Tablazon, Edward James F.

Income Taxation

3rd yr BSBA-HRDM SAT (10:30-1:30)

1) Three inherent powers of government

-Power of Taxation – An inherent power of the state exercised through legislature, to impose
burdens upon subjects and objects within its jurisdiction, for the purpose of raising revenues to
carry out the legitimate objects of the government.Nature:

An inherent power of the state exercised through the legislature.

-Police Power – This is the power vested in the Legislature by the Constitution to make, ordain,
and establish all manner of wholesome and reasonable laws, statutes and ordinances, either with
penalties or without, not repugnant to the Constitution, for the good and welfare of the State and
its subjects.

-Power of Eminent Domain- This is the right of the State to acquire private property for public
use upon payment of just compensation and observance of due process.

It is based on genuine necessity and that necessity must be of public character. It must be
reasonable and practicable such that it would greatly benefit the public with the least
inconvenience and expense to the condemning party ad property owner consistent with such
benefit.

2)

Definition of Taxation

Taxation is a term for when a taxing authority, usually a government, levies or imposes a tax.
The term "taxation" applies to all types of involuntary levies, from income to capital gains to
estate taxes.

Nature of Taxation

1. It is inherent in sovereignty – the power of taxation exists independent of any legislation.

There is no need to enact a law to exercise that power because that power springs at the moment
you have the existence of the state. This is inherent because this is based on necessity. Taxation
is the life-blood of government.

2. It is legislative in character - But in the exercise of that power, that power is assigned to the
law making body. It is not assigned to the judiciary or to the executive branch of the government.
It is assigned to Congress, the law-making body.

3. It is subject to constitutional and inherent limitations – To a certain extent, Congress will

abuse that power. To a certain extent, you have that principle also that the power to tax involves
the power to destroy. Congress may abuse that power given to it by the people through the
electoral process.

 Characteristics of taxation

A good tax system should meet five basic conditions: fairness, adequacy, simplicity,
transparency, and administrative ease. Although opinions about what makes a good tax system
will vary, there is general consensus that these five basic conditions should be maximized to the
greatest extent possible.

 Classification of Taxation

The taxes have been variously classified. Taxes can be direct or indirect, they can be progressive,
proportional or regressive, and indirect taxes can be specific or ad-valorem.

 Direct and Indirect Taxes:

The distinction between direct and indirect taxes is based on whether or not the burden of a tax
can be shifted wholly or partly to others. If a tax is such that its burden cannot be shifted to
others and the person who pays it to the Government has also to bear it, it is called a direct tax.
Income tax, annual wealth tax, capital gains tax are examples of direct taxes. In case of a direct
tax there is a direct contact between the tax payer and tax levying public authority.

On the other hand, indirect taxes are those whose burden can be shifted to others so that those
who pay these taxes to the Government do not bear the whole burden but pass it on wholly or
partly to others. For instance, excise duty on the production of sugar is an indirect tax because
the manufactures of sugar include the excise duty in the price and pass it on to buyers.
Ultimately, it is the consumers on whom the incidence of excise duty on sugar falls as they will
pay higher price for sugar than before the imposition of the tax.

Thus, though excise duties are on the production of commodities but they can be shifted to the
consumers. Likewise, sales tax on commodities can also be passed on to buyers or consumers in
the form of higher prices charged for the commodities.
Therefore, excise duties and sales taxes on commodities are examples of indirect taxes. They are
also known as commodity taxes. In the case of indirect taxes, there is an indirect relation,
between the Government and those who ultimately bear the burden of the taxes.

 Specific and Ad-Valorem Taxes:

Indirect taxes can be either specific or ad-valorem. A specific tax on a commodity is a tax per
unit of the commodity, whatever its price. Thus the amount of total specific tax will vary in
accordance with the changes in total output or sales of the commodity and not with the total
value of output or sales.

On the other hand, an ad-valorem type of an indirect tax is levied according to the value of the
commodity. For instance, sales tax in India is an ad-valorem tax as the rate of sales tax in case of
several commodities is 10 per cent of the value of sales of the commodities. Ad-valorem taxes
are progressive in their burden on consumers whereas specific taxes are regressive.

 Progressive, Proportional and Regressive Taxes:

According to another classification, taxes can be progressive, proportional or regressive. In case

of proportional tax, the same rate of the tax is charged, whatever be the magnitude of the base on
which it is levied. For instance, if rate of income tax is 25 per cent whatever the size of income
of a person, it will then be a proportional income tax. Likewise, if rate of wealth tax is 5 per cent,
it will be proportional wealth tax.

Thus, in case of proportional tax it is the rate which is fixed and not the absolute amount of the
tax. Thus with the rate of 25 per cent proportional income tax, a person with income of Rs.
25,000 will pay Rs. 6,250 as the tax, and a person with income of 50,000 will pay Rs. 12,500 as
the tax. Thus, even under proportional income tax, a richer person has to pay greater amount of
tax though rate of the tax is the same.

On the other hand, in case of a progressive tax, rate of the tax increases as the amount of the tax
base (income, wealth or any other object) increases. The principle underlying a progressive tax is
that greater the tax base, the higher the tax rate. In India income tax, an important direct tax
levied by the Central Government, is progressive.
Its rate at present (1998-99) varies from 10 per cent in the slab of Rs. 40,000 to 60,000 to 30 per
cent in the slab of income above Rs. 1,50,000. Under progressive income tax, the richer person
pays not only absolutely more tax but also a higher rate of the tax. Thus, the burden of
progressive tax falls more heavily on the richer persons as compared to proportional income tax.

A regressive tax is the opposite of a progressive tax. In case of a regressive income tax, the rate
is lowered as the income rises. Thus, under regressive tax system, the burden of the tax is
relatively more on the poor than on the rich. A regressive tax is therefore inequitable and no
civilised Government in the world today will levy such a tax.

3) Principles of a sound tax system

The principles of a sound tax system are fiscal adequacy, administrative feasibility, and
theoretical justice. Fiscal adequacy means the sources of revenue must be sufficient to meet
government expenditures and other public needs. Administrative feasibility means tax laws and
regulations must be capable of being effectively enforced with the least inconvenience to the
taxpayer. And theoretical justice means that a sound tax system must be based on the taxpayers’
ability to pay.

4) Defitinition of following terms

 Tax evation

Tax evasion is an illegal activity in which a person or entity deliberately avoids paying a true tax
liability. Those caught evading taxes are generally subject to criminal charges and substantial
penalties. To willfully fail to pay taxes is a federal offense under the Internal Revenue Service
(IRS) tax code.

 Tax Avoidance

Tax avoidance is the use of legal methods to minimize the amount of income tax owed by an
individual or a business. This is generally accomplished by claiming as many deductions and
credits as is allowable. It may also be achieved by prioritizing investments that have tax
advantages, such as buying municipal bonds.

Tax avoidance is not the same as tax evasion, which relies on illegal methods such as
underreporting income and falsifying deductions.

 Situs of taxation

Situs of taxation literally means place of taxation. The general rule is that the taxing power
cannot go beyond the territorial limits of the taxing authority. Basically, the state where the
subject to be taxed has a situs may rightfully levy and collect the tax.
  Double Taxation

Double taxation is a tax principle referring to income taxes paid twice on the same source of
income. It can occur when income is taxed at both the corporate level and personal level.

5) Inherent and Constitutional Limitations of Taxation

The following are the inherent limitations.

1)Purpose. Taxes may be levied only for public purpose;

2)Territoriality. The State may tax persons and properties under its jurisdiction;

3)International Comity. the property of a foreign State may not be taxed by another.

4) Exemption. Government agencies performing governmental functions are exempt from

taxation

5) Non-delegation. The power to tax being legislative in nature may not be delegated. (subject to
exceptions)

Constitutional limitations.

1)Observance of due process of law and equal protection of the laws. (sec, 1, Art. 3) Any
deprivation of life , liberty or property is with due process if it is done under the authority of a
valid law and after compliance with fair and reasonable methods or procedure prescribed. The
power to tax, can be exercised only for a constitutionally valid public purpose and the subject of
taxation must be within the taxing jurisdiction of the state. The government may not utilize any
form of assessment or review which is arbitrary, unjust and which denies the taxpayer a fair
opportunity to assert his rights before a competent tribunal. All persons subject to legislation
shall be treated alike under like circumstances and conditions, both in the privileges conferred in
liabilities imposed. Persons and properties to be taxed shall be group, and all the same class shall
be subject to the same rate and the tax shall be administered impartially upon them.

2)Rule of uniformity and equity in taxation (sec 28(1)Art VI) All taxable articles or properties of
the same class shall be taxed at the same rate. Uniformity implies equality in burden not in
amount. Equity requires that the apportionment of the tax burden be more or less just in the light
of the taxpayers ability to bear the tax burden.

3)No imprisonment for non-payment of poll tax (sec. 20, Art III) A person cannot be imprisoned
for non-payment of community tax, but may be imprisoned for other violations of the
community tax law, such as falsification of the community tax certificate, or for failure to pay
other taxes.
4)Non-impairment of obligations and contracts, sec 10, Art III . the obligation of a contract is
impaired when its terms and conditions are changed by law or by a party without the consent of
the other, thereby weakening the position or the rights of the latter. IF a tax exemption granted
by law and of the nature of a contract between the taxpayer and the government is revoked by a
later taxing law, the said law shall not be valid, because it will impair the obligation of contract.

5)Prohibition against infringement of religious freedom Sec 5, Art III, it has been said that the
constitutional guarantee of the free exercise and enjoyment of religious profession and worship,
which carries the right to disseminate religious belief and information, is violated by the
imposition of a license fee on the distribution and sale of bibles and other religious literatures not
for profit by a non-stock, non-profit religious corporation.

6)Prohibition against appropriations for religious purposes, sec 29, (2) Art. VI, Congress cannot
appropriate funds for a private purpose, or for the benefit of any priest, preacher or minister or
for the support of any sect, church except when such priest, preacher, is assigned to the armed
forces or to any penal institutions, orphanage or leprosarium.

7)Exemption of all revenues and assets of non-stock, non-profit educational institutions used
actually, directly, and exclusively for educational purposes from income, property and donor’s
taxes and custom duties (sec. 4 (3 and 4) art. XIV.

8)Concurrence by a majority of all members of Congress in the passage of a law granting tax
exemptions. Sec. 28 (4) Art. VI.

9)Congress may not deprive the Supreme Court of its jurisdiction to review, revise, reverse,
modify or affirm on appeal or certiorari, final judgments and orders of lower courts in all cases
involving the legality of any tax, impost, assessment or any penalty imposed in the relation
thereto