MODULE - 01

INCOME TAX ACT, 1961

History of Tax:
Tax is the compulsory financial charge levy by the government on income, commodity, services,
activities or transaction. The word ‘tax’ derived from the Latin word ‘Taxo’. Taxes are the basic
source of revenue for the government, which are utilized for the welfare of the people of the
country through government policies, provisions and practices.
In India, Income Tax was first time introduced in the year 1860 by Sir James Wilson in order to
meet the loss caused on account of ‘military mutiny’ in 1857.
In the year 1886, a separate Income Tax Act was passed; this act was in force for a long time,
subject to the various amendments from time to time. This act remains in force to the assessment
year 1961-62.

At present, this law is governed by the Act of 1961 which is commonly known as Income Tax
Act, 1961 which came into force on and from 1st April 1962. It applies to the whole of India.
Any law is in itself is not complete unless the gaps are being filled. The law of Income Tax in
India governed by the Income Tax Act of 1961 and the gaps are being filled by the Income Tax
Rules, Notifications, Circulars and judicial pronouncement including rulings by the Tribunal.

The Income Tax law in India consists of the following components;

1. Income Tax Act, 1961: The Act contains the major provisions related to Income Tax in
India.
2. Income Tax Rules, 1962: Central Board of Direct Taxes (CBDT) is the body which
looks after the administration of Direct Tax. The CBDT is empowered to make rules for
carrying out the purpose of this Act.

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 3. Finance Act: Every year Finance Minister of Government of India presents the budget to
the parliament. Once the finance bill is approved by the parliament and get the clearance
from President of India, it became the Finance Act.
4. Circulars and Notifications: Sometimes the provisions of an act may need clarification
and that clarification usually in a form of circulars and notifications which has been
issued by the CBDT from time to time. It includes clarifying the doubts regarding the
scope and meaning of the provisions.

Introduction:
Tax is a compulsory payment to be made by every resident of India. It is a charge or burden laid
upon persons or the property for the support of a Government. Government decided the rates and
the items on which tax will be charged, like income tax, GST, etc
Tax can be defined in very simple words as the government’s revenue or source of income. The
money collected under the taxation system is put into use for the country’s development.

Definition of Tax: “Prof. Seligman” defines a tax which is compulsory contribution from the
person to the government to defray the expenses incurred in the common interest of all national,
without reference to special benefits conferred.

Objectives of Tax:

• Economic Development
• Revenue generation
• Regulation of production & consumption
• Better distribution of Income & wealth.
• Reduce the effect of inflation & deflation.
• Price Stability

Types of Taxes:
Taxes are levied by the government on the taxpayer. On the Basis of Incidence and Impact of
Taxes, taxes are divided into two parts namely, Direct Tax and Indirect Tax.
Direct Tax is levied directly on the income of the person. Income Tax and Wealth Tax are the
part of Direct Tax.

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 Whereas, in indirect taxes, the person who pays the tax, shifts the burden to the person who
consumes the goods or services. Before 2017 the Indirect Tax comprises of various taxes and
duties like Service Tax, Sales Tax, Value Added Tax, Customs Duty, Excise Duty and etc. From
July 1st, 2017 all such Indirect Taxes are submerged in one tax law which was named as ‘The
Goods and Services Tax Act, 2017”.

Differences between Direct and Indirect Taxes:

Context Direct Tax Indirect Tax

Imposition Imposed on income or profits Imposed on goods and services
Individuals, HUFs, firms and End-consumer of the goods and
Taxpayer
companies services
Applicable to every stage of the
Applicability Applicable to the taxpayer alone
production-distribution chain
The burden falls directly on the The burden is shifted to the consumer
Tax burden
individual by the manufacturer or service provider
Cannot be transferred to anyone Can be transferred from one taxpayer
Transferability
else to the other
Confined to an entity or Wide coverage because all the
Coverage
individual taxpayer members of the society are taxed
Tax evasion Possible Not possible
Most common
Income, Wealth, Corporate Tax GST or Goods and Services Tax
types (in India)

Basic Concepts and Definitions:

Basic Concept of Income Tax Act:

“Income Tax is levied on the total income of the previous year of every person”. To understand
the basic concept. It is very important to know the various other concepts.

Definition of Income Tax: The Income Tax is the annual charge levied on the income viz.
Salary, wage, commission, dividend, bonus, etc. of an individual, company or a firm. For each
assessment year, the rate of tax levied on different income levels, as prescribed in the slab, is
defined in the Union Budget (Finance Act).

Concept of Income:
In common parlance, Income is known as a regular periodic return to a person from his activities.
However, the Income has broader classified in Income Tax law. The Income Tax Act, even take

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 consideration of income which has not arisen regularly and periodically. For instance, winning
from lotteries, crossword puzzles, income from winning of shows is also subject to tax as per
income tax.

• Cash or Kind
• Legal or Illegal Income
• Temporary or Permanent
• Receipt basis or Accrual basis
• Gifts
• Lump sum or Installments.

Assessment Year: (1/4/2021 to 31/3/2022)

“Assessment Year” means the year in which income of the previous year of an assessee is taxed.
The timed lap of assessment year is of twelve months beginning from the 1st April every year.
The period starts from 1st April of one year and ending on 31st March of next year. Broadly,
assessment year is defined under section 2 (9) of the Act, also called as income tax year.

Previous Year: (1/4/2020 to 31/3/2021)

Income earned during the year is taxable in the next year. The definition of “Previous Year” is
given under section 3 of the Act. Previous Year is the year in which income is earned. Previous
year is the financial year immediately preceding the relevant assessment year.

Assessment: according to section 2 (8), assessment is defined as a computation of income &

procedure for imposing the tax liability.

The various forms of assessment are as follows:

1. Self Assessment
2. Provisional Assessment
3. Regular Assessment
4. Best Judgment Assessment
5. Re- assessment

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 Assessee:
An assessee is a taxpayer means a person who under the income tax act is subject to pay taxes or
any other sum of money, as defined under section 2 (7) of the Act. The expression ‘any other
sum of money’ includes other such obligations payable, for instance fine, interest, penalty and
other tax or sometimes he is liable to pay tax on income of other person is known as “deemed to
be assessee”.

Person:

Income tax is levied on the total income of the previous year of every person, as per Section 2
(31), the term Person includes:

➢ An individual,
➢ A Hindu undivided family (HUF),
➢ A company: a legal entity incorporated under the company act 1956.
➢ A firm: a separate taxable entity distinct from its partners.
➢ An association of persons (AOP) or a body of individuals (BOI), whether incorporated or
not: is the integration of two or more persons for a common purpose, and primarily with an
intention to earn some income.
➢ A local authority: Municipal Corporation, board, other legally entitled or entrusted to the
government.
➢ every artificial juridical person (AJP): all artificial person with judicial personality like
councils, university, library, idol etc.,

The definition of Person starts with the word includes, therefore, the list is inclusive, not
exhaustive.

Income:

The income is defined in Section 2(24) of the Act, "income is the sum of all the wages,
salaries, profits, interest payments, rents, and other forms of earnings received in a given period
of time.

Or the term income includes: profits & gains, dividend, voluntary contribution received by trust,
perquisites in the hands of employee, any special allowance, dearness allowance, city
compensatory allowance, capital gains, insurance profit, winning from lottery, horse race, cross
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 word puzzle etc., For the tax purpose incomes are divided in to the following heads.

Heads of Income:
➢ Income from salary
➢ Income from house property
➢ Income from business or profession
➢ Income from capital gain
➢ Income from other sources

Gross Total Income:

According to Section 2 (14) of the Income Tax Act 1961, Gross Total Income is the aggregate of
all the income earned by assessee during a specified period. Gross Total Income is a
cumulative income which is computed under the five heads of income, i.e. salary, house
property, business or profession, capital gain and other sources but before making deductions
under section 80C to 80U.

Total Income:

Sec – 2 (45) explains, Total Income is the income on which tax liability is determined. It is
necessary to compute total income to ascertain tax liability. Section 80C to 80U provides certain
deductions which can be claimed from Gross Total Income (GTI). The balance amount of
income left over after providing deductions under section 80C to 80U is called Total Income.

Capital & revenue receipts:

Capital Receipt: Capital receipts are the income received by the company which is non-
recurring in nature. They are part of the financing and investing activities rather than operating
activities. The capital receipts either reduce an asset or increases a liability. The receipts can be
generated from the following sources:

• Issue of Shares
• The issue of debt instruments such as debentures.
• Loan taken from a bank or financial institution.
• Government grants.

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 • Insurance Claim.
• Additional capital introduced by the proprietor.
Revenue Receipt: Revenue Receipts are the receipts which arise through the core business
activities. These receipts are a part of normal business operations that is why they occur again
and again however its benefit can be enjoyed only in the current accounting year as its effect is
short term. The income received from the day to day activities of business includes all the
operations that bring cash into the business like:

• Revenue generated from the sale of inventory

• Services Rendered
• Discount Received from the creditors or suppliers
• Sale of waste material/scrap.
• Interest Received
• Receipt in the form of dividend
• Rent Received

Capital and revenue expenditure:

Capital Expenditure: The amount spent by the company for possessing any long-term capital
asset or to enhance the working capacity of any existing capital asset, or to increase its lifespan
to generate future cash flows or to decrease the cost of production, is known as Capital
expenditure. As a huge amount is spent on it, the expenditure is capitalized, i.e. the amount of
expenditure is spread over the remaining useful life of the asset.

The expenditure which is done for initiate current, as well as the future economic benefit, is
capital expenditure. It is a long-term investment done by the entity, in the name of assets, to
create financial gain for the years to come. For example – Purchase of Machinery or installation
of equipment to the machinery which will improve its productivity capacity or life years.

Revenue Expenditure: The expenditure which is incurred on a regular basis for conducting the
operational activities of the business are known as Revenue expenditure like the purchase of
stock, carriage, freight, etc.. As per the accrual accounting assumption, the recognition of
revenues is done when they are earned while expenditure is recognized when they are incurred.

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 Therefore, the revenue expenditure is charged to the Income Statement as and when they occur.
This satisfies the fundamental principle of accounting i.e. Matching Principle in which the
expenses are recorded in the period of their incurrence. The benefit generated by the revenue
expenditure is for the current accounting year.

The examples of revenue expenditure are as under – Wages & Salary, Printing & Stationery,
Electricity Expenses, Repairs and Maintenance Expenses, Inventory, Postage, Insurance, taxes,
etc.

Basis of charge or charge on income tax:

According to Sec – 4, the following basic principles are followed while charging the tax on
income.
➢ Annual tax
➢ Tax rate of assessment year
➢ Tax rates fixed by finance act
➢ Tax on person
➢ Provisions as on 1sr April of the Assessment year.
➢ Tax on Total Income.

Scope of Total Income:

Section -5 of Income Tax Act, 1961 provides Scope of total Income in case of person who is a
resident, in the case of a person not ordinarily resident in India and person who is a non-resident
which includes.

Income can be Income from any source which,

(a) is received or is deemed to be received in India in such year by or on behalf of such person or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year or

(c) accrues or arises to him outside India during such year.

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 Residential status:

The taxability of an individual in India depends upon his residential status in India for any
particular financial year. Residence in India – is determined by Section 6 of the Income Tax Act
1961.

Types of residential status

For Individuals & HUF For Firm, Company, AOP, BOI, local
authority, artificial or judicial persons

Resident & Resident & but Non Resident Non resident

Ordinarily not ordinarily resident
resident resident

Determination of Residential status of an Individual:

The residential status of an individual is determined on the basis of bellow conditions.

• Basic Conditions (sec. 6(1))

• Additional Conditions (sec. 6(6))

Basic Conditions (sec. 6(1)):

An individual is said to be resident in India if he satisfies any one of the following basic
conditions:

a. He is in India for at least 182 days in the previous year (PY).

Or
b. He is in India for at least 60 days in PY & for 365 days or more during 4 years
immediately preceding the PY.

NOTE: Both days i.e. the day when one left & the day on which he came to India is considered
for Number of days of stay in India.

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 Additional Conditions (sec. 6(6)):
An individual who is resident in India, shall be resident and ordinarily resident in India if he
satisfies both the following conditions

a. He has been 'Resident in India' for at least 2 out of 10 previous years immediately
preceding the relevant previous year.

And

b. He has been in India for 730 days or more, during 7 previous years immediately
preceding the relevant previous year.

Exceptions for second condition:

Condition 2 is not applicable when Indian citizen during PY:-

• Leaves India for employment outside India: In case of an individual, who is a citizen
of India and who leaves India in any previous year for the purposes of employment
outside India, the condition No. 2 shall not be applicable for the relevant previous year in
which he leaves India.
• Leaves India as he is a crew member of an Indian ship.
• Comes to visit India: In case of an individual, who is a citizen of India, or is a person of
Indian origin, who, being outside India comes on a visit to India in any previous year, the
condition No. 2 mentioned above in his case also shall not be applicable. In other words,
he shall not be a resident in India unless his stay in India is at least 182 days during the
relevant previous year in which he visits India.
Determination of residential status:

➢ Resident & ordinarily resident: if he / she fulfill one basic condition & both the
additional condition.
➢ Resident & but not ordinarily resident: if he / she fulfill one basic condition but fail to
fulfill one or both the additional conditions.
➢ Non-resident: if he / she fail to fulfill none of basic conditions.

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 Incidence of Tax:

The incidence of tax on a taxpayer depends on his residential status and also on the place and
time of accrual of receipt of income. Section 5 deals with the incidence of income tax; this
section gives a discussion on different types of income taxable in the hands of ordinary resident,
not ordinary resident & non-resident.

Indian Income and foreign income

Indian Income: Any of the following three is an Indian income:

i) If income is received (or deemed to be received) in India during the previous year and at the
same time it accrues (or arises or is deemed to accrue or arise) in India during the previous year;

ii) If income is received (or deemed to be received) in India during the previous year but it
accrues (or arises) outside India during the previous year;

iii) If income is received outside India during the previous year but it accrues (or arises or is
deemed to accrue or arise) in India during the previous year;

Foreign income: If the following conditions are satisfied, then such income is foreign income:

i) Income is not received (or not deemed to be received) in India; and

ii) Income does not accrue or arise (or does not deemed to accrue or arise) in India.

Whether income accrues (or

Whether income is received (or
arises is deemed to accrue or Status of
deemed to be received) in India
arise) in India during the relevant Income
during the relevant years
years.

Yes Yes Indian Income

Yes No Indian Income

No Yes Indian Income

No No Foreign Income

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 Table showing the tax liability on total income of individuals with their residential status:

Resident & Resident & but

Sl Non-
Types of income Ordinarily not ordinarily
No resident
resident resident
Income received in India or
1 deemed to be received in India, Yes Yes Yes
whether accrued in India or not.
Income accrued or arises or
2 deemed to accrue or arise in India Yes Yes Yes
whether received or not.
Income accrued or arises outside
India from business controlled
3 Yes Yes No
from India or profession set up in
India.
Income accrued & received
4 Yes No No
anywhere outside India.
Past foreign income whether taxed
5 or not brought into India during No No No
the previous year.

a. Income received in India:

Any income which is received in India, during the previous year by any assessee, is liable to tax
in India, irrespective of the residential status of the assessee and the place of accrual of such
income.

Receipts means the first receipt: The receipt of income refers to the first occasion when the
recipient gets the money under his own control. Once an amount is received as income, any
remittance or transmission of the amount to another place does not result in receipt within the
meaning of this clause at the other place.

b. Income Deemed to be received:

The following incomes shall be deemed to be received in India in the previous year even in the
absence of actual receipt:

1. Contribution made by the employer to the recognized provident fund in excess of

12% of the salary of the employee;
2. Interest credited to the RPF of the employee which is in excess of 9.5% p.a.

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 3. Transfer balance from the unrecognized fund to a Recognized Provident Fund (It has
been discussed in the Chapter on 'Income from Salaries');
4. The contribution made, by the Central Government or any other employer in the
previous year, to the account of an employee under a notified contributory pension
scheme referred to in section 80CCD.
c. Income accrued or arises:
When an assessee gets a right to receive some income, that income is said to have been
accrued in India. Such incomes which accrue or arise in the hands of an assessee in India
during the previous year will be taxed in the hands of an assessee whether received or
not.
Eg: Interest on fixed deposit.

d. Income deemed to accrue or arise:

The incomes which are not accrued in India during the previous year, but presumed by
the act accrued in the hands of the assessee.

➢ Capital gain arising on transfer of property situated in India.

➢ Income from business connection in India.
➢ Salary received by an Indian national from Government of India in respect of
service rendered outside India.

Incomes which do not form part of Total Income (Sec. 10):

In computing the total income of a previous year of any person, any income falling within any of
the following clauses shall not be included

➢ Agriculture Income [Section 10(1)]

➢ Any sum received by a Coparcener from Hindu Undivided Family (H.U.F.) [Section
10(2)]
➢ Share of Income from the Firm [Section 10(2A)]
➢ Interest paid to Non-Resident [Section 10(4)(i)]
➢ Leave Travel Concession or Assistance (LTC/LTA) to an Indian Citizen Employee

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 [Section 10(5)]

➢ Perquisites and Allowances paid by Government to its Employees serving outside India
[Section 10(7)]
➢ Gratuity [Section 10(10)]
➢ Amount received as Leave Encashment on Retirement [Section 10(10AA)]
➢ Commuted value of Pension Received [Section 10(10A)]
➢ Retrenchment Compensation received by Workmen [Section 10(10B)]

Tax liability of an individual can be reduced through 3 different methods- Tax Planning,
Tax avoidance and Tax evasion.
All the methods are different and interchangeable.

Tax Planning:
Tax Planning can be understood as the activity undertaken by the assessee to reduce the tax
liability by making optimum use of all permissible allowances, deductions, concessions,
exemptions, rebates, exclusions and so forth, available under the statute. Having no intension to
deceit the legal spirit behind the tax law would naturally face within the ambit of tax planning.

Objectives of Tax Planning

• Minimal Litigation: There is always friction between the collector and the payer of tax.
In such a situation, it is important that the compliance regarding tax payment is followed
and used properly so that friction is minimum.
• Productivity: Among the most important objectives of tax planning is channelization of
taxable income to various investment plans.
• Reduction of Tax Liability: As a tax payer, you can save the maximum amount from
payable tax amount by using a proper arrangement of your enterprise working as per the
required laws.
• Healthy Growth of Economy: The growth in an economy depends largely upon the
growth of its citizens. Tax planning estimates generation of white money that is in free
flow.
• Economic Stability: Stability is supplemented when the tax planning behind a business.

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 Tax avoidance:

Tax avoidance is the practice of adjusting your financial affairs in such a manner that you avoid
paying tax to the government. Here, one makes use of shortcomings and loopholes in the law
unfairly for personal benefit. When you indulge in tax avoidance, you don’t violate the tax law
but you override the intent of the law. It is not as severe as tax evasion but can be equally bad.
Tax avoidance is the use of legal methods to modify an individual's financial situation to lower
the amount of income tax owed. This is generally accomplished by claiming the permissible
deductions and credits.

Tax Evasion:
Tax Evasion is an illegal way to minimize tax liability through fraudulent techniques like
deliberate under-statement of taxable income or inflating expenses. It is an unlawful attempt to
reduce one’s tax burden. Tax Evasion is done with a motive of showing fewer profits in order to
avoid tax burden. It involves illegal practices such as making false statements, hiding relevant
documents, not maintaining complete records of the transactions, concealment of income,
overstatement of tax credit or presenting personal expenses as business expenses. Tax evasion is
a crime for which the assessee could be punished under the law.

Features and differences between Tax evasion, Tax avoidance and Tax Planning:

1. Nature: Tax planning and Tax avoidance is legal whereas Tax evasion is illegal

2. Attributes: Tax planning is moral. Tax avoidance is immoral. Tax evasion is illegal and
objectionable.

3. Motive: Tax planning is the method of saving tax .However tax avoidance is dodging of tax.
Tax evasion is an act of concealing tax.

4. Consequences: Tax avoidance leads to the deferment of tax liability. Tax evasion leads to
penalty or imprisonment.

5. Objective: The objective of Tax avoidance is to reduce tax liability by applying the script of
law whereas Tax evasion is done to reduce tax liability by exercising unfair means. Tax planning
is done to reduce the liability of tax by applying the provision and moral of law.

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 6. Permissible: Tax planning and Tax avoidance are permissible whereas Tax evasion is not
permissible.
Conclusion: Tax planning and Tax avoidance are the legal ways to reduce tax liabilities but Tax
avoidance is not advisable as it manipulates the law for one’s own benefit. Whereas tax planning
is an ideal method.

Tax Management:

Every assessee liable to pay tax needs to manage his/her taxes. Tax management relates to
management of finances for payment of tax, assessing the advance tax liability to pay tax in time.
Tax management has nothing to do with planning to save tax it is just related with operational
aspect of payment of tax i.e. while managing his taxes a person ensures that he/she is making
timely payment of taxes without running out of the money and he is complying with all the
provisions of the law.

Tax management means, the management of finances, for the purpose of paying tax, the
objectives are:

• The objective of Tax Management is to comply with the provisions of Income Tax Law
and its allied rules
• Tax Management deals with filing of Return in time, getting the accounts audited,
deducting tax at source etc.
• Tax Management relates to Past, Present, and Future.
Past – Assessment Proceedings, Appeals, Revisions etc.
Present – Filing of Return, payment of advance tax etc.
Future – To take corrective action
• Tax Management helps in avoiding payment of interest, penalty, and prosecution.
• Tax Management is essential for every assessee.

Elements of Tax Management:

• Reduce adjusted gross income
• Increase the amount of tax deductions
• Appropriate use of tax credits

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 • Tax Planning for Retirement Plans
• Tax gain-loss harvesting is another form of tax planning or management relating to
investments. It is useful because it can use a portfolio's losses to offset overall capital
gains.

Question Bank:

1. Define Assessment Year, Previous Year, and Assessee.

2. What do you understand by Capital Receipts & Revenue Receipts? State the difference
between two.
3. Explain the words ‘Assessee’ and ‘Assessee in default’ as per IT act.
4. Who is a person u/s 2(31) of IT Act?
5. What do you understand by Gross Total Income?
6. Define Indian income and foreign income. Explain the relationship between residential
status and incidence of tax in respect of a Person under IT act.
7. Differentiate Tax evasion Tax avoidance and Tax planning.
8. State the objectives of Tax Management.
9. State the importance of tax management.
10. Briefly explain various heads of income.
11. Explain the Incomes, which do not form part of Total Income.

Prof. Ningambika G Meti Dept of MBA, SVIT