Basics of Income Tax in India

The Government of India imposes an income tax on taxable income of individuals, Hindu Undivided Families (HUFs), companies, firms, co-operative societies and trusts (identified as body of individuals and association of persons) and any other artificial person. Levy of tax is separate on each of the persons. The levy is governed by the Indian Income Tax Act, 1961. The Indian Income Tax Department is governed by the Central Board for Direct Taxes (CBDT) and is part of the Department of Revenue under the Ministry of Finance, Govt. of India.

Overview

Charge to Income-tax

Every Person whose total income exceeds the maximum amount which is not chargeable to the income tax is an assessee, and shall be chargeable to the income tax at the rate or rates prescribed under the finance act for the relevant assessment year, shall be determined on basis of his residential status.

Income tax is a tax payable, at the rate enacted by the Union Budget (Finance Act) for every Assessment Year, on the Total Income earned in the Previous Year by every Person.

The changeability is based on nature of income, i.e., whether it is revenue or capital. The principles of taxation of income are-:

Income Tax Rates/Slabs Rate (%) for men:

  • Up to 1,80,000 = NIL ,
  • 1,80,001 – 5,00,000 = 10%,
  • 5,00,001 – 8,00,000 = 20%,
  • 8,00,001 upwards = 30%,
  • Up to 1,90,000 (for resident women)= NIL,
  • Up to 2,50,000 (for resident individual of 60 years or above)= 0,
  • Up to 5,00,000 (for very senior citizen of 80 years or above)= 0.

Education cess is applicable @ 3 per cent on income tax, surcharge = NA

Residential Status

The three residential status, viz.,

(i) Resident Ordinarily Residents (ii) Resident but not Ordinarily Residents (iii) Non Residents.
There are several steps involved in determining the residential status of a person
(i) Resident Ordinarily Residents (Residents)
Under this category ,person must be living in India at least 182 days during previous year. Also,must have been in India 365 during 4 years preceding previous year and 60 days in previous year.
(ii) Resident but not Ordinarily Residents and must have been in India 2 out of 10 years preceding previous year or Have been in India 730 days out of last 7 years
(iii) Non Residents.
Ordinary residents are always taxable. Not Ordinarily residents are taxable in relation to income received in India or income accrued or deemed to be accrue or arise in India and income from business or profession controlled from India. Non Residents are exempt from tax if accrue or arise or deemed to be accrue or arise outside India.Taxable if income is earned from business or profession setting in India or having their head office in India.

Heads of Income

The total income of a person is divided into five heads, viz., taxable

Individual Heads of Income

Income from Salary

All income received as salary under Employer-Employee relationship is taxed under this head. Employers must withhold tax compulsorily, if income exceeds minimum exemption limit, as Tax Deducted at Source (TDS), and provide their employees with a Form 16 which shows the tax deductions and net paid income. In addition, the Form 16 will contain any other deductions provided from salary such as:

  1. Medical reimbursement: Up to Rs. 15,000 per year is tax free if supported by bills.
  2. Conveyance allowance: Up to Rs. 800 per month (Rs. 9,600 per year) is tax free if provided as conveyance allowance. No bills are required for this amount.
  3. Professional taxes: Most states tax employment on a per-professional basis, usually a slabbed amount based on gross income. Such taxes paid are deductible from income tax.
  4. House rent allowance: the least of the following is available as deduction
  • Actual HRA received
  • 50%/40%(metro/non-metro) of basic 'salary'
  • Rent paid minus 10% of 'salary'. basic Salary for this purpose is basic+DA forming part+commission on sale on fixed rate.

Income from salary is net of all the above deductions.

Income from House property

Income from House property is computed by taking into account what is called Annual Value of the property. The annual value (in the case of a let out property) is the maximum of the following:
  • Rent received
  • Municipal Valuation
  • Fair Rent (as determined by the I-T department)

If a house is not let out and not self-occupied, annual value is assumed to have accrued to the owner. Annual value in case of a self occupied house is to be taken as NIL. (However if there is more than one self occupied house then the annual value of the other house/s is taxable.) From this, deduct Municipal Tax paid and you get the Net Annual Value. From this Net Annual Value, deduct :

  • 30% of Net value as repair cost (This is a mandatory deduction)
  • Interest paid or payable on a housing loan against this house

In the case of a self occupied house interest paid or payable is subject to a maximum limit of Rs,1,50,000 (if loan is taken on or after 1 April 1999 and construction is completed within 3 years) and Rs.30,000 (if the loan is taken before 1 April 1999). For all non self-occupied homes, all interest is deductible, with no upper limits.The balance is added to taxable income.

Income from Business or Profession

An example .. An architect works out of home and co-ordinates work for his clients. All the following expenses would be deductible from his professional fees.

  • he uses a computer,
  • he travels to sites in his car,
  • he has a peon to help him collect payments
  • He has a maid who comes in daily
  • part of the society maintenance bills
  • entertainment expenses incurred..
  • books and magazines for his professional practice.

The income referred to in section 28, i.e, the incomes chargeable as "Income from Business or Profession" shall be computed in accordance with the provisions contained in sections 30 to 43D. However, there are few more sections under this Chapter, viz., Sections 44 to 44DA (except sections 44AA, 44AB & 44C), which contain the computation completely within itself. Section 44C is a disallowance provision in the case non-residents. Section 44AA deals with maintenance of books and section 44AB deals with audit of accounts.

In summary, the sections relating to computation of business income can be grouped as under: -

  • Deductible Expenses - Sections 30 to 38 [except 37(2)].
  • Inadmissible Expenses - Sections 37(2), 40, 40A, 43B & 44-C.
  • Deemed Incomes - Sections 33AB, 33ABA, 33AC, 35A, 35ABB & 41.
  • Special Provisions - Sections 42 & 43D
  • Self-Coded Computations - Sections 44, 44A, 44AD, 44AE, 44AF, 44B, 44BB, 44BBA, 44BBB, 44-D & 44-DA.

The computation of income under the head "Profits and Gains of Business or Profession" depends on the particulars and information available.

If regular books of accounts are not maintained, then the computation would be as under: -

Income (including Deemed Incomes) chargeable as income under this head xxx Less: Expenses deductible (net of disallowances) under this head xxx Profits and Gains of Business or Profession xxx.

 

However, if regular books of accounts have been maintained and Profit and Loss Account has been prepared, then the computation would be as under: -

Net Profit as per Profit and Loss Account

XXX

Add : Inadmissible Expenses debited to Profit and Loss Account 

XXX

Deemed Incomes not credited to Profit and Loss Account 

XXX

XXX

Less: Deductible Expenses not debited to Profit and Loss Account

XXX

Incomes chargeable under other heads credited to Profit & Loss A/c

XXX

 

XXX

Profits and Gains of Business or Profession 

XXX

Income from Capital Gains

Transfer of capital assets results in capital gains. A Capital asset is defined under section 2(14) of the I.T. Act, 1961 as property of any kind held by an assessee such as real estate, equity shares, bonds, jewellery, paintings, art etc. but does not include some items like any stock-in-trade for businesses and personal effects. Transfer has been defined under section 2(47) to include sale, exchange, relinquishment of asset, extinguishment of rights in an asset, etc. Certain transactions are not regarded as 'Transfer' under section 47.

For tax purposes, there are two types of capital assets: Long term and short term. Long term asset are held by a person for three years except in case of shares or mutual funds which becomes long term just after one year of holding. Sale of such long term assets gives rise to long term capital gains. There are different scheme of taxation of long term capital gains. These are:

  1. As per Section 10(38) of Income Tax Act, 1961 long term capital gains on shares or securities or mutual funds on which Securities Transaction Tax (STT) has been deducted and paid, no tax is payable. STT has been applied on all stock market transactions since October 2004 but does not apply to off-market transactions and company buybacks; therefore, the higher capital gains taxes will apply to such transactions where STT is not paid.
  2. In case of other shares and securities, person has an option to either index costs to inflation and pay 20% of indexed gains, or pay 10% of non indexed gains. The indexation rates are released by the I-T department each year.
  3. In case of all other long term capital gains, indexation benefit is available and tax rate is 20%.

All capital gains that are not long term are short term capital gains, which are taxed as such:

  • Under section 111A, for shares or mutual funds where STT is paid, tax rate is 10% From Asst Yr 2005-06 as per Finance Act 2004. For Asst Yr 2009-10 the tax rate is 15%.
  • In all other cases, it is part of gross total income and normal tax rate is applicable.

For companies abroad, the tax liability is 20% of such gains suitably indexed (since STT is not paid).

Income from Other Sources

This is a residual head, under this head income which does not meet criteria to go to other heads is taxed. There are also some specific incomes which are to be taxed under this head.

  1. Income by way of Dividends
  2. Income from horse races
  3. Income from winning bull races
  4. Any amount received from key man insurance policy as donation.
  5. Income from shares (dividend otherthan indian company)

Deduction

While exemptions is on income some deduction in calculation of taxable income is allowed for certain payments.

Section 80C Deductions :Section 80C of the Income Tax Act allows certain investments and expenditure to be tax-exempt. The total limit under this section is Rs. 100,000 (Rupees One lac) which can be any combination of the below:

  • Contribution to Provident Fund or Public Provident Fund. PPF provides 8% return compounded annually. Maximum limit to contribute in it is 70,000 for each year. It is a long term investment with complete withdrawal not possible till 15 years though partial withdrawal is possible after 5 years. Besides, there is employee providend fund which is deducted from the salary of the person. This is about 10% to 12% of the BASIC salary component. Recent changes are being discussed regarding reducing the instances of withdrawal from EPF especially when one changes the job. EPF has the option of full settlement on leaving the job, taking VRS, retirement after 58. It also has options of withdrawal for certain expenses related to home, marriage or medical. EPF contribution includes 12% of basic salary from employee and employer. It is distributed in ratio of 8.33:3.67 in Pension fund and Providend fund
  • Payment of life insurance premium
  • Investment in pension Plans. National Pension Scheme is meant to save money for the post retirement which invests money in different combination of equity and debt. depending upon age up to 50% can go in equity. Annuity payable after retirement is dependent upon age. NPS has six fund managers. Individual can make minimum contribution of Rs6000/- . It has 22 point of purchase (banks).
  • Investment in Equity Linked Savings schemes (ELSS) of mutual funds
  • Investment in National Savings Certificates (interest of past NSCs is reinvested every year and can be added to the Section 80 limit)
  • Tax saving Fixed Deposits provided by banks for a tenure of 5 years. Interest is also taxable.
  • Payments towards principal repayment of housing loans. Also any registration fee or stamp duty paid.
  • Payments towards tuition fees for children to any school or college or university or similar institution. (Only for 2 children)or towards coaching fee of various competitive exams.
  • Post office investments

The investment can be from any source and not necessarily from income chargeable to tax.

Section 80CCF: Investment in Infrastructure Bonds

From April, 1 2010, a maximum of Rs. 20,000is deductible under section 80CCF provided that amount is invested in infrastructure bonds. This is in addition to the 100,000 deduction allowed under Section 80(C).

Section 80D: Medical Insurance Premiums

Health insurance, popularly known as Mediclaim Policies, provides a deduction of up to Rs. 35,000.00 (Rs. 15,000.00 for premium payments towards policies on self, spouse and children and (read as in addition to) Rs. 15,000.00 for premium payment towards non-senior citizen dependent parents or Rs. 20,000.00 for premium payment towards senior citizen dependent). This deduction is in addition to Rs. 1,00,000 savings under IT deductions clause 80C. For consideration under a senior citizen category, the incumbent's age should be 65 years during any part of the current fiscal, eg. for the fiscal year 2010-11, the incumbent should already be 65 as on March 31, 2011), This deduction is also applicable to the cheques paid by proprietor firm..

Interest on Housing Loans Section

For self occupied properties, interest paid on a housing loan up to Rs 150,000 per year is exempt from tax.(Excluding Rs.1,00,000/p.a. u/s 80c Saving) However, this is only applicable for a residence constructed within three financial years after the loan is taken and also the loan if taken after April 1, 1999.

If the house is not occupied due to employment, the house will be considered self occupied.

For let out properties, the entire interest paid is deductible under section 24 of the Income Tax act. However, the rent is to be shown as income from such properties. 30% of rent received and municipal taxes paid are available for deduction of tax.

The losses from all properties shall be allowed to be adjusted against salary income at the source itself. Therefore, refund claims of T.D.S. deducted in excess, on this count, will no more be necessary.

Use of Deductions

While the use of the above sections helps one to avoid paying money as tax if one falls in the tax bracket, one should look at this more as an investment-return opportunity. One should still file income tax, even if one is not paying any tax. Except ELSS (Equity Linked Savings Scheme) and the NPS (National Pension Scheme), other schemes under 80C typically offer a relatively risk-free investment and guaranteed returns.

Tax Rates

In India, Individual income tax is a progressive tax with three slabs. About 10 per cent of the population meets the minimum threshold of taxable income.

From April 1, 2011 new tax slabs apply, which are as follows:

  • No income tax is applicable on all income up to Rs. 1,80,000 per year. (Rs. 1,90,000 for women, Rs. 2,50,000 for senior citizens of 60 till 80 yrs (excluding 80) and Rs. 5,00,000 for very senior citizens of 80 yrs and above and must be resident of india)
  • From 1,80,001 to 5,00,000 : 10% of amount greater than Rs. 1,80,000 (Lower limit changes appropriately for women and senior citizens)
  • From 5,00,001 to 8,00,000 : 20% of amount greater than Rs. 5,00,000 + 32,000 ( Rs. 31,000 for women and Rs. 26,000 for senior citizens)
  • Above 8,00,000 : 30% of amount greater than Rs. 8,00,000 + 92,000 ( Rs. 91,000 for women and Rs. 86,000 for senior citizens)

Surcharge

Surcharge has been abolished for Personal income tax in the financial year 2009-10.

A 7.5% surcharge (tax on tax) is applicable if the taxable income (taking into consideration all the deductions) is above Rs. 10 lakh (Rs. 1 million). The limit of 10 lacs was increased to Rs. 10 crore (Rs. 100 million) with effect from 1 June 2009.

All taxes in India are subject to an education cess, which is 3% of the total tax payable. With effect from assessment year 2009-10, Secondary and Higher Secondary Education Cess of 1% is applicable on the subtotal of taxable income. Mainly education cess is applicable on excise duty and service tax.

From Income Tax Year 2010-11, education cess would be 3% and no surcharge would be levied.

Tax Rate for non-Individuals

There are special rates prescribed for Firms, Corporates, Local Authorities & Co-operative Societies.

Refund Status for Salaried tax payers

The Income Tax Department has put on its website the list of income tax refunds of all salary tax payers which could not be sent to the concerned persons for want of correct address.

Salary taxpayers who have not received refunds for assessment years 2003-04 to 2006-07 can click on the link below and query using the PAN number and assessment year whether any refund due to them has been returned undelivered.

Corporate Income tax

For companies, income is taxed at a flat rate of 30% for Indian companies, with a 5% surcharge applied on the tax paid by companies with gross turnover over Rs. 1 crore (10 million). Foreign companies pay 40%.[11] An education cess of 3% (on both the tax and the surcharge) are payable, yielding effective tax rates of 32.5% for domestic companies and 41.2% for foreign companies. [12] From 2005-06, electronic filing of company returns is mandatory.

Tax Penalties

The major number of penalties initiated every year as a ritual by I T Authorities is under section 271(1)(c) which is for either concealment of income or for furnishing inaccurate particulars of income. What is inaccurate particulars of income is not defined under Income Tax Act 1961 , however recently Supreme Court in case of CIT vs Reliance Petroproducts states as under "If we accept the contention of the Revenue then in case of every Return where the claim made is not accepted by Assessing Officer for any reason, the assessee will invite penalty under Section 271(1)(c). That is clearly not the intendment of the Legislature."

"If the Assessing Officer or the Commissioner (Appeals) or the Commissioner in the course of any proceedings under this Act, is satisfied that any person-

(b) has failed to comply with a notice under sub-section (1) of section 142 or sub-section (2) of section 143 or fails to comply with a direction issued under sub-section (2A) of section 142, or

(c) has concealed the particulars of his income or furnished inaccurate particulars of such income,

he may direct that such person shall pay by way of penalty,-
(ii) in the cases referred to in clause (b), in addition to any tax payable by him, a sum of ten thousand rupees for each such failure;
(iii) in the cases referred to in clause (c), in addition to any tax payable by him, a sum which shall not be less than, but which shall not exceed three times, the amount of tax sought to be evaded by reason of the concealment of particulars of his income or the furnishing of inaccurate particulars of such income.

 

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