax would have to be paid.

 Gift Tax in India

A gift tax can be simply defined as the tax imposed upon the individual giving any value to the
other individual. It may be defined as a tax imposed on the value of a gift. The person who gives
the gift generally pays the gift tax in most cases. So it is a tax on the monetary gifts to another
person. Gift tax in India is regulated by the Gift Tax Act which was constituted on April 1, 1958.
It came into effect in all parts of the country except Jammu and Kashmir. As per the Gift Act
1958, all gifts in excess of Rs. 25,000, in the form of cash, draft, check or others, received from
one who doesn't have blood relations with the recipient, were taxable. However, with effect from
October 1, 1998, gift tax got demolished and all the gifts made on or after the date were free
from tax. But in 2004, the act was again revived partially. A new provision was introduced in the
Income Tax Act 1961 under section 56 (2). According to it, the gifts received by any individual
or Hindu Undivided Family (HUF) in excess of Rs. 50,000 in a year would be taxable. .(web site,
income tax department) According to the law, individuals can receive gifts from the following
sources: Relatives or Blood Relatives, At the time of Marriage, As inheritance, In contemplation
of death Gifts Exempted from Tax Gifts are exempted from India gift tax in the following cases:
The gift was given by a blood relative, irrespective of the gift value Immovable properties
located outside the country.

87
Unit-IV

88
 Introduction
Tax is calculated on the income earned in the previous year. For providing relief to the tax payers
from payment of tax, income tax law provisions contains concept of exemption and deduction.
Exempted income means the income which does not at all charged to any taxes, while
calculating the Gross Total Income. Under Income Tax Law, section 10 provides for incomes
which are exempted from levy of income tax for example Scholarship, whereas deduction means
the amount which needs to be included in the income first then they are allowed for deduction in
full or in part on fulfillment of certain conditions.
For example, deduction for payment of donations under section 80G. This lesson deals with
incomes which do not form part of total income, covering sections 10, 10AA, 11, 12, 12A, 13
and 13A. Section 10 provides for various categories of income that are exempt from tax, Section
10AA, deals with exemption in respect of income of industrial units in special economic zones.
Section 11 provides exemption in respect of income derived from property held under trust
wholly for charitable or religious purposes and section 13A exempts income derived by a
political party.
General Exemption:

Under Section 10 of the Income-tax Act, various items of income are totally exempt from
income-tax. Therefore, these incomes are not included in the total income of an assessee. Section
10 provides that in computing the total income of a previous year of any person, any income falls
in its ambit shall not be included in the total income, provided the assessee proves that a
particular item of income is exempt and falls within a particular clause.

The onus is on the assessee i.e. the assssee has to prove that his income falls under Section 10.
The items of ‘exemptions’ specified in Section 10, are explained as follows:

1. Agricultural Income: Section 10(1)

Agricultural income as defined in Section 2(1A) is exempt from income-tax in the case of all
assesses. This exemption has been granted on account of the constitutional provisions relating to
the powers of the Central and the State Governments for levying tax on agricultural income.
Under the Constitution only the State Governments are empowered to levy tax on agricultural
income. Hence, the Central Government while imposing income-tax on incomes of various types

89
has specifically excluded agricultural income from the purview of Central income-tax. This
exemption would, however, be available only in cases where the income in question constitutes
agricultural income within the meaning of Section 2(1A).

2. Definition of Agricultural Income

As per section 2(1A) of the Act, agricultural income is defined as follows: Agricultural income
means –

 Any rent or revenue derived from land which is situated in India and is used for
agricultural purposes;
 Any income derived from such land by –
 Agriculture; or
 The performance by a cultivator or receiver of rent-in-kind of any process
ordinarily employed by a cultivator or receiver of rent-in-kind to render the
produce raised or received by him fit to be taken to market; or
 the sale by a cultivator or receiver of rent-in-kind of the produce raised or
received by him, in respect of which no process has been performed other than a
process of the nature described in paragraph (ii) of this sub-clause ;
 Any income derived from any building owned and occupied by the receiver of the rent or
revenue of any such land, or occupied by the cultivator or the receiver of rent-in-kind, of
any land with respect to which, or the produce of which, any process mentioned in
paragraphs (ii) and (iii) of sub-clause (b) is carried on:

Provided that:

 the building is on or in the immediate vicinity of the land, and is a building which the
receiver of the rent or revenue or the cultivator, or the receiver of rent-in-kind, by reason
of his connection with the land, requires as a dwelling house, or as a store-house, or other
out-building, and
 the land is either assessed to land revenue in India or is subject to a local rate assessed
and collected by officers of the Government as such or where the land is not so assessed
to land revenue or subject to a local rate, it is not situated –

90
 a) in any area which is comprised within the jurisdiction of a municipality (whether known
as a municipality, municipal corporation, notified area committee, town area committee,
town committee or by any other name) or a cantonment board and which has a population
of not less than ten thousand ; or
b) in any area within the distance, measured aerially,—
 not being more than two kilometres, from the local limits of any municipality or
cantonment board referred to in item (A) and which has a population of more than ten
thousand but not exceeding one lakh; or
 not being more than six kilometres, from the local limits of any municipality or
cantonment board referred to in item (A) and which has a population of more than one
lakh but not exceeding ten lakh; or
 not being more than eight kilometres, from the local limits of any municipality or
cantonment board referred to in item (A) and which has a population of more than ten
lakh.
3. Conditions to be satisfied for Agricultural Income:

According to the definition of Agricultural Income as per Section 2(1A) of the Act, the income
which satisfies following conditions is treated as agricultural income.

A. Rent or revenue derived from land:

 The word rent denotes the payment of money either in cash or in kind by one person to
another (owner of the land) in respect of grant of right to use land.
 The recipient of rent or revenue should be the owner of the land.
 The expression revenue is used in the broader sense of return, yield or income, and not in
the sense of land revenue.
 Income is said to be derived from land only if the land is the immediate and effective
source of the income and not the secondary and indirect source. Thus interest on arrears
of rent payable in respect of agricultural land is not agricultural income because the
source of income (interest) is not from land but it is from rent which is a secondary
source of income and is taxable under the head Income from other sources. CIT v.
Kamakshya Narain Singh

91
 B. Land must be situated in India:

Land must be situated in India but it is immaterial whether the agricultural land in question has
been assessed to land revenue or local taxes assessed and collected by the Officers of the
Government in India.

C. Land must be used for agricultural purpose:

The land must be used for agricultural purposes. There must be some measure of cultivation on
the land, some expenditure of skill and labour upon it, to have been used for agricultural
purposes within the meaning of the Act. (Mustafa Ali Khan v. CIT). He operations on the land
for agricultural purposes can be:
 Basic operation:
These include tilling of the land, sowing of seeds, planting or an operation of a similar kind
(digging pits in the soil to plant a sapling).
 Subsequent operations:
These include weeding, digging the soil around the growth, nursing, pruning, cutting, etc.

4. Concept of Agricultural Income:

Agricultural Income means and includes
 Rent received from the land used for agricultural purposes:
When a person (landlord or tenant) lets out a piece of land, which is situated in India, for
agricultural purposes, the rent received either in cash or kind from the tenant is considered as
agricultural income.
 Revenue income derived from agriculture:
When the landlord or tenant cultivates the farm, raises the product and sells it or appropriates it
for his individual needs, the difference between the cost and selling price (including the value of
self consumption on the basis of average market rate for the year) is the income derived from
agriculture.
 Income from making the produce fit to be taken to market:
The crop as harvested might not find a market. If, in order to make the product a saleable
commodity, the cultivator or receiver of rent-in-kind performs some operation (manual or
mechanical) and enhances the value of the produce, the enhancement of value of the produce is

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also agriculture income. Such income to be regarded as agricultural income, the following
conditions must be satisfied:
 The operation must be one which is ordinarily employed by the cultivator to make the
produce fit for market, i.e., threshing, winnowing, cleaning, drying, etc.
 There is no market (ready and willing and not a theoretical market) for the produce as
received from the farm.
 The process to make it marketable has been performed either by the cultivator or receiver
of rent-in-kind.
 The produce must not change its original character.

 Income from sale of produce:

When the cultivator or receiver of rent-in-kind sells the produce either after performing certain
activities to make it fit for market (discussed in III above) or without doing any such activity, the
income is agricultural income. It is immaterial that he has sold the produce to the wholesaler in
the market or through his own retail shop directly to the consumers.
 Income from Building:
In the following cases the income from building or house property is treated as agricultural
income:
(A)
i. If the land-lord receives rent in cash, it is owned and occupied by him; or
ii. If the land-lord receives rent-in-kind, it is occupied by him -whether owned or not; or
iii. if it is occupied by the cultivator - whether owned by him or not;
(B) If it is on or in the immediate vicinity of the agricultural land;
(C) If it is required as a dwelling-house or as a store house or as an out-house by the land-lord or
cultivator;
(D) If it is required by reason of the land-lords or cultivators connection with the land, i.e., either
the building is required to make the produce fit to be taken to the market or there is a sufficient
quantity of produce which requires a store house or there are numerous tenants and it is
necessary to stay there to collect the rent or it is necessary for the cultivator to be there to look
after the farm.
(E) i The land is assessed to land revenue in India; or

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ii. The land is subject to land revenue or local rate assessed and collected by the officers of the
Government - either Central or State for the benefit of local bodies. Where the land is not so
assessed, the building should not be situated:
 in an area of municipality (whether known as Municipal Corporation, Notified Area
Committee, Town Area Committee, or by any other name or Cantonment Board whose
population according to the latest census figures published is 10,000 or more; or
 In a notified area within such limits of a Municipality, etc., as may be notified by
Government. However, the distance of notified area cannot exceed 8 kilometres from the
local limits. The department has issued various circulars from time to time specifying the
notified areas.
5. Determination of Tax Liability:
While determining the tax-liability, due consideration is to be given to the following rules to
arrive at the tax on non-agricultural income:
 Compute the net agricultural income as if it were income chargeable to income-tax under
the head: “Income from other sources”.
 Aggregate agricultural and non-agricultural income of the assessee and calculate income-
tax on the aggregate income as if such aggregate income were the total income.
 Increase the net agricultural income by the first slab of income on which tax is charged at
nil rates and calculate income-tax on net agricultural income, so increased, as if such
income were the total income of the assessee.
 The amount of income-tax determined at (2) will be reduced by the amount of income-tax
determined at (3).
 The amount so arrived at will be the total income-tax payable by the assessee.
From the amount of tax determined as above, the following tax reliefs/tax rebates are
deductible:
 Rebate under Section 86 in respect of share of profit from an association of
persons.
 Rebate under Section 92 in respect of doubly taxed income.
The sum so arrived at will be the income-tax in respect of the total income.

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 6. Money Received By An Individual As A Member Of H.U.F.: Section 10(2)
Any sum received by an individual in his capacity as a member of H.U.F. is wholly exempt from
income-tax where such sum has been paid out of the income of the family, or out of the income
of an impartibly estate belonging to the family, because that has been taxed in hand of H.U.F.
This exemption is, however, subject to the provisions of Section 64(2), where the incomes from
self acquired assets which are converted into property of the H.U.F. are to be clubbed with the
income of the person who makes the conversion subject to certain conditions. For the purpose of
this exemption, it is immaterial whether the H.U.F. has been subject to tax in respect of the
income. It is also immaterial whether the member who has received the share of income from the
family is a coparcener or not but he must be a member of that family at the time of receiving the
money.
7. Share Of Profit From Partnership Firm: Section 10(2a)
Share income of a person being a partner of a firm (includes Limited Liability Partnerships)
which is separately assessed as such is exempt from tax. For the purposes of this clause, the
share of a partner in the total income of a firm separately assessed as such shall be an amount
which bears to the total income of the firm the same proportion as the amount of his share in the
profits of the firm in accordance with the partnership deed bears to such profits.
8. Income of minor child: Section 10(32)
Where the income of an individual includes any income of his minor child in terms of Section
64(1A), such individual shall be entitled to exemption of the amount includible under Section
64(1A) of each minor child or 1,500 for each minor child whichever is less.

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Unit-V

96
 Introduction

The taxability of income of a person depends on the chargeability of such income under the
Income tax Act 1961. The total income of an assessee (subject to statutory exemptions) is
chargeable under Section 4(1). The scope of the total income, which v aries with the residential
status, is defined in Section 5. Section 14 enumerates the heads of income under which the
income of an assessee will fall.

The rules for computing income and the permissible deductions under different heads of income
are dealt in different sections of the Act. The heads of income, along with their corresponding set
of sections for the purpose of computation of income, are given below:

 Salaries (Sections 15 to 17);

 Income from house property (Sections 22 to 27);
 Profits and gains of business or profession (Sections 28 to 44D);
 Capital gains (Sections 45 to 55A); and
 Income from other sources (Sections 56 to 59).

It may be noted here that an income belonging to a specific head must be computed under that
head only. If an income cannot be placed under any of the first four heads, it will be taxed under
the head “Income from other sources”.

Certain expenses incurred in earning incomes under each head are allowed to be deducted from
its gross income according to the provisions applicable to that specific head. Then, the net
income under various heads is aggregated together to compute gross total income of the person.
After making certain deductions which are allowed from gross total income (relating to certain
expenses incurred or payments made or certain incomes earned) we arrive at the figure of total
income for taxation purpose.

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 1. Meaning of Salary:
Salary, in simple words, means remuneration of a person, which he has received from his
employer for rendering services to him. But receipts for all kinds of services rendered cannot be
taxed as salary. The remuneration received by professionals like doctors, architects, lawyers etc.
cannot be covered under salary since it is not received from their employers but from their
clients. So, it is taxed under business or profession head. In order to understand what is included
in salary, let us discuss few characteristics of salary.
2. Characteristics of Salary:
 The relationship of payer and payee must be of employer and employee for an income to
be categorized as salary income. For example: Salary income of a Member of Parliament
cannot be specified as salary, since it is received from Government of India which is not
his employer.
 The Act makes no distinction between salary and wages, though generally salary is paid
for non-manual work and wages are paid for manual work.
 Salary received from employer, whether one or more than one is included in this head.
 Salary is taxable either on due basis or receipt basis which ever matures earlier:
 Due basis – when it is earned even if it is not received in the previous year.
 Receipt basis – when it is received even if it is not earned in the previous year.
 Arrears of salary- which were not due and received earlier are taxable when due
or received, whichever is earlier.
 Compulsory deduction from salary such as employees’ contribution to provident fund,
deduction on account of medical scheme or staff welfare scheme etc. is examples of
instances of application of income. In these cases, for computing total income, these
deductions have to be added back.

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