Income Tax Act, 1961

Tax is the mandatory financial charge demand by the government on pay, product,
administrations, exercises or exchange. Taxes are the fundamental modes of income for the
government, which are used for the welfare of the general public.

Income tax is a tax on the income of an individual or an entity. Income tax is the main source
of income for the government to carry out its functions.

Purpose of Taxation
1. The money spent on the development of roads, schools, and hospitals, market
regulations or legal systems, etc. is raised by the revenue generated by the collection
of taxes
2. Redistribution of resources by the richer section to the poorer section of the society.
3. Taxes are levied on certain products to eliminate externalities such as the taxes on
tobacco to discourage smoking.

Important Definitions under The Income Tax Act, 1961

Assessment Year - Acc. Section 2(9) of the Income Tax Act, 1961, states that assessment
year means the 12-month period beginning on the 1st day of April every year.

Previous Year - Acc. Section.3 of Income Tax Act, 1961, the term “previous year” means
the financial year immediately preceding the assessment year.

Assesse - The term ‘assesse’ is defined under Section 2(7) of the Act. An assesse is a person
who is liable to pay tax under the Act. As per the Act, a person can also be an assesse in the
following conditions:

1. If any proceedings under this Act have been initiated against a person.
2. If a person is deemed to be an assesse,
3. If a person fails to comply with duties which are imposed upon him under the Act, he
is an assesse in default.

Person - Acc. Section 2(31) of Income Tax Act, 1961 - person includes:

1. an individual
2. a Hindu Undivided Family
3. a company
4. a firm
5. an association of person or a body of individuals
6. a local authority
Total Income - As per Section 2(45) of the Act, total income means the total amount of
income referred in Section 5, computed in the manner laid down in this Act.

Concept of Income - The Income Tax Act does not define the term Income but section 2
(24) of the Act describes the various receipts which are included under the ambit of income.

1. Profits and gains.

2. Dividends
3. Voluntary contributions received by a charitable trust
4. The value of any perquisite or profit in lieu of salary.
5. Any capital gains.
6. Any winnings from lotteries

Heads of income - Income is classified under 5 main heads under section 14 of the act

1. Income from salary

2. Income from house property
3. Income from capital gains
4. Profit and gains from business and profession
5. Other sources of income

Charge of Income Tax (Section 4)

Section 4 of the Income-Tax Act, 1961 (the Act), is the basic charging section under which
income-tax is chargeable on the total income of every person.

Accordingly, the section provides that:

1. The rates are prescribed under the finance act of every assessment year. Income tax
for the previous year is to be charged according to the given rates.
2. The taxable income is that of the previous year not the assessment year
3. The total income, computed according to the provisions of the act, is leviable
4. TDS or advance tax wherever applicable is to be charged.
5. No tax can be levied or collected in India except under the authority of law. Section 4
gives such authority of charging income tax.

Scope of Total Income (Section 5)

Total Income of an assesse cannot be computed without determining his residential status in
the previous year. The residential status of an assesse can either be:

1. Resident in India.
2. Non-resident in India
S. 5(1) - The total income of any previous year of a person who is a resident includes all
income from whatever source derived which -

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

person
b) Accrues or arises or is deemed to accrue or arise to him in India during such year
c) Accrues or arises to him outside India during such year

S. 5(2) - The total income of any previous year of a person who is a non-resident includes all
income from whatever source derived which -

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

person
b) Accrues or arises or is deemed to accrue or arise to him in India during such year

Residential Status - Residence in India (Section 6)

Residential Status of Individual

S. 6(1) - An individual is said to be resident in India in any previous year, if -

a) He stays in India for a period of 182 days or more in total during the relevant previous
year.
b) He stays in India for 60 days or more during the relevant previous year AND has been
in India for a period of 365 days or more during the 4 previous years immediately
preceding the relevant previous year.

Person of Indian Origin: A person is said to be of Indian origin if he, or either of his parents
or any of his grandparents was born in undivided India i.e., before India was partitioned.
[Explanation to Section 115C(e)].

S. 6(6) - Resident not ordinary resident - A person is said to be not ordinary resident if:

a) He has not resided in India for 9 out of the 10 previous years preceding that year
b) The individual has not resided for 729 days or more in India in the 7 previous years
c) A Hindu undivided family whose manager has fulfilled above conditions

Non-resident in India [Section 2(30)]: An individual is said to be a Non-Resident, if he is

NOT a ‘Resident’ in India i.e., none of the conditions (with exception/concession) for
Resident in India are satisfied.
Residential Status of HUF [Section 6(2)]

S. 6(2) - Lays down the provision for the residential status of a Hindu Undivided Family.

A Hindu Undivided Family is considered to be resident in India in any previous year in every
case except where during that year control and management of its affairs is situated wholly
outside India (in such case, it shall be a non-resident).

A HUF is a resident and ordinarily resident in India if the -

a) Karta has to be a resident under 2 out of the 10 of the previous years immediately
before the relevant previous year.
b) Karta must be in India for at least 730 days during 7 previous years immediately
preceding the relevant previous year.

Residential Status of a Firm, Association of Persons, Body of Individuals and of other

persons (except companies) [Section 6(2) & 6(4)]

S. 6(2) - Resident in India: If the direct control and management of affairs of a firm,
association of persons, body of individuals and other persons (except companies) are situated
wholly outside India during the previous year then such firm, AOP, BOI, etc will not be
resident in India in the relevant previous year. In all other cases, such an entity will be a
resident in India.

S. 6(4) - Non-resident in India: If the control and management of the affairs of these entities
are wholly outside India during the relevant previous year then they are said to be non-
resident. So, we can say that to be a Non-Resident, the part of management and control
should not take place in India.

Residential Status of a Company [Section 6(3)]

S. 6(3) - A company is said to be a resident in India in any previous year if -

a) It is an Indian company.
b) It’s place of effective management, in that year, is in India.

A company will be non-resident in any previous year if:

a) That is not an Indian Company.

b) India is not the place of effective management.
Income deemed to be received [Section 7]
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 Recognised Provident Fund Account (RPF) of the employee
which is in excess of 9.5% p.a.
3. Transfer balance from the unrecognized fund to a Recognised Provident Fund.
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.

Dividend Income [Section 8]

1. Dividend income is defined by the Internal Revenue Service (IRS) as any distribution
of an entity's property to its shareholders. While usually cash, dividends can also be
stock or any other property.
2. Usually, dividend income is the distribution of a company's taxable income to its
investors.
3. Dividends are returns distributed to shareholders from the company earnings or
profits. Dividends can either be in cash or stock.

Types of Dividend

1. Cash Dividend
2. Stock Dividend

Are Dividends Taxed as Income?

Yes, dividends are taxable as income. This income is taxable as per the applicable income tax
slab rate of the shareholder. Also, the they are subject to TDS of 7.5% in case the dividend
receivable is greater than INR 5,000.

Bacha F. Guzdar v/s Commissioner of Income Tax, Bombay AIR (1955) SC 74In this case,
the question was whether 60% of the dividend received by the assessee from two tea
companies is agricultural income and exempt under Section 4(3)(viii) of the Act. It was held
that it will be taxable as it is not agricultural income. There exists no relationship between the
dividend and the land.
Income deemed to accrue or arise in India [Section 9]
S. 9(1) - The following incomes shall be deemed to accrue or arise in India:

All income accruing or arising, whether directly or indirectly, through from any business
connection in India, or through from any property in India, or through from any asset or
source of income in India, or through the transfer of a capital asset situate in India.

'Accrue' means 'to arise or spring as a natural growth or result', to come by way of increase.
'Arising' means 'coming into existence or notice or presenting itself.

Example - If Mr. X transfer his residential property situated in Delhi then capital gain arising
on transfer of such capital asset is deemed to accrue in India.

Incomes are treated as incomes deemed to have accrued or arisen in India

1. Income which falls under the head "Salaries", if it is earned in India.

2. Income chargeable under the head "Salaries" payable by the Government to a citizen
of India for service outside India.
3. Dividend paid by an Indian company.
4. Income by way of interest payable by Government of a person who is a resident and a
person who is a non-resident.
5. Royalty received from Government, a person who is a resident and a person who is a
non-resident.
6. Income by way of fees for technical services payable by a person who is a resident
and a person who is a non-resident.
7. Capital gain arising on transfer of property situated in India
8. Income from any Property, Asset or Source of Income situated in India
9. Income from a business connection in India.

In CIT v. Fried Krupp Industries, it was held that an isolated transaction between a non-
resident and a resident in India without any course of dealings such as might fairly be
described as business connection does not attract section 9.
Diversion of Income
Diversion of Income is the process of diverting income before it is earned by the assesse.
Such amount shall be excluded from the Total Income of the assesse as the income is diverted
to someone else before being earned by the assesse.

Eg - The payments made by the surviving members in the discharge of their obligation to
maintain the widow of a deceased coparcener in a HUF is a diversion of income. Here, the
surviving members will pay the tax and not the HUF.

Test to determine whether there is Application of Income or Diversion of Income:

It has to be determined whether the amount sought to be diverted reached the assesse or not
as his income. It has to be seen whether the disbursement of income made by the assesse for
the fulfilment of an obligation on him has been done before or after it has reached the assesse.

Application of Income
Application of Income means spending of Income after it is being earned by the assesse. Such
amount shall not be excluded from total income of the assesse as it is merely application of
earned income. In other words, applied income shall be taxable in the hands of the assesse.

Example

1. Income from property (rental income) part of which was paid as maintenance
allowance and with a court’s decree is an application of income.
2. Voluntary foregoing of salary by an employee which was due to him is an example of
the application of income.