Introduction to Indian Taxation System
Tax:
A Tax is a compulsory charge or payment levied or imposed by a public authority on an individual. It is levied to meet public spending incurred by the Government in general interest of the Nation.The Taxation System in Republic of India is quite well structured and well developed with the authority to levy the Taxes is divided between the Union Government and the State Government. Indian Constitution has made a provision for the introduction of Federal Tax Structure.
The Constitution has made a detailed provision for the imposition of various types of taxes both by the Central Government and by the State Governments.
The Constitution has made a provision for division of the power for levying taxes between Centre and the States in most unambiguous manner.
The distribution of such legislative powers is specified in the Lists of Seventh Schedule (VII) to the Constitution i.e. Union List, State List and Concurrent List, which came into effect on 26/01/1950. List I -Article 246(1)- is union list which contains the matters in which power to make laws are with Parliament i.e. Central Government. List II-Article 246(2)- is State list which contains the matters in which power to make laws are with State Government. List III is Concurrent List which contains the matters in which power to make laws are with both Central and State Government.
The Union Government levies various Direct Taxes such as Income Tax(except on Agricultural Income), and also Indirect Taxes like Customs, Excise(except excise on liquor, opium, narcotics, Indian hemp), CST, Service Tax etc. So, the Tax on Incomes, Customs Duties, Central Excise and Service tax are levied by the Central Government. The States are empowered to levy State Tax like VAT/State Sales Tax apart from various Local Taxes like Entry Tax, Octroi etc. so, the State Government levies Agricultural Income Tax, VAT/Sales Tax, State Excise, Land Revenue, Luxury Tax and Tax on Profession. However, some of the taxes are even levied solely by the Local State Bodies or the respective Government of the different States. The Local Bodies have the authority to levy Tax on Properties, Octroi/Entry Tax and Tax for Utilities like water supply, drainage etc.
The Department of Revenue, Ministry of Finance, Government of India is responsible for the computation, levy as well as collection of most of the taxes in the country.
Two Boards working under the Ministry of Finance, Department of Revenue, Government of India, administer Taxes in India ; Central Board of Direct Taxes (CBDT) for the administration of Direct Taxes and Central Board of Excise and Customs (CBEC) for administration of Indirect Taxes on behalf of Central Government.
Constitutional Provisions relating to Taxation:
Article 265 of Constitution of India: No tax shall be levied or collected except by the authority of Law. Where any tax is collected in contravention of Article 265, the Government cannot retain such tax collected and must repay such illegal collected tax.
Article 246 of Constitution of India: Keeping in view the federal structure, the Constitution of India has empowered both Centre and States to enact laws relating to taxation. The authority to levy the Taxes is divided between the Union Government and the State Government.
Article 271 of Constitution of India: Parliament has a power to levy surcharge on any duty or tax and the proceeds of such surcharge shall go into the consolidated fund of India.
Types of Taxation:
A..ON THE BASIS OF RELATIONSHIP BETWEEN TAX BASE AND TAX RATE:
1.Proportional Taxes:
Taxes in which the rate of tax remains constant, though the tax base changes, are called proportional taxes. The tax base may be income, money value of property, wealth or goods. In a proportional tax system, taxes vary in direct proportion to change in income.
2.Progressive Taxes:
Taxes in which the rate of tax increases are called progressive taxes.thus in a progressive tax, the amount of tax paid will increase at higher rate than the increase in tax base or income. Example is Income Tax.
3.Regressive Taxes:
When the rate of tax decreases as the tax base increases, the taxes are called regressive taxes. It must be noted that in regressive taxation , though the amount of tax increases on higher income but the rate of tax decline on higher income.
4.Digressive Taxes:
Taxes which are mildly progressive but not very steep, so that the high income earners do not make a due sacrifice on the basis of equality. In digressive, a tax may be progressive up to a certain limit, after that it may be charged at a flat rate.
B. ON THE BASIS OF METHOD OF ASSESSMENT:
1.Specific: Taxes which are based on certain attributes of goods like weight, number, or volume of the commodity are specific.
2.Ad-Valorem Taxes:The taxes which are levied entirely on the basis of money value of goods are called ad valorem taxes like sales tax on the selling price of goods.
C.ON THE BASIS OF INCIDENCE AND IMPACT OF TAXES:
1.Direct Taxes: Tax which is directly to be paid by assessee out of his/her income or wealth or estate and borne by such assessee is a direct tax i.e. incidence of tax and burden of tax is on the same person.
2.Indirect Taxes:The tax which is paid by some other person and burden shift to other person i.e. ultimately to be borne by customer andcustomer indirectly pays the tax at the time of purchasing the goods or availing the services.
Income Tax:
Entry 82 of Union List (List I) of Seventh Schedule to the Constitution empowers Parliament to levy “Taxes on Income other thanAgriculture Income”. Accordingly, the Parliament enacted Income Tax Act, 1961 to tax income in India.
The law relating to Income tax is contained in Income Tax Act, 1961.The Income Tax Act, came into force on and from 1st April, 1962 and extends to whole of India including the State of Jammu & Kashmir and Sikkim. The Income Tax Act is very comprehensive in nature & is divided into various Chapters, Sections and Schedules. It contains 23 Chapters, 298 Sections and 14 Schedules (at the end, which forms the part of Act). Income Tax is one of the forms of Direct taxes. Income Tax is one of the major sources of revenue for the Government. The responsibility for collection on Income-Tax vests with Central Government.
Every Act gives power to an authority, responsible for administration of the Act and to make rules for effective implementation. Section 295 of Income Tax Act, 1961 gives powers to ‘CBDT’ to make such rules, subject to the approval of Central Government which are then notified in the Gazette of India and forms the part of Income Tax Rules, 1962. As ‘Income Tax’ is one of the major sources of revenue for the Government, it is collected by Central Government and administered by Central Board of Direct Taxes (CBDT), which has given wide powers under the Act to make rules for carrying out the purposes of the Act .In addition to Income Tax Act, study of Income Tax Rules, 1962, various circulars and clarifications issued by CBDT and various court judgments are necessary for proper understanding of the Income Tax law and procedures.
Income Tax Rules, 1962:
For implementing various provisions of the Act, Income Tax Rules’ 1962 have been framed which prescribe the procedures, time limit, conditions, returns, forms, etc provided under the Act. Such rules are made to facilitate the implementation of Act. Section 295 of Income Tax Act, 1961 empowers the CBDT to make rules for the purpose of implementation of Income Tax Act, 1961. Such rules contain the Schedule of Depreciation rates, various forms etc.
Annual Finance Acts:
Parliament makes amendments to Income Tax Act through Annual Finance Act (Commonly known as Budget). Every year finance bill is proposed and presented before the Parliament during the budget session. The finance bill contains various amendments in tax laws, rates of taxes, TDS rates etc. Finance Bill proposed will become Finance Act, when such Bill is passed by both the Houses of Parliament (Lok Sabha & Rajya Sabha). Finance Act is divided into different Schedules containing rates of Income Tax, rates of Tax Deducted at Source (TDS). The rates of Income Tax or for Deduction of Tax at Source are not provided either in the Income Tax Act or Income Tax Rules. They are prescribed every year separately in Finance Act. Chapter II (Section 2) of Finance Act, deals with the Rates of Income Tax, subsequently these rates are specified in First Schedule of Finance Act. The First Schedule also provides for Rates for Deduction of Tax at Source.
Notifications:
The CBDT issues notifications from time to time for proper administration of Income Tax Act. These notifications become rules and collectively called Income Tax Rules.
Circulars:
Circulars are issued by CBDT to clarify the doubts regarding the scope and meaning of the provisions. These provisions are issued for the guidance of the Income Tax officers and the assessee. These circulars are binding on the Department, not on the assessee but assessee can take benefit of these circulars.
Judicial Decisions:
Decisions pronounced by Supreme Court become law and they are binding on all Courts, Appellate Tribunal, Income Tax Authorities and on the assessee while, High Court decisions are binding on assesses and Income Tax Authorities which come under its jurisdiction.
Authorities responsible for administration of Act
1)Central Board of Direct Taxes constituted under ‘Central Boards of Revenue Act, 1963’ working under the Ministry of Finance.
2)Director General of Income Tax/Chief Commissioner of Income Tax;
3)Director of Income Tax/ Commissioner of Income Tax/ Commissioner of Income Tax (appeals);
4)Additional Director of Income Tax/ Additional Commissioner of Income Tax.
5)Joint Director of Income Tax/ Joint Commissioner of Income Tax.
6)Deputy Director of Income Tax/ Deputy Commissioner of Income Tax/ Deputy Commissioner of Income Tax (appeal).
7)Assistant Director of Income Tax/ Assistant Commissioner of Income Tax,
8)Income Tax Officer,
9)Tax Recovery Officers,
10)Inspector of Income Tax.
Charging Section –Section 4
“Income Tax is aDirect, Annual tax levied by Government on Total Income of Assessee beingPerson earned during Previous Year computed in Assessment Year, at the rates prescribed by Finance Act”.¬So, following are the essentials of Income Tax:
1)Income Tax is a Direct, Annual tax,
2)It is charged on the Person,
3)It is charged on the Income of Assessee,
4)It is charged on the income of PreviousYear computed in AssessmentYear,
5)Rates of income tax are specified in FinanceAct every year.
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:
1.Every person in respect of whom any proceedings under this Act have been taken for assessment of his income/loss sustained by him or the income/loss sustained by any other person in respect of whom he is assessable or amount of refund due to him or to such person.
2.Every person who is Deemedto be an assessee under any provisions of this Act like Guardian for minor,
3.Every person who is Deemed to be an assessee- in- default under any provisions of this Act like who has failed to deduct TDS or who has received a notice from the Income Tax Department for the payment of tax etc.
Person-Section 2(31): Person includes;
1)Individual:
Individual means natural person/human being (male, female, minor or a person of sound or unsound mind etc.)
2)HinduUndividedFamily:
HUF means all persons lineally descended from a common ancestor and includes their wives and unmarried daughters. It consists of members of joint Hindu, Sikh or Jain family and is governed by rules of Hindu Succession Act. The head of HUF is karta, male members and daughters of karta are called coparceners.
3)Company:
Company is an artificial person created by law having characteristics like separate legal entity, perpetual succession, common seal, limited liability etc.
4)Firm:
Firm is an association of more than one person joins together with written partnership deed showing profit sharing ratio, the copy of deed has to be filed with ITR in the 1st year of assessment. Firm may be registered or unregistered.
5)AssociationofPersons (AOP) orBodyofIndividuals (BOI), whether incorporated/ not:
AOP means two or more persons join to work for a common purpose/ object to earn income without formally entered into written partnership deed i.e. a voluntary association getting together for a definite purpose. The members of AOP can be individuals or non-individuals (like Company, Firm, HUF or other artificial persons).
BOI means two or more individuals join with or without common purpose like trustees or executors appointed to receive income jointly. The members of BOI can only be individuals.
6)Localauthority:
Local authority includes Panchayat, Municipality, District Boards, Cantonment Board, Development Authority, Body of Port Commissioners or any other authority legally entrusted by the Government with the control and management of Municipal/local Fund.
7)Any other ArtificialJudicialPerson (AJP) not covered in any of preceding clauses. Those persons not having physical existence but regarded as person in the eyes of law like statutory corporations, charitable institutions, religious associations, universities etc. are covered under this category.
Note:Central and State Govt. are not covered under the definition of person as defined under Section 2(31), so income of Central and State Govt. is not chargeable to income tax.
Every assessee is a person but every person may not be an assessee.
Assessment Year- Section 2(9)
It is a period of 12 months commencing on 1st April every year and ending on 31st March next year. Income of previous year of an assessee is assessed to tax during the next following assessment year at rates prescribed by the relevant Financial Act. The year in which the return of income of PreviousYear is filed is called Assessment Year.
Previous Year-Section 3
It means financial year immediately preceding the assessment year; Provided that in case of a Business/Profession newly set up or for a new source of income in said financial year, the previous year shall be the period beginning with date of setting up/commencement of business/profession or the date on which new source of income comes into existence in the financial year and ending with 31st March of the said financial year. Similarly, in case business is closed or discontinued during the financial year, then the previous year shall be the period which begin with 1st April and end with the date of closure or discontinuance of business in the said financial year.
Income earned in a particular year is assessed to tax in next year. The year in which income is earned is known as previous year and the next year in which income is assessed to tax is known as assessment year. A financial year is the period, which starts on 1st April of a year and ends on 31st March of the next year.
Income-Section 2(24):
Income includes:
1)Profit and Gains;
2)Dividend;
3)Voluntary Contributions received by Religious/Charitable trusts, Scientific Research Associations or by Institutions or by University/ Other Educational institutes.
4)Value of Perquisites or Profit in Lieu of Salary;
5)Special Allowances or benefits specifically granted to meet personal expenses or for performance of duties;
6)Other Allowances;
7)Benefits or Perquisites obtained from a company by a director or person holding substantial interest or relative of such director/person;
8)CapitalGains arising from transfer of capital assets;
9)Winning from Lotteries, Crosswordpuzzles, Races including horse races, Card Games and Betting;
10)EmployeeContribution received by employer towards any welfare fund (like: contribution to ESI/PF or superannuation fund);
11)Interest, Remuneration, Bonus, Commission, Salary received /due to a partner from firm in which he is a partner;
12)Profit from sale of Import licenses;
13)Cash Assistance received against exports;
14)DutyDrawback of Customs and Excise;
15)InsuranceProfits,
16)Income from business of Banking carried on by Co-operative society with its members;
17)Any sum received under KeyManInsurance Policy.
18)Benefits arising from Business or Profession;
Characteristics of Income
1)Inclusive Definition:
The definition given under section 2(24) of the Act is only inclusive and not exhaustive;
2)Cash or Kind:
Income may be received in cash or in kind (money or money’s worth). When the income is received in kind, its value will be calculated in accordance with the rules prescribed in the Income Tax Rules, 1962.
3)Legal or Illegal Source:
Legality or illegality of income is not relevant for Income Tax purposes. Illegal incomes are also subject to tax after deducting losses/expenses relating to such incomes.
4)Disputed incomes:
In case of disputed incomes or income from a disputed title of ownership, the receiver of the benefit is liable for such income to pay tax.
5)Lumpsum/Installments: Income is taxable whether received in lumpsum or installments (periodical). For example, arrears of salary or bonus received in lumpsum are income and taxable as salary.
6)Voluntary/ Gratuitous payments to friends/relatives/strangers do not entitle income in hands of recipient;
7)Temporary or Permanent:Income may be temporary or permanent. Both the incomes are taxable under the Act.
8)Definite and Regular:
Income must be from outside and from a definite and regular source. No one can earn from himself, income must be from outside source and such source should be a definite source.
9)Receipt or Accrual basis:
Income is taxable on accrual or receipt basis. Tax is generally charged on the receipt or accrual on income whichever is earlier, unless Act otherwise provides.
10)Pinmoney received by a lady is not taxable as income.
11)Receipt from hobby/recreational sports are not taxable provided it is not received by a professional in any professional or commercial activity.
12)Reimbursement of Expenses:
Any reimbursement of expenses incurred for the official purpose or on the behalf of other is not income. But if such expenses are incurred for personal benefit then any reimbursement shall be treated as income.
13)Gifts:
Gift of personal nature do not constitute income subject to a maximum of Rs. 50,000/- in cash. Gifts from relative or on occasion of marriage or gifts under will or gifts in kind are however not taxable. Other gifts if in excess of Rs. 50,000/- in cash are taxable.
14)Income must be real and not fictional. A person cannot earn an income by trading with himself or by transferring funds from one pocket to another. Income does not arise in a transaction between head office and branch office.
15)Compensation for death on account of fatal accident is not an income.
16)Capital receipt and Revenue receipt:Revenue receipts are taxable whereas capital receipts are not taxable unless otherwise specified in the Act,
17)Loan is not income:
Loan is a liability and not an income. Loan has to be repaid and shown on the liability side of Balance Sheet.
18)Diversion or Application of income:
If income is diverted at source, the balance only is income. However if it is application of income, the total amount received will be income. Application of income is taxable in the hands of receiver/assessee. Diversion of income is not income of the assessee. Diversion means an obligation to apply the income in a particular way before the assessee receives it or before it has accrued or arisen. Application of income means obligation in the nature of apportionment of income after its being accrued or received. If assessee has to pay education fee of his children, house rent, electricity bill etc. out of his salary, then this obligation is application of income as entire salary received by him & is his own money and the amount spent on various obligations is application of income. He is taxable for his entire salary income. On the other hand, if court passes an order asking assessee to pay certain sum to other person under obligation (like estranged wife) per month and it is charged to his salary income, then this is diversion of income & his income will be the balance left after deduction of such obligation.
Gross Total Income: Section 14-
Income of a person is computed under the following five heads and aggregate of income of such five heads is GTI: -
1)Salaries (Section 15-17);
2)Income from House Property (Section 22-27);
3)Profit and Gains of Business/Profession (Section 28-44);
4)Capital Gains (Section 45-55); and
5)Income from Other Sources (Section 56-59).
Total/Taxable Income:{Section 2(45)}-
It is Gross Total Income as reduced by the amount permissible as Deduction under Section 80 (Chapter VI-A) of the Act.
Computation of Total Income:
1.Salary Income
(after Deductions under Section 16 (ia),16(ii),16(iii)
2.House Property Income
(after Deductions under Section 24)
3.Profit & Gains from Business/Profession
4.Capital Gain : ( after Exemptions u/s 54 )
a.STCG
b.STCG(STT)
c. LTCG
5. Income from Other Sources
GROSS TOTAL INCOME (GTI)
Less: Deductions u/s 80(ChapterVI-A)
TOTAL/TAXABLE INCOME
Tax -Section 2(43):
‘Tax’ means income tax chargeable under the provisions of this Act.
Calculate Tax on Total Income by applying tax rates as applicable for LTCG, STCG
(Subject To STT), Casual Incomes and Other Incomes.
Less: Rebate u/s 87A (in case of individual)
Add: Surcharge (if applicable) on Tax less Rebate
Less: Marginal Relief, if any
Add: Health &Education Cess and SHE on Total Tax including surcharge.
Total Tax Liability
Less: Rebate u/s 86
Less: Relief u/s 89
Add: Interest u/s 234A, 234B, 234C
Less: Advance Tax Paid
Less: T.D.S.
=‘NET TAX PAYABLE, if any’/Refund.
Rounding Off Income u/s 288A and Income Tax etc. u/s 288B:
Total Income, Tax, TDS, Advance Tax, Interest, Penalty, Fine or other sum payable under the Act, the amount of any refund etc. will rounded off to the nearest multiple of 10 rupee i.e. if the last figure of rupee five or more shall be raised to rupee ten whereas if the last figure is less than five, it shall be reduced to lower amount which should be multiple of ten.