Income tax is a tax levied on the income of a person or an entity. It is one of the basic sources of revenue of the GOI. The government tries several functions including welfare and development activities related to health, education and rural development etc. for which it requires public finance. Taxes are one of the important sources through which the government raises revenue for public spending and it has been broadly categorized into the following two sections:
Direct taxes- These involve taxes which are paid by the person on whom these are levied like income tax, corporation tax, etc.
Indirect taxes- These constitute taxes levied on goods and services rather than on income or profits like Goods and Services Tax.
Law Governing Income Tax in India
Income Tax is normally the most visible and discussed segment of the Indian tax system. It is commonly believed that taxes on income are phenomena of modern days. Nonetheless, there is enough evidence to show that taxes on income were levied in ancient days in India as well. In this regard, references can be made to the ancient scriptures like Manusmriti and Kautilya Arthashastra.
In modern India, the law related to income tax was introduced for the first time in 1860 to overcome the financial crisis of 1857. Thereafter, the Income Tax (IT) Act of 1886, IT Act of 1918 and IT Act of 1922 was introduced, despite, these acts were repealed later due to their difference with the changing demands of the Indian society. After some time, with the consultation of the Ministry of Law the Income Tax Act 1961 was brought into effect which is currently operative in India.
Provisions under the Income Tax Act
The Income Tax Act, 1961 is the Indian statute that renders for levy, administration, collection, and reimbursement of income tax in India. It includes 23 chapters, 298 sections and 14 schedules in total. Under the Income Tax Act, every person, who is an assessee and whose income passes the maximum exemption limit, shall be chargeable to the income tax at the rate or rates prescribed in the Finance Act, such income tax will be paid on the total income of the previous year in the relevant assessment year. Assessment year is a time of 12 months starting from 1st day of April every year and ending on 31st day of March of the next year and last year/financial year is the 12 months period before the assessment year.
Though there is no precise definition of the term, income as per section 2(24) of the Act means and involves salary, income from house property, profits and gains of business and profession, capital gains and income from other sources. Income tax returns have to be filed compulsorily by every taxpayer such as individual, Hindu Undivided Family (HUF), firms, companies etc. whose income surpasses the exemption limit. Income Tax Act provides a penalty for non-filing of income tax returns. The last date of filing income tax return is July 31 in case of people but in case of business or professional, the last date for filing the return is 31st October and the penalty for non-filing of income tax returns is Rs. 5,000.
The income tax to be paid by any person/assessee is based on his living status and place of receipt of income. Section 6 of the income tax Act, 1961 specifies the basis for determination of residential status. The assessee grows resident and ordinarily resident in India, if he/she satisfies any one of the basic and both the additional conditions stated under section 6 of the Act. If an individual meets any one of the primary conditions and any one or none of the additional conditions, he/she shall be treated as resident but not ordinarily resident in India but any person who does not fulfill any of the basic conditions laid down under section 6 of the Act shall be treated as a non-resident. The conditions are:
Presence in India for a point of 182 days or more in the relevant last year;
Presence in India through the relevant previous year for 60 days or more and presence in India for 365 days or more during 4 years immediately preceding the previous year;
He has been resident in India in at least 2 out of 10 years quickly preceding the relevant previous year;
Closeness in India for more than 730 days over 7 years quickly preceding the relevant previous year. But in the case of companies, the residential status is based on the location of the head office of the company it can be resident or Non-resident Company.
The taxes are levied/ decided based on the cannons of taxation and differentiation between capital and revenue receipt, expenditure and losses are very significant because capital items are spared from tax unless they are expressly taxable and revenue receipts, expenditure, and losses are taxable unless they are expressly exempted. While calculating taxable income of an assessee certain exemptions are allowed under section 10 of the Income Tax Act 1961 to encourage the taxpayers like agricultural income, share of income from Hindu Undivided Family, share of income from partnership firm, life insurance policy, allowances to MLA’s, MP’s, awards made by the government in public interest, family pension, dividends from domestic company, income from units of mutual fund etc. A taxpayer may get differences of income in a period of 12 months starting from 1st day of April every year and ending on 31st day of March of the next year. All these incomes are grouped into 5 heads of income for computation of taxable income that is, income from salaries, house properties, business or profession, capital gains, and other sources.
What are the categories under which income tax is calculated?
To levy income tax, one must have a knowledge of the various concepts related to the charge of tax like the last year, assessment year, income, total income, person etc.
Income has been classified into 5 categories in the Indian Income Tax Act –
INCOME FROM SALARY
As per Section 15, the income chargeable to income tax under the head salaries would introduce:
Any salary due to an employee from an employer or a former employer to an assessee during the last year irrespective of the fact whether it is paid or not.
Any salary paid or allowed to the employee throughout the last year by or on behalf of an employer, or former employer, would be taxable under this head even though such amounts are not due to him during the accounting year.
Arrears of salary paid or allowed to the employee during the last year by or on behalf of an employer or a former employer would be chargeable to tax during the last year in cases where such arrears were not charged to tax in an earlier year.
INCOME FROM HOUSE PROPERTY
SECTION 22 of the Act provides as follows:
“The annual value of property consisting of any buildings or lands appurtenant thereto of which the assessee is the owner other than such portions of such property as he may occupy for the purposes of any business or Profession carried on by him, the profits of which are chargeable to income tax, shall be chargeable to income tax under the head from House Property.”
Tax is charged on income from the buildings or lands appurtenant thereto: the buildings include residential buildings, buildings let out for business or profession or auditoriums for entertainment. Tax is levied on income from lands appurtenant to buildings: the lands appurtenant to buildings include approach roads to and from public streets, courtyards, compound, playground, motor garage. In the event of non-residential buildings, car parking spaces, drying grounds shall be the lands appurtenant to buildings.
Tax is levied on the owner of the buildings and lands appurtenant thereto: where the recipient of the Income from House Property is not the owner of the building, the income is not chargeable under this title but under the head ‘Income from Business or Other Sources.’
INCOME FROM BUSINESS OR PROFESSION
The provisions of Sections 28 to 44D deal with the system of computing income under the head “ Profits and Gains of Business or Profession.”
The meaning of the expression ‘Business’ has been explained in Section 2(13) of the Income Tax Act. According to this definition, business includes any trade, commerce or manufacture or any adventure or concern in the nature of trade commerce or manufacture.
The idea of business presupposes the carrying on of any activity for profit, the meaning of business given in the Act does not make it quintessential for any taxpayer to carry on his activities constituting a business for a considerable length of time.
The expression ‘profession’ has been specified in Section 2 (36) of the Act to enter any vocation. The word profession involves the concept of an occupation requiring either intellectual skill or manual skill controlled and directed by the intellectual skill of the creator. For example an auditor, a lawyer or a doctor carrying on their profession and not a business.
The general feature in the case of both business, as well as business, is that the object of carrying them out is to derive income or to make a profit.
INCOME FROM CAPITAL GAINS
Sections 45 of the Act renders that any profits or gains arising from the transfer of a capital asset performed in the previous year shall, save as otherwise provided in Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G, 54GA and 54H be liable to income tax under the head “Capital Gains” and shall be deemed to be the income of the previous year in which the transfer took place. The requirements of a charge to income tax, of capital gains under Section 45 (1) are:
There must be a capital asset
The capital asset must have been transferred
The transfer must have been effected in the previous year
There must be a gain arising on such transfer of a capital asset
Such capital gain should not be exempt under Sections 54, 54B, 54D, 54EC, 54ED, 54F, 54G or 54GA.
INCOME FROM OTHER SOURCES
Income chargeable under Income Tax Act which does not particularly fall for assessment under any of the heads discussed previously, must be charged to tax as “Income from Other Sources.”
Sections 56 (2) particularly gives for the certain items of incomes as being chargeable to tax under the head as dividend, keyman insurance policy , winnings from lotteries, contribution to provident fund , money gifts, share premiums in excess of the fair market value to be treated as income, income by way of interest received on compensation.
The whole income of winnings, without any expenditure or allowance or deductions under Sections 80C will be liable to tax. But, expenses relating to the activity of owning and keeping racehorses are allowable. Moreover, such income is taxable at a special rate of income tax i.e. 30% + surcharge + cess @ 3%
The income chargeable under the head “Income from Other Sources” is the income after making the reductions such as sum paid by way of commission or salary to a banker or any other person for the purpose of realising such interest or a reduction of a sum equal to 50% of from interest on compensation or improved compensation and any other expenditure laid out or expended wholly.