Chapter 1 - Basic Concepts of Income Tax - AY - 20-21 PDF
Chapter 1 - Basic Concepts of Income Tax - AY - 20-21 PDF
Government needs money to finance defense, welfare, health, education, sanitation and infrastructural development
such as construction of roads, dams, power projects, railways etc. The primary source of Govt. funds is taxes,
followed by borrowing from India and abroad. Tax is a financial charge or levy upon an individual or an entity, by a
Government. Any failure to pay such tax is punishable by law.
Basically, taxes are collected and used by a Govt. for the following functions –
Public welfare,
Expenditures on defence,
Enforcement of law and order,
Economic infrastructure
Education systems,
Health care systems, pensions for the elderly,
Unemployment benefits,
Transportation, energy, water and waste management systems etc. and
Operations of government itself.
2. DEFINITIONS OF TAX
“A tax is compulsory contribution from the person to the government to defray the expense incurred in the
common interest of all without reference to special benefits conferred”. Prof Seligman
“A tax as a compulsory contribution of the wealth of a person, or body of persons for the service of public
powers.” Bastable
“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.” Deviti De Marco
“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.” Hugh Dalton
“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” Jom Bouvier
“The essence of Tax as distinguished from other charges by government is the absence direct quid pro quo-
tit for tat between the tax payers and the public authority”. Trussing
3. EVOLUTION OF TAX
o Income Tax Act, 1860 – Income Tax was introduced in India for the first time by the British in the year 1860.
o Income Tax Act, 1886 – The Act of 1886 levied a tax on the income of residents as well as non-residents.
The Act defined agricultural income and exempted it from tax liability.
o Income Tax Act, 1918 – The Act of 1918 brought receipts of casual nature under tax bracket.
o Income Tax Act, 1922 – This Act laid down the mechanism of administering the tax and the rates at which
the tax was to be levied would be laid down in annual finance acts.
o Income Tax Act, 1961 – The present law of income tax in India is governed by the Income Tax Act, 1961,
came into force on April 1, 1962.
4. NATURE OF TAXES
1) Tax is compulsory – Any tax is imposed by the law, making it a compulsory payment to the Govt. Hence, any
refusal to pay tax is an offence and punishable as per the law.
2) Tax is contribution – Tax is a contribution from members of a country towards the Government. Paying tax is
the duty of every citizen for availing benefits such as security, welfare, infrastructure etc.
3) Tax is for Public Benefit – Tax is levied for the common good of society without any benefit to specific
individual. Government spends the amount on rehabilitation from a natural disaster, defense of the country etc.
4) No direct benefit – There is no direct benefit to a tax-payer. There is no direct quid-pro-quo. Taxes are for
common benefits to all the members of the society.
5) Government has the power to levy tax – Government as a sovereign authority has the power to levy and
collect taxes from the people.
6) Tax is for the economic growth and public welfare – The main objectives of a Govt. are to maximize
economic growth and social welfare. Taxes are collect to fulfill these objectives.
5. CANONS OF TAXES
Adam Smith proposed the canons of taxes, pertaining to the administration aspects of tax. They are related to the
rate, amount, method of levy, and collection of a tax. Following are the canons of taxes –
a) Canon of Equity – Tax system to be based on principle of social justice. Taxes shall be linked to ability to pay.
b) Canon of Certainty – Tax rules, regulations and procedures shall be certain, creating trust in tax-payers.
6. CLASSIFICATION OF TAXES
TAXES
Income Tax Property Tax Custom Duty Goods & Services Tax (GST)
Direct Tax
Merits Demerits
Equity – based on level of income Tax Evasion on a very large scale
Certainty – tax-payers are aware of the tax rates, Unpopular with public, since hard earned money
dates of payment, mode of payment etc. to be paid to Govt., unsuitable for poor nations
Progressive in nature High administration cost of collection
Set rules, regulations, procedures Arbitrary mechanism, computations etc.
Indirect Tax
Merits Demerits
Very high revenue source for the Govt. Regressive nature i.e. rich and poor pay same tax
Very low chances of tax evasion May give rise to inflationary conditions
Convenient and easy to collect taxes Difficult to estimate annual tax collection
Covers larger population, low admin costs. Reduces savings due to high cost of goods
Article 265 of the Constitution provides that tax shall be levied or collected only by authority of law. The power to levy
Income tax appears in the Union List of the Constitution, i.e. Central Govt. Entry 82 of List I to the Seventh (VII)
Schedule of the Constitution of India confers power on Parliament to levy taxes on income other than agricultural
income. The State Govt. has the power to levy tax on agricultural income, along with excise on alcohol, entry tax,
octroi duty, tax on professionals etc.
Every year, the Finance Minister of the Govt. of India introduces the Finance Bill in Parliament budget
session. When the bill is passed by both the houses of Parliament and after it gets the assent of the
President of India, it becomes the Finance Act.
Every year, the tax rates are fixed by the annual Finance Act and not by the Income Tax Act. Sometimes, on
the first day of April of the AY, the new Finance Bill is not enforced by the Parliament. In such cases, the
provisions of the preceding AY or the provisions of the proposed Finance Act, whichever are more beneficial
to the assessee, shall apply until the new provisions become effective.
The first schedule of the Finance Act contains the following –
o Part I – specifies the rates of tax applicable for the current Assessment Year,
o Part II – specifies the rates at which tax is deductible at source for the current Financial Year,
o Part III – provides computation of income tax for salary income and computation of advance tax, and
o Part IV – specifies rules for computing net agricultural income.
Section 295 empowers the Central Board of Direct Taxes (CBDT) to make rules for carrying out the purpose
of the Income Tax Act.
These Rules supplement the provisions of the Act, i.e. Rules are subordinate to the Act
Generally, the Rules relevant to a particular section is referred to in the footnotes to the section
Basically, the Rules –
o provide the procedural aspects of the tax machinery (system)
o prescribe the formats of various documents, certificates and returns, methods of perquisite valuation,
manner to be adopted for conversion, rates of depreciation etc.
The Central Board of Revenue or Department of Revenue is the apex body charged with the administration
of taxes. It is a part of Ministry of Finance. It is bifurcated into Central Board of Direct Taxes (CBDT) and
Central Board of Indirect Taxes and Customs (CBIC)
CBDT is empowered to issue notifications, circulars, instructions, directions etc. to the Income tax authorities
Such notifications, circulars, instructions etc. are mandatory (binding effect) on the Revenue authorities
o Circulars – Clarify any doubts about applicability, scope of any provisions (not binding on assessee)
o Notifications – To give information / notify certain schemes (changes made from time to time)
Case laws form a vital part for law. They serve as judicial precedents for future references
These judgments help in better interpretation of the statute (the Act).
The Supreme Court decisions are binding on everyone, i.e. it is treated as a law of the land.
Further, the High Court judgments apply in respective states, under their jurisdictions. Hence, decision of
one High Court does not bind another High Court of different State.
8. BASIC CONCEPTS
India means the territory of India as per Article 1 of the Constitution, its territorial waters (upto 12 nautical miles),
seabed and subsoil underlying such waters, continental shelf, exclusive economic zone (upto 200 nautical
miles) or any other specified maritime zone and the air space above its territory and territorial waters.
Assessment Year (AY) is a year in which income is charged to tax or year in which income tax is payable.
In other words, income earned during a certain period is taxed during the immediate next Assessment Year.
An Assessment Year is always a period of 12 months commencing on 1st April every year and ending on 31st
March of the next year.
Example – income earned in FY 2019-20 shall be taxed in the Assessment Year (AY) 2020-21.
Cases where Income of PY is Taxable in the same year, and not in the next AY –
In certain cases, the income earned in previous year is not taxed in the AY, but in the same financial year. The
logic behind these exceptions is administrative convenience, ease of collection of taxes and reducing tax
evasion. Following are such cases –
Assessee means a person by whom any income tax or other sum of money (interest, penalty etc.) is payable
under this Act. It includes the following persons –
i. Every person in respect of whom any proceeding under the Income Tax Act has been taken for the
assessment of his income or to determine loss suffered by him or to determine the amount of refund due,
ii. Representative assessee, i.e. a person who is assessable for the income / loss of some other person, and
iii. Every person who is deemed to be assessee in default under any provision of this Act. Example – a person
who does not deduct tax at source, or after deducting fails to pay such tax to the Govt. is deemed to be an
assessee in default. Also, a person whose income is taxable, but does not pay tax is assessee in default.
Assessment is the procedure by which the income of an assessee is determined by the Assessing Officer.
The income tax rates varies as per status of the assessee. The term ‘person’ includes the following (7 types) –
1. An Individual
An Individual means a natural person i.e. a human being. It includes a male, female, and even a minor child
A Hindu Undivided Family has not been defined under the tax laws. However, as per Hindu law, it means a
family, which consists of all individuals lineally descended from a common ancestor, including their wives
and unmarried daughters. Dayabhaga school – Assam & West Bengal whereas Mitakshara – rest of India.
Company includes any Indian Company, Foreign Company and any institution, association or a body which
is declared by general or special order of the CBDT as a Company. An Indian company means a company
formed and registered under the Company Act, 2013 (or earlier Acts). A Foreign company means a
company formed and registered outside India, i.e. under foreign country laws.
4. A Firm
The Indian Partnership Act, 1932 defines partnership as “relationship between persons who have agreed to
share the profits of business, carried on by all or any of them acting for all”. For the purpose of taxation, a
firm also include Limited Liability Partnership (‘LLP’) under the LLP Act, 2008.
An AOP means two or more persons who join for common purpose whether or not with a view to earn profit.
Thus, if two or more persons come together to carry on a business but do not constitute a partnership, they
are assessed as AOP. On the other hand, Body of Individuals (BOI) consist of Individuals only.
An AOP may consist of non-individuals but BOI has to consist of individuals only. If two or more persons (like
firm, company, HUF, individuals etc.) join together, it is called as AOP. But if only individuals join together, it
is called a BOI. The difference between AOP and BOI is that whereas an association implies a voluntary
getting together for a definite purpose, a body of individuals would be just a body without an intention to get-
together. Example – If Sam, Yan, Zen join together, it is called as BOI. But, if Joe, ABC Ltd. and PQ Firm
join together for particular venture, they are referred as an AOP. Profit motive not necessary for AOP & BOI
6. A Local Authority
A Local Authority means a municipal corporation, district board, or other authority legally entitled to or
entrusted by the Govt. with control and management of a municipal or a local fund. A local authority is not
taxable for the income which arises from the supply of commodities / services within its own jurisdiction area.
An Artificial Juridical Person (‘AJP’) is a person not falling within any of the previous categories. Artificial
Juridical Persons are the entities, which are not natural persons, but they are separate entities in the eyes of
law, i.e. deity, charitable institution etc. Profit motive is not necessary for an Artificial Juridical Person. E.g. a
charitable institution, Bar Council, Temple, and University etc.
Basically, income is a monetary return with some sort of regularity. The definition of income given in Section 2(24) of
the Act is inclusive and not exhaustive. Following points should be considered –
Profits and gains of any business Dividends received Contributions recd. by Trust
Perquisites recd. by employees Allowances recd. by employees Benefits recd. by Directors / relatives
Gain from sale of land Money for not doing business Income of a co-operative society
Winning from lottery, races, games Employers’ contribution to PF Money from employer voluntarily
Gift recd exceeding Rs 50,000 p.a. Advance money forfeited Profit on sale of shares
House Rent received Machinery given on rent Retrenchment compensation etc.
As per section 14, income of a person is computed under the following five heads:
12. EXEMPTION
Income which is ‘exempted’ does not form part of the total income, i.e. not included in total income. In other words,
exempted income is an income which is not chargeable to tax. Exemption can never exceed the amount of income.
Examples of exempted income include agricultural income, interest on PPF, NSC etc.
13. DEDUCTION
‘Deduction’ is an amount allowed by the Act to be reduced (i.e. deducted) from the income chargeable to tax. The
amount of deduction can be equal to the income or less than income or even more than the income. For example
interest paid on loan is allowed as a deduction while computing business profits.
14. REBATE
Rebate is an amount to be reduced from income tax payable. It is a reduction from income tax amount.
The total income as computed above shall be rounded off to the nearest multiple of ten rupees.
The income tax on payable shall be rounded off to the nearest multiple of ten rupees (after surcharge & cess)
Total income of an assessee is GTI, as reduced by amount deductible under sections 80C to 80U.
As per Category of Person / Amount of Income / Residential Status / Age of Individual / Type of Income
a) Individual of Age below 60 years (during the PY) as well as any HUF / AOP / BOI / AJP
Rs 2,50,001 to 5,00,000 5 % of [ Total income – Rs. 250,000 ] (less) Rebate u/s 87A*
Surcharge 10 % (if net income > Rs. 50 lakhs and upto Rs. 1 crore)
15 % (if net income > Rs. 1 crore and upto Rs. 2 crores)
25 % (if net income > Rs. 2 crores and upto Rs. 5 crores)
Health and Education Cess 4 % of Total of income tax plus surcharge (if any)
Rs 3,00,001 to 5,00,000 5 % of [ Total income – Rs. 3,00,000 ] (less) Rebate u/s 87A*
Surcharge 10 % (if net income > Rs. 50 lakhs and upto Rs. 1 crore)
15 % (if net income > Rs. 1 crore and upto Rs. 2 crores)
25 % (if net income > Rs. 2 crores and upto Rs. 5 crores)
Health and Education Cess 4 % of Total of income tax plus surcharge (if any)
c) Resident Super Senior Citizen of age 80 years or above (anytime during the PY, i.e. upto 31-Mar-20)
Surcharge 10 % (if net income > Rs. 50 lakhs and upto Rs. 1 crore)
15 % (if net income > Rs. 1 crore and upto Rs. 2 crores)
25 % (if net income > Rs. 2 crores and upto Rs. 5 crores)
Health and Education Cess 4 % of Total of income tax plus surcharge (if any)
Surcharge 10 % (if net income > Rs. 50 lakhs and upto Rs. 1 crore)
15 % (if net income > Rs. 1 crore and upto Rs. 2 crores)
25 % (if net income > Rs. 2 crores and upto Rs. 5 crores)
Health and Education Cess 4 % of Total of income tax plus surcharge (if any)
(A domestic company whose total turnover or gross receipts in the PY 2017-18 does not exceed Rs. 400 crores shall
be taxable at a rate of 25%)
Surcharge @ 7% on income tax if net income > Rs.1 crore and upto Rs. 10 crores, and
j) Special Tax Rates (AY 2020-21) [in these cases, the above slabs do not matter]
ONLY RESIDENT INDIVIDUALS whose taxable income does not exceed Rs. 500,000 can claim a rebate u/s 87A
from income tax. Amount of rebate is lower of –
For an individual tax payer, if net income exceeds Rs. 50 lakhs then surcharge is applicable. To avoid
hardship to the tax payer whose income is slightly higher than Rs. 50 lakhs, a provision has been made to
provide for relief in such cases.
Such marginal relief is available to all other assessees (non-individual) having income above Rs. 1 crore.
Companies (domestic and foreign) having income exceeding Rs. 10 crores, can claim marginal relief.
1. Compute amount of income tax and surcharge on total income without adding education cess
2. Compute tax on 1 crore without adding education cess
3. Excess tax = Step 1 – step 2
4. Excess income = total income – 1 crore
5. Marginal relief = Step 3 – Step 4 (i.e. excess tax – excess Income)
Average Rate of Income Tax means the rate computed by dividing the amount of income tax calculated on the total
income, by such total income.
Maximum Marginal Rate of Income Tax means the rate of income tax (including surcharge, if any) applicable in
relation to the highest slab of income in the case of an individual, AOP, BOI.
The method of accounting selected by the assessee matters only for the following heads of income –
An assessee may select cash or mercantile system of accounting in respect of above income. In case of remaining
heads (i.e. Salary, House property and capital gains) accounting method adopted by the assessee is irrelevant.
Mercantile System – Under mercantile system, income and expenditure are recorded at the time of occurrence
during the PY. For example, income accrued during the PY is recorded irrespective of whether paid or not. Thus,
under the mercantile system of accounting profit is calculated as actually earned / due during the PY, even though not
necessarily realized in cash.
Capital receipts are exempt from tax unless they are expressly taxable.
Whereas revenue receipts are taxable unless expressly exempt from tax.
The terms are not defined hence natural meaning and relevant cases need to be considered. A receipt on account of
a circulating capital is a revenue receipt whereas a receipt on account of a fixed capital is a capital receipt. A receipt in
lieu of a source of income is a capital receipt.
Capital Receipt is exempt from tax unless Revenue Receipt is always taxable unless
specified as taxable specified as exempt
e.g. receipt of loan on installment basis e.g. salary income, interest income
Sale of land is taxable under the act even Agricultural income is exempt from tax under
though it’s a capital receipt the act even though it is a revenue receipt.
Examples –
Govt. grant received for a specific purpose (e.g. research) Capital receipt
Liquidated Damages (related to procurement of asset) Capital receipt
Reimbursement of capital outlay (even if more than outlay) Capital receipt
Compensation received for damage or loss of trading asset Revenue receipt
Conversion of capital asset into stock and selling such stock Revenue receipt
Gift received by a person Capital receipt
Company Secretaries as experienced tax professionals can assist in resolving various challenges related to complex
tax regulations and efficiently manage compliances. Following are the key areas where a Company Secretary can
play an important role –
Establish tax efficient Indian business presence for MNC Advising on withholding tax obligations on payments
Expanding into new sectors Filing various tax returns and adequate disclosures.
Planning a heavy capital outlay in the existing business Tax diagnostic reviews
Addressing Cash flow and examining tax inefficiencies Enhancing ERP system for better tax management
Ensuring tax function is aligned with the business plan Tax implications on payments (local or overseas)
Impact of any tax and regulatory changes/ amendments Reporting of multi-layered tax issues