tax

Taxation

1.1 INTRODUCTION In India, the Constitution is the parent law. All other laws should be enacted without violating the framework of the Constitution and subject to the norms laid down therein. The constitution of India authorises the Central Government to levy tax on income. By virtue of this power and to achieve this goal, the Income Tax Act-1961 was enacted and it extends to entire India.

"It was only for the good of his subjects that he collected taxes from them, just as the Sun draws moisture from the Earth to give it back a thousandfold" - Kalidas in Raghuvansh eulogising King Dalip.It is a matter of general belief that taxes on income and wealth are of recent origin but there is enough evidence to show that taxes on income in some form or the other were levied even in primitive and ancient communities. The origin of the word "Tax" is from "Taxation" which means 'estimate'. The rapid changes in administration of direct taxes, during the last decades, reflect the history of socioeconomic thinking in India. From 1922 to the present day, changes in direct tax laws have been so rapid that except in the bare outlines, the traces of the I.T. Act, 1922 can hardly be seen in the 1961 Act as it stands amended to date. It was but natural, in these circumstances that the set up of the department should not only expand but undergo structural changes as well. 1.2 DEFINITIONS UNDER ACT Every person whose total income of the previous year exceeds the maximum amount which is not chargeable to income tax, is an Assessee and chargeable to income tax at the rate or rates prescribed in the Finance Act for the relevant Assessment Year. However, his total income shall be determined on the basis of his residential status. Assessment Year and Previous Year According to Section 2(9), Assessment Year (AY) is the period of 12 months which starts from 1 st April and ends on 31 st March. According to Section 2(34), Previous Year means the Previous Year as defined in Section 3 of the Act. Section 3 of the Act defines Previous Year as the financial year immediately preceding Assessment Year, e.g. income earned during previous year 1.4.2006 to 31.3.2007 will be assessed or charged to tax in A.Y. 2007-208.

Definitions Under Income Tax Act, 1961 Umi \

Significance of these two terms is that the income earned by a person during the Previous Year is subjected to tax during the Assessment Year. The term Previous Year should not be confused with the Accounting Year for financial accounting purposes. There may be a possibility that an organisation may have the Accounting Year for financial accounting purposes which does not end on 31 st March. However, for income tax purposes, Previous Year essentially ends on 31st March.

PersonAccording to Section 2(31), the term Person includes: a. b. An Individual A Hindu Undivided Family (HUF) - The term has not been defined under the Act. However, HUF means a family consisting of all persons ideally descended from a common ancestor including their wives and unmarried daughters. A Company - A Company means a company formed as per the provisions of Companies Act, 1956.

c.

d. A Firm-A Firm means a partnership firm.

e.

An As soc iati on of Per so ns (A OP ) or A Bo dy of Ind ivi du als (B OI )A OP is for me d wh en tw o or mo re per so ns co me tog eth er to ear

n the income. BOI is formed when more than two individuals come together to earn the income. f. A Local Authority

g. Every Artificial Person not falling under any of the preceding sub-clauses. We will restrict our discussions in respect of taxability of an individual, a company and a firm Assessee According to Section 2(7), Assessee means a person by whom any tax or any other sum of money (say interest and/or penalty) is payable under the Act and includes the following a. Every person on whom any proceeding under the Act has been taken for the assessment of his income or the income, of any other person in respect of which he is

Taxation

assessable to determine the loss sustained by him or by such other persons to determine the amount of refund due to him or to such other person. b. c. A person who is deemed to be an Assessee under the provisions of this Act. This would include the legal representative of a deceased person or agent of a person. Every person who is deemed to be an Assessee in default as per the provisions of the Act. A person is said to be Assessee in default if he fails to comply with the provisions of the Act. E.g. A person who fails to deduct the tax at source and pay the same to the Central Government.

1.3 TOTAL INCOME For calculating the Total Income of the Assessee, the income is required to be classified under the following five heads of income. a. b. c. d. e. Income from Salaries Income from House Property Profits from Business and Profession Income from Capital Gains Income from Other Sources

For calculating the income from the heads of incomes stated above, the deductions available for each of the above heads of income are considered. E.g. while calculating the Income from Salaries, deductions under Section 16 are considered or while calculating income from House Property, deductions under Section 24 are considered. Combined amount of all the above five heads of income gives the amount of Gross Total Income (GTI). From GTI, the amounts available as deductions as per the provisions of Chapter VI-A of the Act are deducted. These deductions are as per the provisions of Section 80CCC to Section SOU of the Act. Gross Total Income duly reduced by the deductions as per the provisions of Chapter VIA of the Act gives the Total Income.

Unit 1

Definitions Under Income Tax Act, 1961

^Activity A; Define the following provisions Assessment Year_________

Previous Year Income Tax Assessee

1.4 RATES OF TAXES The rates at which the tax is payable are not prescribed in the Income Tax Act, 1961. The rates of tax are prescribed by the Finance Act. For the Assessment Year 2007-2008, the income tax will be payable as per the following Provisions For Individuals-

Income

Rates of Taxes NIL 10% 20% 30%

Income less than Rs. 1,00,000 Income Rs. 1,00,000 to 1, 50,000 Income Rs. 1,50,000 to 2,50,000 Income above Rs. 2,50,000

II-

Note - If the Total Income of an individual exceeds Rs. 10,00,000, a surcharge @ 10% of the tax payable will be applicable. In case of other individuals, no surcharge is applicable. The tax so computed will be increased further by Education Cess payable @ 2% on the total amount of tax and surcharge, if applicable.

Taxation

For Firms Firms are required to pay tax at a flat rate of 30% of the Total Income, irrespective of the amount of Total Income. In other words, no basic exemption limit applies to partnership firms. The amount of tax payable will be increased by a surcharge @ 10% of the tax liability. The amount of tax payable will be further increased by Education Cess payable @ 2% of the tax and surcharge payable. For Companies Domestic Companies are required to pay tax at a flat rate of 30% of the Total Income, irrespective of the amount of Total Income. In other words, no basic exemption limit applies to domestic companies. The amount of tax payable will be increased by a surcharge @ 10% of the tax liability. The amount of tax payable will be further increased by Education Cess payable @ 2% of the tax and surcharge payable. Note - If the income from other sources consists of the income by way of winning from lotteries, cross word puzzles, horse races, gambling, betting etc., it will attract the tax at the flat rate of 30% as per the provisions of Section 115BB of the Act. 1.5 RESIDENTIAL STATUS The tax liability of an Assessee under the tax is affected due to the Residential Status of the assessee. There are different rules for deciding the residential status of an individual, a firm and a company. Let us discuss the same in detail. Individual As per the provisions of Section 6 of the Act, an Individual is classified basically as Resident and Non-Resident. Resident Individual is further classified as Ordinarily Resident and Not ordinarily Resident. Resident and Ordinarily Resident (ROR) An individual is treated as Resident and Ordinarily Resident if he satisfies Any One of the following Basic Conditions and Both the following Additional Conditions -

Unit


Basic Conditionsa. He is in India for a period or periods amounting in all to at least 182 days in the relevant Previous Year.

b. He is in India for 60 days or more during the relevant Previous Year and has been in India for 365 days or more during four Previous Years immediately preceding the relevant Previous Year.

Note a. In case of an individual who is a citizen of India and who leaves India in any Previous Year for the purpose of employment out of India or as a crew member of an Indian ship, the period of 60 days stated above shall be substituted by 182 days.

b. In case of an individual who is a citizen of India or is a person of Indian origin, who comes on a visit to India, the period of 60 days stated above shall be substituted by 182 days. Aperson is considered to be of Indian origin if he or either of his parents or any of his grandparents (maternal or paternal) was born in undivided India. c. While calculating the period of stay in India, it is not necessarily a continuous period

or tha t the sta y sho uld be at one pla ce onl y. Additio nal Conditi ons a. He has bee n Re sid ent in Ind ia for at lea st 2 out of 10 Pre vio us Ye ars im me dia tel y pre

ceding the relevant previous year b. He has been in India for 730 days or more during 7 Previous Years immediately preceding the relevant previous year. Resident but Not-Ordinarily Resident (RNOR) An individual is treated as Resident but Not-Ordinarily Resident if he satisfies Any One of the Basic Conditions and One or None of the Additional Conditions. The basic conditions and the additional conditions are the same as applicable to a Resident and Ordinarily Resident. Non-Resident (NR) An individual will be considered to be a NonResident if none of the Basic Conditions are satisfied by an individual. Partnership Firms A partnership Firm is said to be a Resident in India in any previous year if the control and management of the affairs of the firm are situated in India.

Taxation

A partnership Firm is said to be a Non-Resident in India in any previous year if the control and management of the affairs of the firm are situated outside India. The management and control of the firm will be assumed to be in India if the partners of the firm are residents of India and the principal place of business of the firm is situated in India Company A Company is said to be a Resident in India in any Previous year ifa. b. It is an Indian Company or The control and management of the affairs of the Company are situated in India.

A Company is said to be a Non-Resident in India in any Previous Year if a. b. It is not an Indian Company and The control and management of the affairs of the Company are situated outside Irufo

Incidence of Tax and Residential Status - Section 5 As per the provisions of Section 5 of the Act, the incidence of tax of the assessee depends upon his residential status and also on the place and time of accrual of income. Resident and Ordinarily Resident - Section 5(1) A Resident and Ordinarily Resident is taxable in respect of a. b. Income which is received or deemed to be received in India in the previous year Income which accrues or arises or is deemed to accrue or arise in India during the previous year->

c.

Income which accrues or arises outside India

Resident but Not-ordinarily Resident - Section 5(1)A Resident but Not Ordinarily Resident is taxable in respect of a. b. Income which is received or deemed to be received in India in the previous year Income which accrues or arises or is deemed to accrue or arise in India during the previous year

Unit 1


c. d.

Income which accrues or arises outside India from a business controlled or profession set up in India. Income received outside India from a business controlled or profession set up in India.

Non-ResidentA Non-Resident is taxable in respect of a. b. Income which is received or deemed to be received in the previous year Income which accrues or arises or is deemed to accrue or arise in India during the previous year

The taxability as discussed above is summarised in the table shown below : Table 1.1 Types of Income / Status Income received in India, whether accrued in India or outside India Income deemed to be received in India, Whether accrued in India or outside India Income accruing or arising in India, whether received in India or outside India Income deemed to accrue or arise in India, Whether received in India or outside India Income received or accrued outside India from a business controlled in or profession set up in India Income received or accrued outside India from a business controlled from outside India or a profession set up outside India Income (other than business or profession) received and accrued outside India Income earned and received outside India and remitted to India ROR RNOR

NR Yes Yes Yes Yes

Yes Yes Yes Yes

Yes Yes Yes Yes

Yes

Yes

No

Yes Yes No

Yes No No

No No No

Taxation

NoteROR indicates Resident and Ordinarily Resident RNOR indicates Resident but Not Ordinarily Resident NR indicates Non-Resident 1.6 ACCRUAL OF INCOME

a.

10 Income received in India - Section 7Any income received by the assessee in India is liable for the payment of tax irrespective of the residential status of the assessee and place of accrual of such income. Income deemed to be received in India Section 7 The following incomes are deemed to be received in India even if they are not actually received a. Annual accretion to the balance of an employee who is the member of a Recognised Provident Fund. As a result, following amounts will be deemed to be the income in the hands of employee -

t h e p r o f i t s o n f. w h i c h t h e a s s e s s e e i s r e q u i r e d t

o p a y t h e t a x .

Employer's contribution to the provident fund in excess of 12% of the salary of the employee.

D e e m e d p r o f i t s o n w h i c h t h e a s

Interest credited on the balance at the rate exceeding 9.5%b. Transferred balance in a Recognised Provident Fund c. Any contribution made by the Central Government to the account of an employee under pension scheme referred to in Section 80 CCD. Tax deducted at source from the several incomes shall be deemed to be received in the hands of the payee. In simple words, for deciding the tax liability, the income will be grossed up by adding the tax deducted at source to the net income received. Unexplained investments or unexplained cash credits are deemed to

d.

e.

sess ee is req

uired to pay the tax as per the provisions of Section 41 of the Act. The provisions are discussed in the later units.

Unit 1


Incomes which are deemed to accrue or arise in India - Section 9In case of resident assessee, the place where the income is deemed to accrue or arise is not material. However, in case of a Non-Resident assessee, the income is subjected to tax only if it accrues or arises in India. However, the following are some of the incomes which are deemed to have accrued or arisen in India, even if they accrue or arise outside India : a. b. Income from a business connection in India Any income which arises from any tangible property situated in India, whether movable or immovable Income from transfer of any capital asset situated in India Any salary earned in India, even if it is paid outside India Salary paid by Government to an Indian citizen or Indian national for services rendered outside India

ivec. d. e.

ctivity B:Define the following provisions : Resident But Ordinarily Resident R-NOR

Non resident What will be the tax payable if total Income of an Individual is Rs. 12,00,000?

1.7 ILLUSTRATIONS____________________________________________Mr. A, a citizen of UK, comes to India for the first time during the financial year 2000-2001. His stay in India during the financial years 20012002,2002-2003,2003-2004,

11

Taxation

2004-2005 and 2005-2006 is as below :

2001-2002 2002-2003

55 days63 days

2003-2004 2004-2005 2005-2006

75 days 166 days65 days

Determine his residential status for the Assessment Year 2006-2007. Solution Mr. A has been in India for a period of 65 days during the previous year 2005-2006. However, his stay in India during the previous 4 previous years is 359 days. As such, he does not satisfy both the conditions that his stay should be minimum 60 days during the previous years and should be 365 days during the preceding four previous years. As he does not satisfy any of the basic conditions, his status will be that of a Non-Resident. Illustration Mr. Ashok provides the following details about his stay in India Year 1994 -1995 1997-1998 2000-2001 2003-2004 Duration of Stay 365 days 115 days 180 days 059 days Year 1995-1996 1998-1999 2001-2002 2004-2005 Duration of Stay 365 days 080 days 067 days 105 days Year 1996-1997 1999-2000 2002-2003 2005-2006 Duration of Stay 366 days 050 days 160 days 120 days

Determine the residential status of Mr. Ashok for the Assessment Year 2007-2008. Solution Mr. Ashok has been in India for more than 60 days during the previous year and for 391 days during the preceding four previous years. As such, he is Resident. However, as he is in India for a total period of 701 days during the preceding seven previous years, he is a Resident but Not-Ordinarily Resident.12

Unit 1


Illustration Mr. Ashok is the member of crew of an Indian ship. He leaves India for the first time on 15th November, 2002. Without returning to India, he takes up employment in USA. He comes back to India on a visit on 10th July, 2004 and stays for 196 days. Determine his residential status for the Assessment year 2005-2006. Solution During the previous year 2004-2005, Mr. Ashok was in India for a period of 196 days. As such, he is a Resident. Moreover, his stay in India during the preceding four previous years exceeds 365 days. As such, Mr. Ashok will be a Resident and Ordinarily Resident. Illustration Mr. Ashok submits the details of his income for the Assessment Year 2004-2005. Particulars Profit from business carried on in India Profit from consultancy set up in India Profit from business earned on in U K (income is earned in UK and the business is controlled from UK) Pension for services rendered in Sweden and received in Sweden but remitted to India Interest on bank deposits received in UK Capital Gains on a property situated in Mumbai, received in UK Calculate the Gross Total Income of-Mr. Ashok assuming that he is

Rs, 1, 00,000 0, 45,000 4,50,000

6,00,0002, 00,000 3, 00,000

Resident and Ordinarily Resident Resident but Not-Ordinarily Resident Non-Resident

Solution Calculation of Gross Total Income of Mr. Ashok

1 3

Taxation

ROR Profit from business carried on in India Profit from consultancy set up in India Profit from the business carried on in UK (income is earned in UK and the business is controlled from UK) Pension for services rendered in Sweden and received in Sweden but remitted to India Interest on bank deposits received in UK Capital Gains on a property situated in Mumbai, received in UK Gross Total Income Note ROR - Resident and Ordinarily Resident RNOR Resident but Not Ordinarily Resident NR - NonResident 1.8 SUMMARY 1, 00,000 0, 45,000 4,50,000

RNOR 1, 00,000 45,000

NR1, 00,000 45,000

Nil Nil Nil

Nfl Nil Nil

Nil2, 00,000

3, 00,000 3, 00,000 3, 00,000 10, 95,000 4, 45,000 4, 45,000

In this unit, we have looked at the special meanings attached to certain terms in the Indian Income Tax Act of 1961. Understanding of those terms is imperative to the correct computation of income tax. Learners of Taxation need to familarise themselves with meanings of words such as 'person', 'assessee', 'total income', 'residential status' etc. This unit has also explained how different types of income are perceived in the Income Tax Act. 1.9 KEYWORDS___________________________________________________ Note: All the definitions are already given in 1.2 of this unit. 1.10 SELF-ASSESSMENT QUESTIONS________________________________ Q1. Discuss the conditions for deciding the Residential Status of an individual. How does the tax liability of the individual get affected due to his residential status?14

Unit 1


I

Q2. Write short notes on the following-

Assessment Year and Previous year Assessee Person Rates of Tax

ProblemsQ1. Mr. Ashok, an Indian citizen, left India for the first time as a member of crew of an Indian ship on 10th November 2003. After he left India, he took up employment in UK and settled down in UK. He comes to India on a visit on 15th June 2004 and

st ne the residential status of Mr. Ashok for the AY 2006-2007 and 2007-2008. ay ed Q2. Mrs. Alaka Joshi, an Indian citizen, took up an employment in Canada and left India for the first time on 20th September 2003. During the financial year 2004-2005, in she came to India and stayed in India for 170 days. Determine her residential status In for the AY 2007-2008. di a Q3. Mr. Ashok was born in Karachi in 1947. He has been staying in Canada since fo 1975. He came to visit India on 4th October 2004 and stayed in India till 31st ra March 2005. Determine his residential status for the AY 2006-2007 and 2007pe 2008. ri od Q4. Following are the details of income earned by Mr. Ashok during the financial year of 2006-2007. 19 5 a. Profits earned from a business in Mumbai which is managed from Dubai da Rs. 1,00,000 ys b. Interest on investments made in UK, half of which is received in India . Rs. 50,000 D et c. Income from property situated in Bangla Desh and received there - Rs. 75,000 er mi d. Income from agriculture in Nepal and remitted to India - Rs. 50,000

1 5

t a

2.1 INTRODUCTION Generally an assessee is required to pay tax on all the receipts made by him which give rise to the income, unless it is specifically considered to be the income which is not included while calculating the total income, in other words the income which is considered to be the exempt income. Following incomes do not form a part of Total Income: a. b. c. d. Incomes exempt as per the provisions of Section 10 of the Act. Incomes of newly established industrial undertaking in Free Trade Zones (FTZ)Section 10A. Incomes of newly established 100% Export Oriented Units (EOUs) - Section 10B. I Income of political parties - Section 13 A. b. c. *;*$&

2 A c. a. b.

4 5 F A

2.2. INCOMES EXEMPT UNDER SECTION 10 OF THE ACT While calculating the total income of the Assessee, certain incomes will not be considered as the incomes chargeable to tax. Following are some of the important incomes which are exempt from tax: 2.2.1 Agricultural Income - Section 10(1) The tax treatment of the Agricultural Income is specified in the Annexure. 2.2.2 Share of profit of a partner from a Firm - Section 10(2A) The share of profit earned by a partner from a partnership firm is exempt from tax. The detailed discussion is given in the unit on Taxation of Partnership Firms. Interest on securities or bonds held by a Non-Resident or interest on Non-Resident (External) Account - Section 10(4) In case of any assessee who is a Non-Resident in India, income by way of interest on specified securities or the premium on the redemption of specified securities is exempt from tax. Foreign Allowance - Section 10(7) Any allowance or perquisite paid outside India by the Government to a citizen of India for rendering services outside India is exempt from tax.

2

Unit 2

Income Exempt from Tax

2.2.3Amount received under a Life Insurance Policy - Section 10(10D) Any sum received under a Life Insurance Policy, including the amount of bonus on such policy shall be exempt from tax. However, the section does not apply toa. any sum received under Section 80DD (3) or Section 80DDA (3)

b. any sum received under a Keyman Insurance Policy c. any sum received in respect of an insurance policy issued after 1 st April 2003 in respect of which the premium payable for any of the years during the term of policy exceeds 20% of the actual sum assured. However, this provision will not apply to any sum received on the death of the person. 2.2.4 Interest, premium or bonus on specified investments - Section 10(15) a. Any income by way of interest, premium on redemption or any other payment on the notified securities, bonds, annuity certificates, saving certificates etc. issued by the Central Government are exempt from tax. b. In case of the individuals and HUF, the interest on notified Capital Investment Bonds and Relief Bonds is exempt from tax. 2.2.5 Educational Scholarship - Section 10(16) Scholarships granted to meet the cost of education are exempt from income tax. 2.2.6 Payments to MPs, MLAs etc. - Section 10(17) i tax. The Resident%

Following incomes are exempt from income tax a. Daily allowance received by a Member of Parliament (MP) or a Member of Legislative Assembly (MLA) or any committee thereof. b. Any other allowance received by a MP under the Members of Parliament (Constituency Allowance) Rules, 1986. c. All allowances (to the extent of Rs. 2,000 per month in aggregate) received by any person by reason of his membership of any state legislature or any committee thereof. o

iterest on | is exempt

22

Taxation

Pensi on to gallan try awar d winne rs Sectio n 10(18)Any pensi on receiv ed by an indivi dual who was the emplo yee of the State Gover nment or Centr al Gove rnme nt and has been award ed Para m Vir Chakr a or Maha Vir Chakr a or Vir

Chakra or any such gallantry award as may be specified by the Government, is exempt from tax. The pension received by the family of such an individual is also exempt for tax,

Family pension under certain circumstances - Section 10(19)Family pension received by the widow or children or legal heirs of a member of armed forces (including Para-military forces) of the Union, where the death has occurred during the course of operational duties, in the specified circumstances as specified by Central Board of Direct Taxes (CBDT), will be exempt from tax.

Property in possession of a former ruler - Section 10(19A)Annual Value of any one palace in possession of a former ruler is exempt from tax. a. b. Income by way of Income from House Property, Capital Gains and Income froi Other Sources. Income arising from a trade or business of supplying a commodity or service (except water and electricity) within its own jurisdiction.

2.2.7 Income of a Local Authority - Section 10(20) Following income of a local authority like Panchayats, Municipalities or Cantonment Boards is exempt from tax c. Income from the supply of water and electricity within or outside its own jurisdiction. In other words, entire ineome of a local authority is exempt from tax except the income arising from a trade or business of any commodity or service (except water and electricity) outside its own jurisdiction.

Income of a specified news agency - Section 10(22B)Any income of the notified news agencies set up in India for collection and distribution of news is exempt from tax, provided that the said agency applies its income for collection and distribution of news and does not distribute its income to its members. For the purpose of this section, following news agencies have been notified by the Central Government -

Unit 2


Press Trust of India (PTI) United News of India (UNI)

Income of Professional Institutions - Section 10(23A)Any income (other than Income from House Property or any income received for rendering specific services or income by way of dividend or interest on investments) of an association or institution in India having as its objective the supervision, control, regulation and encouragement of certain specified professions is exempt from tax. The various professions which are specified for this purpose are -

Law Medicine Accountancy Engineering Architecture Company Secretaryship Chemistry Materials Management Town Planning

2.2.8 Income of a Mutual Fund - Section 23DAny income of the following mutual funds is exempt from tax a. A mutual fund registered under Securities and Exchange Board of India Act, 1992 or the regulations made thereunder.

b. Any other mutual fund set up by a public sector bank or public financial institution or authorised by RBI.

2.2.9 Income of a Venture Capital Fund - Section 10(23FB)This section applies to a Venture Capital Company or a Venture Capital Fund which has been granted the certificate by Securities and Exchange Board of India (SEBI) and which fulfils the terms and conditions as may be specified by SEBI. The deduction under this section is available if the Venture Capital Company or Venture Capital Fund is set up to

23

Taxation

raise funds for investment in a Venture Capital Undertaking where the term Venture Capital Undertaking as a company a. which is a domestic company,

b. whose shares are not listed in a recognised stock exchange in India. If the above conditions are satisfied, any income of such Venture Capital Company Venture Capital Fund is exempt from tax, even if the shares of the Venture Capital Undertaking in which the Venture Capital Company or Venture Capital Fund has made the initial investment, are subsequently listed on the stock exchange. 2.2.10 Income of Trade Unions - Section 10(24)

24

Any income chargeable under the heads "Income from House Property" and "Income from Other Sources" of a trade union, registered under the Trade Unions Act, 1926 formed for the purpose of regulating the relationship between workmen and employers or between workmen and workmen is exempt from tax. 2.2.11 Income of Certain Funds - Section 10(25)

T h e

ated below is exempt from income tax a. Interest on securities held by a statutory provident fund and any capital gains arising from the transfer of such securities. Any income received by the trustees on behalf of a recognised provident fund, approved superannuation fund and approved gratuity fund. Any income received by the Board of Trustees of the Deposit Linked Insurance Fund.*,*-

b. i n c o m e c.

2.2.12 Income of Employees State Insurance Fund - Section 10(25A) Any income received by the Employees State Insurance Fund set up under Employees' State Insurance Act (ESI Act) is exempt from tax. 2.2.13 Capital Gains arising from the transfer of units of UTI - Section 10(33)

s t

Any amount of Capital Gains arising from the transfer of units of Units Trust Scheme, 1964 is exempt from tax, provided that the transfer takes place after 1st April 2002.

Capital

Ipmpany or fce Capital lhas made . "Income 16 formed r between

Unit 2


2.2.14 Dividend received from a Domestic Company - Section 10(34) Any amount of dividend received by the assessee from a domestic company is exempt from tax. 2.2.15 Some other Exemptions Income from Mutual Fund - Section 10(35) Any income received in respect of the units of the specified Mutual Funds or the specified Company is exempt from tax. Long term capital gains on the transfer of listed equity shares - Section 10(36) Long Term capital gains arising from the transfer of certain equity shares are exempt from tax if the following conditions are satisfied a. The assets transferred must be a long term capital asset being an eligible equity share in a company b. The shares must have been purchased after 1 st March 2003 and before 1 st March 2004 and must have been held for a period of more than 12 months. c. Eligible Equity Shares means (i) any equity shares in a company which is a constituent of BSE-500 Index of the Mumbai Stock Exchange as on 1 st march 2003 and is traded on the stock exchanges in the country or (ii) any share allotted through the public issue made after 1 st March 2003 and is traded on the stock exchanges in the country. Capital Gains due to compulsory acquisition of agricultural land - Section 10(37) Any capital gains arising due to thecompulsory acquisition of an agricultural land situated within the jurisdiction of a municipality or a cantonment board will be exempt from tax if such land was being used by the individual if or his parents for agricultural purposes for a period of two years immediately preceding the date of such acquisition. Long Term Capital Gains from the transfer of securities - Section 10(38) Long Term Capital Gains arising out of the sale and transfer of securities through the recognised stock exchange will be exempt from tax. The securities for the purpose of this exemption consist of 25

ins arising dent fund, Insurance

Employees m 10(33) ist Scheme, 112002.

Taxation

Shares, debentures or bonds Units of mutual funds Government securities

2.2.16 Occasional Incomes or Gifts - Section 10(39)Following incomes will be exempt from tax -

Any income referred to in Section 2(24)(xiii), to the extent that the aggregate of such incomes does not exceed Rs. 25,000. The amount not exceeding Rs. 1,00,000 received by an individual on the occasiq of his marriage.

Note - Section 2(24)(xiii) provides as below -Following amount will be considered to be income Any sum received by an individual in cash or a cheque or a draft or by way of credit or a amount received otherwise than by way of consideration for goods or services. Howeve following amounts will not be covered by the above section -The amount received ( credited from a relative out of natural love and affection.

The amount received or credited under a will or inheritance. The amount received by an employee or dependant of the deceased employee frol the employer, by way of bonus or gratuity or pension or insurance solely in recognition^ of the services rendered by the employee.

For this section the term "relative" means i. ii. Spouse of the individual Brother or sister of the i ndi vidual

26

iii. Brother or sister of the spouse of the individual iv. Brother or sister of either of the parents of the individual v. Any lineal ascendant or descendant of the individual

Unit 2


vi. Any lineal ascendant or descendant of the spouse of the individual vii. Spouse of the person referred to in "ii" to "vi" above.

^Activity A;Write Short Notes on: Amount received under a Life Insurance Policy - Section 10( 1OD)

Payments to MPs, MLAs etc. - Section 10(17) Occasional Incomes or Gifts - Section 10(39) Income of a Venture Capital Fund - Section 10(23FB) Income of a Mutual Fund - Section 23D

2.3 NEWLY ESTABLISHED UNDERTAKINGS IN FREE TRADE ZONES, SOFTWARE TECHNOLOGY PARK ETC. - SECTION 10ASection 10A applies to all the assessees who derive the profits or gains from an undertaking engaged in the export of an article or things or computer software which are established in the following areas: a. yee from cognition Free Trade Zones - For the purpose of this section, following are the Free Trade Zones

Kandla Free Trade Zone Santacruz Electronics Export Processing Zone Falta Export Processing Zone Madras Export Processing Zone Cochin Export Processing Zone Noida Export Processing Zone

b. Electronic Hardware Technology Park - Electronic Hardware Technology Park means any park set up according to Electronic Hardware Technology Park Scheme notified by the Central Government, Ministry of Commerce and Industry.

27

TaxaSxov x

Unit 2

c. S o a. ft b. w c. a r e T e c h n o l o g y P a r k S o ft w a r e T e c h n o l o g y P a r k m e

a.28

c

Ich means |d by the > section, following ted out of ssessee in is from the vious year efore 30th iNo.56F ! claimed. [existing

Unit 2


a. 100% of the profits or gains derived from the export of such articles or things or computer software for a period of 5 consecutive assessment years commencing from the assessment year relevant to the previous year in which the assessee begins to manufacture or produce articles or things or computer software, and thereafter 50% of the profits or gains for further two consecutive assessment years. b. For the next three consecutive assessment years, 50% of the profits provided that the same profits are debited to Profit and Loss Account and credited to ("Special Economic Zone Re-Investment Allowance Reserve Account"). The amount credited to this account should be used for acquiring new machinery within the period of three years following the year in which the reserve was created. If the assessee uses the amount in this reserve account for any other purpose or does not use the amount within the specified period, the amount so used or not used shall be deemed to be the profit and shall be subjected to tax. 2.4 INCOME OF 100% EXPORT ORIENTED UNITS - SECTION 10B Section 10B applies to all the assessees who derive any profits or gains from 100% Export Oriented Units by the export of articles or things or computer software. For claiming the exemption under this section, the assessee should satisfy the following conditions a. The sale proceeds of the articles or things or computer software exported out of India must have been received in or must be brought in India by the assessee in convertible foreign exchange during the previous year or within six months from the end of the relevant previous year. Eg. For the exports made during the previous year ending on 31 st March, 2006, the proceeds must be brought into India before 30th September 2006. b. The assessee should enclose a certificate of a chartered accountant in Form No. 56G along with the return of income certifying that the deduction has been correctly claimed. c. The undertaking should not be formed by splitting up or reconstruction of existing business. If the above conditions are satisfied, the amount of deduction under Section 1 OB will be 29

side India ed within i will be -

Hiunencin g j begins to ibegins to deduction

1e deduction wiF6e avaiS5/e for a penocfoffO consecutive assessment years coi from the assessment year relevant to the previous year in which the assesses be&vas^ manufacture or produce articles or things or computer software.2.5 INCOME OF A POLITICAL PARTY - SECTION 13A_______

c.

30

Following types of incomes earned by a political party are exempt from tax a. Income from House Property, Capital Gains or Income from Other Sources b. Any income by way of voluntary contributions For claiming the deduction under this section, the political party needs to satisfy the following conditions i. The political party maintains such books of accounts and documents so as to enable the assessing officer to calculate the amount of income of the political party therefrom.

ii. The political party maintains the records of each voluntary contribution in excess of Rs. 10,000 and the name and address of each person who has made such contribution. iii. The accounts of the political party are audited by a Chartered Accountant. Specific Incomes Exempt from Tax Following incomes exempt from tax have been discussed in detail in the unit "Income from Salaries": Section 10(5) Particulars 10(10) Leave Travel Concessions or Leave Travel 10(10A) Allowance 10(10AA) 10(10B) 10(10C) Death-Cum-Retirement Gratuity Pensions Leave Encashment Retrenchment Compensation Compensation on Voluntary Retirement Scheme

Unit 2


)mmencing ebegins to

10(11) 10(12) irces 10(13) 10(13A)I 2.6 ANNEXURE tie following

any payment from a Provident Fund Accumulated balance in a Provident Fund

Agricultural Income Payment from a Superannuation FundHouse Allowance As per Rent the provisions of Section 2( 1 A) of the Income Tax Act, 1961, the term Agricultural Income meansa. Any rent or revenue derived from land which is situated in India and is used for agricultural purposes. b. Any income derived from such land by agricultural operations including processing of the agricultural produce c. Income attributable to a farm house provided that the building is situated on or is in immediate vicinity of the land and is used as dwelling house, store house or other outbuilding and the land is assessed to land revenue or a local rate or alternatively, the building is situated on or is in immediate vicinity of the land (which though not assessed to land revenue or local rate) is situated outside the urban areas. Urban area is defined as any area which is included within the jurisdiction of a municipality or a cantonment board having a population of 10,000 or more or in any area within 8 kilometers from the local limits of such municipality or cantonment board.

3 as to enable % therefrom. n in excess of [contribution.

come from

llowance

Tax treatment of Agricultural IncomeFor deciding the tax treatment of agricultural income, following steps are involved a. Calculate Total Income including Agricultural as well as Non-agricultural Income b. Calculate the total tax liability on the Total Income described above. c. Consider the Agricultural Income and increase the same by first slab of income on which the tax rate is Nil i.e. Rs. 50,000

tieme

31

Taxatio n

Unit 2

d . C a l c u l a t e t h e t o t a l t a x o n t h e a m o u n t s t a t e d

i n " c " a b o v e . e . D i f f e r e n c e b e t w e e n " b " a n d " d " a b o f.

v e i s t h e G r o s s T a x P a y a b l e .

T h e G r o s s T a x P a y a

b l e c a l c u l a t e d i n " e " a b o v e s h a l l b e r e d u c e d b y

t h e T a x R e b a t e s a s p e r t h e p r o v i s i o n s o f S e c t i

o n 8 8 , 8 8 B a n d 8 8 C . ^ A c t i v i t y B : T h e t o t a l i n c o m

e e a r n e d b y M r . A s h o k f o r t h e A Y 2 0 0 7 2 0 0 8 w o r k s

o u t t o R s . 3 , 0 0 , 0 0 0 a n d t h e a g r i c u l t u r a l i n c o m e

e a r n e d b y h i m w o r k s o u t t o b e R s . 8 0 , 0 0 0 . C a l c u

l a t e h i s t a x l i a b i l i t y f o r t h e A Y 2 0 0 7 2 0 0 8 .

> g T A c t i v i t y C ; M r . A s h o k c a l c u l a t e d h i s i n c o m e f o

Sol C a l a . b . c . d . e . C o n c l u s i32.7 2ILL

UST RAT ION 1 . D u r i n g t h e A s s e s s m e n t Y e a r 2 0

0 7 2 0 0 8 , A g r i c u l t u r a l I n c o m e o f M r . A s h o k w a s R s

. 1 , 5 0 , 0 0 0 a n d t h e N o n A g r i c u l t u r a l I n c o m e w a s R s . 2 , 2 0 , 0 0 0 . C a l c u l a t e t h e t a x l i a b i l i t y o f M

r . A s h o k f o r t h e A Y 2 0 0 7 2 0 0 8 . S o l u t i o n C a l c u l a t i

on of Tax Liab ility of Mr.

A s h o k

Unil 2


a. Total Income (Agricultural and Non-Agricultural) 3,70,000 b. Tax on above 61,000 Tax Rebates c. Agricultural Income + Basic Exemption Limit i.e. Rs. 1,00,000 d. Tax on above 25,000 e. Difference Tax Payable Rs. 36,000(b-d) jRs. 3,00,000 Iculate his tax 2. During the Assessment Year 2007-2008, Agricultural Income of Mr. Ashok was Rs. 58,000 and the Non-Agricultural Income was Rs. 1,20,000. Calculate the tax liability of Mr. Ashok for the AY 2005-2006. Solution Calculation of Tax Liability of Mr. Ashok a. Total Income (Agricultural and Non-Agricultural) 1,78,000 b. Tax on above: 10,600 ind calculated i his agricultural is tax liability for c. Agricultural Income + Basic Exemption Limit= 58,000+1,00,000 d. Tax on above: 6,600 e. Difference between b and d i.e. Gross Tax Payable 4,000 Conclusion Had the agricultural income been totally exempt from tax, the tax liability of Mr. Ashok would have been Rs. 2,000 (i.e. tax payable on Rs. 1,20,000). However, as the agricultural income is considered for deciding the tax slabs, the gross tax payable by Mr. Ashok works out to Rs. 4,000 I. Ashok was Rs. Iculate the tax 2.8 SUMMARY __________________________________________________ Although an assessee is required to pay tax on all income, there are certain categories of income that are free from Income tax. Such categories have been discussed in this unit. They are dealt with in section 10 of the income tax act.

33

Taxation

The following incomes are exempt from Income Tax:

6, 7, 8, 9,2.9

Incomes exempt as per the provisions of Section 10 of the Act. Incomes of newly established industrial undertaking in Free Trade Zones. Incomes of newly established 10% EOUs. Income of Political parties. KEYWORDS

Income Exempt from Tax: While calculating the total income of the Assessee, certain incomes will not be considered as the incomes chargeable to tax. Newly Established Undertakings in Free Trade Zones, Software Technology Park: Section 10A- applies to all the assessees who derive the profits or gains from an undertaking engaged in the export of an article or things or computer software are exempt from tax. Income of 100% Export Oriented Units : SECTION 10B- applies to all assessees who derive any profits or gains from 100% Export Oriented Units by the export of articles or things or computer software. 2.10 SELF-ASSESSMENT QUESTIONS Q1. State and discuss any fifteen types of incomes which are exempt from tax as per the provisions of Section 10 of the Income tax Act, 1961. Q2. Discuss the provisions of Section 10A in respect of exemption available to undertakings situated in Free Trade Zones etc. Q3. Discuss the provisions of Section 1 OB in respect of exemption available to 100% Export Oriented Units. Q4. Write short notes on the following:

Income of a political party Agricultural Income

34

Taxatio n

Unii .>

. j

d.

*.'

3 . 1 M E A N I N G O F S A L A R Y [ I N C L U S I V E D

Terec ern the A m fu n unr int ei

c.

A mi th ea ta xa l N

Unit 3

Income from Salaries

yea r,

a. Terminal Compensation : This includes any amount of compensation received or receivable by the employee from the employer at the time of termination of his employment or at the time of modification of terms and conditions in connection with the employment. b. Amount from an unrecognised provident fund or unrecognised superannuation fund : This includes the amount received from the unrecognised provident fund or unrecognised superannuation fund representing the employer's contribution and interest thereon. c. Amount received under Keyman Insurance Policy : Any amount received by the assessee under a Keyman Insurance Policy including the bonus on such policy is taxable under the head salaries. Note: Keyman Insurance Policy is taken by a person (usually employer) on the life of another person (usually a senior employee) where the employee pays a key role in the organisation of the employer. If the maturity proceeds of such policy are received by the employee, the same are taxed as Income from Salaries. Basis of Charge (Section 15) As per section 15, the following income shall be chargeable to income-tax under the head "salaries":12, Any salary due from an employer (or a former employer) to an assessee in the previous year, whether paid in that previous year or not; 13, Any salary paid or allowed to him in the previous year by or on behalf of an employer (or a former employer) though not due in that previous year or before it become due to him; 14, Any arrears of salary paid or, allowed to him in the previous year by or on behalf of an employer (or a former employer) if not charged to Income-tax in any earlier previous

W he re an y sa la ry is pa id in th e ad va nc e is in cl ud ed in th e to ta l in co m e of an y pe rs on fo r an y pe

rvious, year, it shall not be included again in the total income of the person when the salary becomes due.

If the salary is payable on a monthly basis, it normally become due at the end of the month although it is paid in the next month. In this case, it will be taxable on

39

Taxation

'due' basis because 'due' is earlier than 'receipt'. Therefore, salary is normally taxable from April to March as the salary of March becomes due at the end of the month. However, in some cases the salary becomes due on the 1 st day of the next month, In that case we shall tax the salary from March to February because salary of the month of March of current year will be due only in the next financial year and salary of the month of March of previous year became due only on 1 st April of the current year. The head of income in the form of Income from Salaries is applicable in respect of the remuneration received by an employee from the employer. For charging the income in the form of salaries, there needs to be an employer-employee relationship between the payer and the payee. E.g. Remuneration received by a University Teacher received from his college will be treated as his salary. However, similarly, any remuneration received by a Member of Parliament or a Member of Legislative Assembly is taxable as Income from Other Sources. If an employee receives the salary from more than one employer during the previous year, salary from each source will be clubbed together to calculate Income from Salaries.

Exceptions 15, A Member of Parliament or of state legislature is not Government employee and therefore, remuneration received by him is not taxable as salary income, but as income from other sources. 16, Partner's Salary: Any salary, bonus, commission or remuneration due to or received by an assessee from a firm, in which he is partner, shall not be taxable under the head "Salaries" as there is no employer-employee relationship. It will, however, be taxable under the head "Profits and gains of business or profession." Important Concept 1 ] Surrender of SalaryAny salary surrendered by the employee to the Central Government, under the Voluntary Surrender of Salaries (Exemption from Taxation) Act, 1961, will not k %:*"~1 included while computing his taxable income, whether he is a private sector/ public sector or Government employee.

140

Unit 3


2] Foregoing of Salary Once salary has been earned by an employe e, it becomes taxable in his hands though he may subsequ ently waive the right to receive the same from the employe r. The waiver of salary by the employe e would be treated as applicati on of the income and salary though waived would be taxable

in his han ds.

3 ] P l a c e o f A c c r u a l [ S e c t i o n 9 ( 1 ) ]The gold en rule is that salar

y w i l l b e d e e m e d t o a c c r u e o r a r i s e , a t a p l a c e w h e r e s e

or arise in India. If a person retires and settles abroad, and receives any pension on account of the same, such pension shall be an income which is deemed to accrue or arise in India as the services on account of which pension accrues were rendered in India.4] Arrears of Salary

Althou gh salary is taxable on 'due'

or' recei pt whic heve r is the earlie r basis , but if there are arrea rs of salar y whic h have not been taxed in the past, such arrea rs will be taxed in the year in whic h these arrea rs are paid or allo wed to the

e m p l o y e e . F p r e x a m p l e , i f t h e g o v e r n m e n t a n n o u n

rs of salary relate to past periods in the past year. In such cases the assesse e can claim relief of income tax under section 89(1).

ee becau se salary is taxabl e when it becom e due or when it is paid, which ever is earlier.

5] Basis of Accountin gThe provisi ons of section 145 which relate to the metho d of accoun ting are not attracte d in the salary incom e of the assess

6] Ex em pt Inc om eIncom e which does not form part of total income is called as income exempt from tax as per sectio n 10 to 13 A, certain

i n c o m e a r e e it h e r t o t a ll y e x e m p t f r o m t a x o r e x e m p t 41 u p t o a c

Taxation

Therefore, these incomes, to the extent they are exempt, are not included in the total income of an assessee for computation of his total Income.

7]

Bonus

Bonus is taxable on receipt basis. Therefore, it will be included in the gross salary only in the year in which the bonus is received. If bonus is received in arrears, the assessee can claim relief u/s 89(1).

3.2 EXEMPTIONS; SECTION 10 (5) TO 10(14)_________________________ 3.2.1 Section 10(5): Leave Travel Concession (Read with Rule 2B)Value of travel concession or assistance received by an individual from his employer or former employer for himself and his family in connection with his proceeding:

Non

17, On leave to any place in India 18, To any place in India after retirement from service or after the termination of his service shall be exempt"Family", for the purpose of this provision means:

19, The spouse and children; and 20, Parents, brothers and sisters of the individual wholly or mainly dependent on the individual. Note : 21, The exemption shallnctf be available to more than two surviving children of an individual after 1 October 1998. This restriction shall not apply in respect of children bora before 1st October, 1998 and also in case of multiple births after one child. 22, The exemption shall be available in respect of 2 journey s performed in a block of 4 calendar years commencing from the calendar year 2002 to 2005. The block of 4 calendar years is uniform for all the employees. Where an individual does not avail such travel concession or Assistance during any such block of 4 calendar years, the value of travel concession or assistance first availed during first calendar year of the immediately succeeding block. This exemption shall be in addition to the exemption that will be available in respect of two journeys for that succeeding block. Therefore,42

(i)(ii)

Unit 3


.block of 4 block of 4 H avail iyears, the year of the - exemption , Therefore.

1 only one trip can be carried forward to be availed in the immediately succeeding block. The next block of calendar year is 2006-09. e.g. Mr. Ashok can claim the exemption for two journeys in the block of four years i.e. 1998-2001. If Mr. Ashok has availed the exemption only once or has not availed any exemption at all, he can carry over the exemption to the next block of four years i.e. 2002-2005 provided that he avails the exemption of LTC in the first calendar year of the next block i.e. 2002. In Note: he deduction under this section is applicable to the expenses incurred in connection with the travel by air, by rail or by road. It does not cover any other expenses like lodging and hoarding in connection with the travel.

3.2.2 Section 10(10); Gratuit y: This is the amoun t payabl e by the emplo yer to

the employee as recognition for the long !p rm association of the employee with the employer. The gratuity may be payable by the iiiployer-

Salaries" while the amount paid by the employer on the death of the employee is xed as "Income from Other Sources". aj Government employee: Any death cum retirement gratuity received by government employees is wholly exempt from tax. h] Employees covered by The Payment of Gratuity Act, 1972: Any gratuity received by an employee covered by the said Act, is exempt from the tax to the extent' of the least of the following: (i) Rs.3,50,000 (ii) 15 days salary (out of 26 days) based on last drawn salary for each completed year of service or part of the year-in excess of 6 months; however in case of an employee who is- employee in a seasonal establishment & is not so employed

To the employee on his retirement To the legal heirs of the employee on the death of the employeeThe amount paid by the employer to the employee on his retirement is taxed as "Income from

43

Taxation

throughout the year, the exemption shall be for 7 days wages for each season; or v, (iii) Gratuity actually received. *Salary means basic + Dearness Allowance (D.A.) c] Any other employee: Any gratuity received by any other employee on retirement, death, termination or resignation is exempt from tax to the extent of the least of the following: i) Rs.3, 50,000-; or . ii) Half month's salary (on the basis of last 10 months average # salary immediately preceding the month in which any such event occurred) for each completed year of service; or iii) Gratuity actually received. # Salary means Basic + D.A. (if provided in terms of employment) + Commission (as% of turnover achieved by the employee)

I.

Jv)

3.2.3 Pension SectionlO (10A)Pension indicates a periodical payment received by the employee from the employer he ceases to be the employee. Pension received is taxed as salary for all practical purposes.

Calculation of pension can be done in basically two forms :Uncommuted Pension: Uncommuted pension refers to regular periodical pensi employee, which is taxable to all kinds of employees. Commuted Pension: Commuted Pension is a lump-sum payment in lieu of periodii pension:

23, In case of commuted pension received by government employee is wholly exempt including judges of High courts and Supreme Court. 24, Non-government employees can avail exemption to the following extent:i) If employee is in receipt of gratuity, 1/3 of commuted value (i.e. 100%)

ii) If not, then one-half of commuted value.

44

Unit 3


s nsion to f

3

t o y e r a f t e r 1 p u r p o s e s .

periodica l lolly exempt, ;nt: 100 %)

l

p e

(c) i)

ieof s' 10 in% C thof on e the tri h sal bu a ary tio n of n dsthe by ofem ce e plo nt myee ral pl) go o und ve y er rn eesect m . ion en 80 t ii) CC to S D. th u e iii) c pe h Em ns c plo io o yee n nts sc ri con he b trib m ututio e ion to is n the ispen fir d sio st en in d sch cl u em ud cte ed ib(to un lethe de (t ext r o ent th thof e e 10 he e% ad xtof 'S e the al ntsala ar

r y o f t h e e m p l o y e e ) i s d e d u c t i b l e u n d e r s e c t i o n

ham 0 np C dl C ofo D. rey . cie pie iv) en: W t. he A n 3. n pe 2. y ns 4 io L a ea m n v o is re e u ce S n iv al t ar ed y r ou [S e t ec of ti c th o e i e n af 1 v e or 0 d es (1 0 ai A a d A s a )] m c ou25, In a nt c s it as h wi e ll of e be G q ch o u ar v i ge er v ab n a m l le e e in nt n th e t e

8

of leave at the time of retire ment whet her on super annu ation or other wise is exem pt. , 26, Othe r Employe es: least of the following exempt: i) C a s h e q u i v a l e n t o f

th e lea ve (o n the ba sis of the av era ge of las t 10 mo nth s' *sa lar y) to the cre dit of the em plo ye e at the tim e of reti re me nt (ca lcu lat ed

atsalar 30 day); ysor cr iii) ed it Rs. for 3000 ea ch00; coor miv) pl Actu ete d al ye amo ar ofunt ser recei vi ceved. ): *Sala orry = ii)Basic + 10 D.A. (if mo provi nth ded s' in terms sal of ary empl (av oyme nt) + era Com ge missi ofon (as las %,of t Turn 10 over achie mo ved) nth s^ A

ctivity A: 1. Mr. Ani l reti red fro m A Ltd . aft er co mp leti ng ser vic e of 39 yea rs and 9 mo nth s. His sal ary dra wn at the tim e of reti re me nt wa s

R s . 1 0 , 5 0 0 p e r m o n t h w h i l e t h e a v e r a g e s a l a r y d r a

w. n 9, 8 f0 o0 rp er t m ho e nt h. pT rh ee c ac e tu d al i a nm go u 1 nt 0 of gr mat o ui n ty t re h ce s iv e wd ob ry k hi em d at th oe u ti t m e t re o tir e Rm se

nt wa s Rs. 2,8 0,0 00. Cal cul ate the am oun t of gra tuit y exe mp t fro m tax ass um ing that he is cov ere d by the pro visi ons of Pay me nt of Gra tuit y Act ,

1 9 7 2 . W i l l t h e c a l c u l a t i o n s b e d i f f e r e n t i f h e i s n

o? t45

c o v e r e d b y t h e P a y m e n t o f G r a t u i t y A c t , 1 9 7 2

T a

2. Mr. Ashok retired from A Limited, a private sector organisation, from 30th Jui 2006. He receives the pension of Rs. 6,000 per month till 31st December 2005, Since 1st January 2006, he gets 60% of his pension commuted for Rs. 90,000, Calculate the amount of pension includible in the salary income for the AY 20072008. Assume that Mr. Ashok is not in receipt of the gratuity. Will calculations be different if Mr. Ashok retires as a Central Government employee?

c

3. R

46

v

retirement of a

w

workman for an: dinary action but

Unit 3


ii. Retirement of a workman on reaching the age of superannuation. iii. Termination of service of workman as a result of non-renewal of contract of employment iv. Termination of service of workman on the grounds of continued ill health. Compensation received by workman at the time retrenchment is exempt to the extent least of the following-: a. * Amount calculated under Industrial Dispute Act, 1947; or 130th June nber2005. Rs. 90,000. e AY 2007julations be b. Rs. 500000/-; or c. Actual amount received. * under the said Act a workman is entitled to retrenchment compensation equal to 15 days' average pay for every completed year of service or any part thereof in excess of 6 months. 3.2.6 Voluntary Retirement/Separation scheme [Section 10(10C)] This Section deals with the amount paid by the following types of employers at the time of Voluntary Retirement Scheme: ince Manager ,0 years and 7 e encashment ear of service. - whe had No i av c cot d.AT

i

b. c. d.

5.2 EXPENSES ALLOWED AS DEDUCTIONS - SECTION 30 TO SECTIONS? __________________________________________________________ 5.2.1 Rent, Rates, Repairs, Taxes and Insurance on Buildings - Section 30In respect of building used for business and profession, following expenses are expressly allowed as deduction while calculating the profits from business and profession: a. b. c. d. When the premises used for business and profession is taken on rent, the rent paid or payable by the assessee to the landlord are allowed as expenses. The amount of current repairs incurred by the assessee for the purpose of maintaining an already existing building is allowed as expenses. The amount of municipal taxes paid by the assessee is allowed as expenses. Any insurance premium paid by the assessee for insuring the building against the risk of damage or destruction is allowed as expenses.

c.

5.2.2 Repairs and maintenance of machinery, plant & furniture - Section 31following

N i f o

Unit 5

Profit and Gains from Business and Profession

a. The amount of current repairs incurred by the assessee for the purpose of maintaining already existing machinery, plant or furniture is allowed as expenses. b. Any insurance premium paid by the assessee for insuring the machinery, plant or furniture against the risk of damage or destruction is allowed as expenses.5.2.3 Depreciation - Section 32

The tax implications of Depreciation are discussed in detail in the Annexure. Other Sections Allowability of expenses under sections 33AB, 33ABA, 33AC, 35, 35ABB, 35AC, 35CCA, 35CCD, 35D and 35E are discussed in the chapter on "Tax Audit".5.2.4 Other deductions - Section 36

Following deductions are expressly allowed as expenses while calculating profits from business and profession: a. Any insurance premium paid for insuring stocks and stores against risk of damage or destruction. [Section 36(l)(i)j b. Any premium paid by the assessee by cheque as an employer to effect or keep in force insurance on the health of his employees. In normal language, insurance premium for Group Insurance Scheme. [Section 36(l)(ib)] c. Any amount paid to an employee as Bonus or Commission for services rendered where such amount would not have been payable to him as profits or dividend if it had not been paid as bonus or commission. [Section 36(l)(ii)J Note: The above provision is to curtail the tendency on the part of companies to avoid the tax by showing their members as employees and paying them bonus or commission instead of paying them the dividend. d. Any amount of interest paid in respect of funds borrowed for the purpose of business. [Section 36(l)(iii)] Note: The amount of interest on funds borrowed for the extension of existing

b us in es s fo r a n y p er io d c o m m e n ci n g fr o m th e d at e o n w hi c h th e fu n ds w er e b or ro

wed till the date such asset was first put to use, shall not be allowed as deduction. In other

107

Taxation

words, the Profits & Gains from Business & Profession interest on funds borrowed for the period before the asset was first put to use needs to be capitalised. e. Any amount paid by the assessee as an employer by way of contribution to a recognised provident fund or a superannuation fund [Section 36( 1 )(iv)]. Any amount paid by the assessee as an employer by way of contribution to an approved gratuity fund created by him for the exclusive benefit of the employees. [Section 36(1 )(v)] In order to curb the tendency on the part of certain employers to deduct the amounts from the salaries and wages payable to the employees towards the various welfare schemes like PF, ESI etc. and not paying the same amounts to the respective authorities for a very long time, the Act provides that any amount deducted from the salary of the employees towards the employee's contribution to provident fund or ESI or superannuation fund or any other welfare scheme for the benefit of the employees is treated as the income of the employer. However, if such employees' contribution is actually paid on or before the due date for filing of return of income, the same will be allowed as deduction. [Section 36(1) (va)]

f.

g.

h. The amount of any bad debts which is written off by the assessee as irrecoverable in the books of accounts will be allowed as deduction if such debt has been taken into consideration as income in the previous year or any of the earlier previous year and such debt must be incidental to the business or profession carried on by the assessee. However, any provision made for the bad debts will not be allowed as the expenditure while calculating the profits from business and profession. [Section 36(1 )(vii)] i. Any bona fide expenditure incurred by a company for promoting the family planning among its employees is allowed as expenditure. If such expenditure is of capital nature, 1/5th of such expenditure is allowed in the year in which it is incurred and the balance is deductible in four installments in the next four years. [Section 36(l)(ix)]

108

5.2.5 ed wholly and exclusively for the purpose of business or profession is allowed as a Gener deduction while computing "Profits and Gains from Business or Profession". al Deduc tions Sectio n 37(1) Any other expen diture (not being the expen diture referr ed to in Sectio n 30 to 36 of the Act) and not being the expen diture in the natur e of capita l expen diture or perso nal expen diture of the assess ee and incurr

UnitS


f u lf il l e d t o a a. The expenditure should not v a be capital expenditure. il d b. The expenditure should not e d be personal expenditure. u c. The expenditure should have c ti been incurred during the previous o n s year. ? d. The expenditure should have been incurred wholly and exclusively for the purpose of business or profession. The above description indicates that Section 37 is a residuary section. The expenditure which is not covered by Sections 30 to 36 gets covered by this section. Following basic conditions should be satisfied for claiming the deduction under this section. >gT Activity A: 1. Discuss deduction under section 30 of Income Tax Act. 5 . 3 C A P I T A L E X P E N D I T U R

2. What are the deductions under section 36 of Income Tax Act?

3. Define General Deductions. What are the conditions to be

E n VS. u REV e EN UE EXP EN DIT URE As capit al expe nditu re is not allo wed as a dedu ction whil e com putin g the Profi ts from Busi ness and Prof essi on, corr ect dete rmin atio n of capit al expe ndit ure and reve

109

u

'"""

Taxation

expenditure is of utmost importance. The terms are not specifically defined under the Act. It is a matter of interpretation based upon the basic accounting practices. Following are some of the types of expenditures which are held as capital expenditures and not allowed as deductible expenditures while calculating the profits from business and profession: a. b. c. d. e. 1s

Expenditure incurred by a company in connection with the issue of new shares Registration charges in connection with the increasing of authorised share capital of the company Expenditure in connection with the issue of rights shares - CIT Vs. Motor Industries Company Limited Expenditure incurred in connection with the issue of bonus shares - CIT Vs. Ajit Mills Limited Expenditure incurred in connection with the issue of preference shares of the company - Bombay Burmah Trading Corporation Limited Vs. CIT Expenditure incurred for shifting of the registered office - CIT Vs. Jamshedpur Engineering and Machine Company Limited < Expenses for launching a new project-Indian Oxygen Limited Vs. CIT Expenses incurred for getting the proj ect report prepared even if the proj ect does not materialise. !

I * ;

f. g.

ih.

Following are some of the types of expenditures that are allowed as revenue expenditures while calculating the profits from business and profession: a. b. c. Amount paid to the employees for inducing them to take premature retirement - CIT Vs. Assam Oil Company Limited Expenditure incurred on stamp duty, registration fees, legal expenses on the issue of debentures by the company - Premier Automobiles Limited Vs. CIT Expenditure incurred as discount on issue of debentures - Madras Industrial Corporation Limited Vs. CIT h i.

a

ty

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d. Premium on the redemption of debentures - CIT Vs. Tungabhadra Industries Limited Brokerage or commission paid to obtain certain premises on lease

e. f. Amount paid to the competitor inorder not to bid at auction sale to enable to get the stock at reasonable price A g. Legal expenses in connection ll o with resolving the winding up w a petition by the shareholders bl e Business Expenditure E x The basic requirement of Section p 37 is that the expenditure should e have been incurred by the n assessee wholly and exclusively di for the purpose of business. tu Unless this condition is satisfied, re the expenditure incurred will be considered to be disallowable expenditure. Whether the expenditure is incurred wholly E and exclusively for the business x or not is a matter of p interpretation. Following are e some of the cases of n expenditures which are di considered to be allowable tu business expenditure or re disallowable business in c expenditure: o

n n e c ti o n w it h t h e st a m p d u ty , r e g is tr a ti o n c h a r g e s, l e g a l e x p e n

s e s e t c c. . i n d.

paid by the assessee to the Government for legalising unauthorised construction - Jaswant Trading Company Vs. CIT Expenditure for stamp duty and registration charges for agreement with bank for overdraft facilities Interest paid to the sales tax

c department on arrears of sales o tax payable n n e. Interest paid on fixed e c deposits borrowed to pay the t excise duty i o f. Interest paid for delayed n remittance of provident fund wdues i t g. Interest paid on funds h borrowed for the payment of t dividend h h. Compensation paid by the e assessee for the breach of contract - CIT Vs. Todi Tea l Company Limited e a i. Damages paid to a worker ill s to dismiss him in the interest of e business j. Expenditure by way of bank guarantee commission - Vikram A Mills Limited Vs. CIT m o u n t

c.

Compensation paid by the assessee for the breach of contract in respect of purchai of a capital asset - Swadeshi Cotton Mills Company Limited Vs. CITd. Litigation expenses in connection with the recovery of a debt which is not a trading debt e. Penalty paid to the sales tax department for the delayed payment of sales tax dues CIT Vs. Jolly Steel Industries Private Limited Penalty paid for the delayed remittance of delayed PF dues

f.

5A EXPENDITURE NOT ALLOWED AS DEDUCTIONS________________Following expenditures are expressly not allowed to be deducted while computing the Profits from Business and Profession: 5.4.1 Section 40(a) a. Any interest, royalty and fees for technical services which is payable outside India or in India to a non-resident (not being a company or a foreign company) on which tax has not been deducted or after deduction has not been paid before the expiry of time prescribed under the Act.

b. Any interest, commission or brokerage, professional fees or fees for technical services,

UnitS


calculating the income from business or profession. However, the said amounts will be allowed as expenditure in the previous year in which they have been paid. c. Any sum paid on account of rate or tax on the profits or gains of any business or profession or assessed at a proportion of or otherwise on the basis of any such profits or gains. Any payment which is chargeable under the head "Salaries" payable outside India or to a non-resident and if the tax has not been thereon or deducted therefrom.

d.

e. Any sum paid on account of wealth tax. 5.4.2 Section 40(b) This section refers to the interest on capital and salary/remuneration paid by a firm to its partners. The discussions about the extent to which these payments can be made by the firm to its partners have been made in the unit on "Taxation of Partnership Firms". Any payment in excess of the limits specified therein is not allowed while computing the Profits from Business and Profession. 5.4.3 Section 40A (2) If the assessee incurs any expenditure in respect of which

t h e p a y m e n t h a s b e e n m a d e o r is t o b e m a d e t o c e rt a i n s p e c if i e

d perso ns and the Asse ssing Offic er is of the opini on that the said expe nditu re is exces sive or unrea sona ble as comp ared to the mark et value of the good s, servi ces or facilit ies for whic h the paym ent has been made

o sessee therefrom, such r excessive or unreasonable expenditure shall not be allowed i as business expenditure. s For the purpose of this Section, t the term "Specified Persons" o may take the following forms b If the Assessee is an Individual e m a d e o r t h e b e n e f i t d e r i v e d b y t h e a s a. Any relative (i.e. spouse, brother, sister, lineal ascendant or descendant) of such individual. h. Any person (individual, company, firm etc.) having a substantial interest in the business or profession of the individual or any director or partner of such company or firm or any relative of such person.

11 3

Taxation

c.

Any person (company, firm etc.) of which a director or partner has a substantial interest in the business or profession of the individual or any director or partner of such company, firm etc. or any relative of such person. Any person who carries on a business or profession and in his business or profession, the assessee himself or his relative has a substantial interest.

d.

If the Assessee is a company a. b. Any director of the company or his relative Any person (individual, firm, company etc.) having a substantial interest in the business or profession of the company or any director or partner of such firm or company or the relative of such person. Any person (company, firm etc.) of which a director or partner has a substantial interest in the company or any director or partner of such company or firm or the relative of such person. Any person who carries on a business or profession and in his business the assessee or any director of such company or relative of such director has substantial interest.

c.

d.

If the Assessee is a Firm a. b. c. Any partner of the firm or his relative Any person having the substantial interest in the business or profession of the firm or any director or partner of such company or firm or any relative of such person. Any person of which a director or partner has substantial interest in the business or profession of the firm or any director or partner of such company or firm or any relative of such person. Any person who carries on business or profession and in his business or profession the assessee or any partner of such firm or relative of such partner has substantial interest.b.

d.

Meaning of "Substantial Interest" A person shall be deemed to have substantial interest in a business or profession ifa. If the business or profession is carried on by a company, such person is the beneficial owner of '20% of the shares carrying the voting rights.

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b.

In any other case, such person who is beneficially entitled to more than 20% of the profits of such business or profession.

5.4.4 Section 40A (3) - Read with Rule 6DD if an assessee incurs any expenditure in respect of which payment is made in a sum exceeding Rs. 20,000 otherwise than by a crossed cheque or a crossed demand draft, 20% of such expenditure shall not be allowed as deduction. However, Rule 6DD provides for certain exceptions stated below where the expenditure, even exceeding Rs. 20,000, shall be allowed as expenditure even though the same is not made by a crossed cheque or a crossed demand draft. Exceptions : a. Payments made to banks

b. If the payment is made in a village or a town which is not served by any bank, to any person who ordinarily resides or is carrying on any business or profession or vocation in any village or town. c. If payment is required to be made on a day on which banks were closed on account of holiday or strike.

5.4.5 Section 40A (7) Any amount of provision made by the assessee for the payment of gratuity to his employees on their retirement or termination of their employment for any reason shall not be allowed as expenditure while computing the Profits from Business and Profession, except when the provision has been made for the purpose of payment made as a contribution to an approved gratuity fund or when the payment has been made for any gratuity that has been payable during the previous year. In other words, the amount of gratuity will be allowed as deduction only when: a. the amount of gratuity has actually become payable to the employees during the previous year. b. the provision has been made for the payment of a sum by way of contribution to an approved gratuity fund. 5.4.6 Section 43B Section 43B of the Act provides that the following payments are allowed as deduction only if they are actually paid for. However, if the assessee follows mercantile system of

115

Taxation

accounting, the said payments can be claimed on "due" basis as well provided that the payment of the same is made on or before the due date of furnishing the return of income. The various payments which are referred to the said section are as below : a. Any sum payable by the assessee by way of tax, duty, cess or fee by whatever name it may be called. In practical situations, these amounts include taxes like sales tax, excise duty, customs duty, professional tax etc. It may happen in practical situations that some of these payments don't affect the profitability of the assessee. Eg. Indirect taxes like sales tax, excise duty etc. Still they are added back as disallowable expenditure as per the provisions of the said section. Any Employer 's Contribution payable by the assessee towards any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of the employees. Any sum payable by the employer to the employee as bonus or commission for services rendered, where such sum would not have been payable to him as profits or dividend if it had not been paid as bonus or commission. Any sum payable by the assessee as interest on any loan or borrowed by him from any public financial institution or state financial corporation as per the terms on the agreement. Any sum payable by the assessee as interest on any loan or advances borrowed by him from any scheduled bank as per the terms of the agreement. Any sum payable by the employer in respect of any leave standing to the credit of the employee (i.e. in simple words, Leave Encashment)

A ct iv it y B : 1. What do you mean by disall owan ces under the Act?

b.

c.

d.

e.

f.

116

It goes without saying that if any of the above amounts are not allowed as deduction in any of the previous years but are paid during the current previous year, they will be allowed as deduction during the current previous year.

c.

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2. Discuss the conditions to be fulfilled under section 43B of Income Tax act.

3. If assessee incurs cash expenses of Rs. 50000, what will be amount which can be disallowed under Act?

4. Discuss Section 40A (2) of Income Tax Act.

5.5 ALLOWABILITY OF CERTAIN EXPENDITURES a. Following expenditures which were subject to certain restrictions earlier, are now allowed as expenditures without any limit -

Entertainment Expenditure Advertisement Expenditure Travelling Expenditure Expenditure on the maintenance of Guest House

Note: Expenditure incurred by an assessee on advertisement in any brochure, tract, pamphlet or like published by a political party shall not be allowed as business expenditure. b. Deposits made under "Own Your Telephone Scheme" and 'Tatkal Telephone Deposit Scheme" is allowed as business expenditure. c. Professional Tax by a person carrying on business is allowed as business expenditure.

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Taxation

fr li;

d. e. f. g.

Expenditure incurred by way of fees etc. in connection with any proceedings under Income Tax Act are allowed as business expenditure. Sales tax and expenses in connection with the proceedings for the assessment of sales tax are allowed as business expenditure. Expenditure incurred in connection with the local festivals like Diwali etc. are allowed as business expenditure. Insurance premium paid for the Loss of Profit policy is allowed as business expenditure.

h. Any expenditure incurred by the assessee for any purpose which is an offense or which is prohibited by law shall not be allowed as business expenditure. i. As per the provisions of Section 35DD A of the income tax Act, if the assessee incurs any expenditure by way of payment of any amount to an employee at the time of voluntary retirement in accordance with any scheme of voluntary retirement, l/5th of the amount shall be deducted while calculating the profits from business and profession of that previous year while the balance shall be deducted in four equal installments during each of the following previous years. Computation of Profits from Business and Profession For the purpose of calculation of Profits from Business and Profession, Profit and Loss Account prepared as per the Financial Accounting is considered to be the starting point and after making the adjustments to the profit as per Profit and loss Account, Profits from Business and Profession as per the Income tax Act, 1961 is arrived at. Atypical format for such calculations is given below Profit as per Profit and Loss Account Add: Expenses debited to P & L Account, but disallowed for Income tax purposes a. b. c. d. e. f. g. Capital Expenditure Personal Expenditure Income Tax / Wealth Tax Expenditure disallowable under Section 40 Expenditure disallowable under Section 40A Other disallowable expenditure Depreciation as per Profit and Loss Account

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Add: Income not credited to P & Salary to Mr. Pawar L Account but to be treated as Contribution to PF income Income tax Less: Amounts credited to P & L Previous year expenses Account but not taxable from Depreciation Income tax Purposes as Profits from Business and Profession: Net Profit a. b. Dividend Income (NonIncome by way of rent taxable) (Taxable as Income from House Property) c. d. e. f. Capital Gains (Taxable as Refund of Income tax Any other refund not Bad Debts recovered not Capital Gains)

0, 30,000 0, 15,000 0, 10,000 0, 03,500 0, 18,000 1, 51,000 7, 95,000 Total

Total

allowed as deduction earlier allowed as deduction in earlier years g. Depreciation as per Income tax rules 5.6 ILLUSTRATIONS _____________________________________________

1. Following is the Profit and Loss Account of Mr. Pawar for the year ending on 31 st March 2007. Expenditure Salaries & Wages Advertisement Expenses General Expenses Insurance Expenses Interest on Bank Loan Interest on Capital

4, 80,000 0, 28,000 0, 15,000 0, 04,500 0, 28,000 0, 12,000

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Taxation

Additional Information a. b. Depreciation as per Income Tax rules (including the depreciation on sign board mentioned below) amounted to Rs. 24,500. Salaries and Wages include an amount of Rs. 60,000 being the salary paid to Mrs. Pa war, who is employed as Administration Manager. The salary is considered to be excessi veto the extent of Rs. 12,000. General Expenses include the expenditure incurred by Mr. Pawar for hosting a party in the honour of his friend who has returned from USA, amounting to Rs. 5,000. Interest on Bank Loan includes an amount of Rs. 8,000 being the interest for the quarter ending 31 st March, 2005 which is not paid till the date of filing the return. Advertisement Expenses include an amount of Rs. 3,000 towards fixing a permanent signboard on the office premises. Depreciation allowable on the signboard amounts to Rs. 750. An amount of Rs. 1,200 was disallowed in the immediately preceding previous year for the Employer's Contribution to PF which remained unpaid on the due date for filing the return of that year. The same was paid during the previous year ending on 31st March 2007.

c. d. e.

f.

g. Tax deducted at source on interest on debentures amounted to Rs. 3,000. Calculate the Profits from Business and Profession for Mr. Pawar for the AY 2007Solution;

Calculation of Profits from Business & Profession Particulars Profit as per Profit and Loss Account Add: Inadmissible Expenses Depreciation (Considered separately) Salary to Mrs. Pawar (Considered excessive) General Expenses being Personal Expenditure Interest on Bank Loan allowed on payment basis Cost of signboard being Capital Expenditure

Rs.

Rs.1,51,000 18,000 12,000 5,000 8,000 3,000

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Units


Contribution to PF allowable on payment basis Interest on Capital Salary to Mr. Pawar Income Tax Previous year expenses ,

1 2 0 0 1 2 , 0 0 0 3 0 , 0 0 0 1 0 , 0 0 0 3 , 5 0 0 80, 02,700

81, 53,700Less: Income not taxable as Business Income I 12 ,0

0 2. Dr. B h al e, a m e di c al pr a ct it io n er , m ai nt ai n s hi s b o o k s of a c c o u nt s o n c as h

b a s i s . Receipts Balance b/fd FConsultation Fees o Visit Fees l l Sale of Medicines o Dividend Received wInterest on Securities i Bank Interest n Rent received g Bank Loan for Car

Account for the year ending on 31 st March 2007. Calculate the Gross Total Income of Dr. Bhale for the AY 2007-2008.

Rs.18,000 40,000 70,000 65,300 20,000 18,000 12,300 24,000 80,000 12,000 22,000 26,200 12 1 59,600

i Honorarium as Paper s Setter Interest on Bank Loan Balance c/fd t Total h e R e c e i p t s a n d P a y m e n t

Taxation

Additional Information a. b. c. d. e. Rent of the clinic includes the rent paid for the quarter ending on 31 st March 2006, amounting to Rs. 7,500. Telephone in the clinic was used for personal purposes to the extent of 20%. Opening and closing stock of medicines amounted to Rs. 8,000 and Rs. 9,000 respectively. Rent received indicates the amount received from a sub-tenant who uses the clinic on table space basis. Car was purchased on 10th May 2006 and the equipment was purchased on 12th January 2007. 50% of the Medical Books were purchased on 18th April 2006 and the balance on 19th December 2006. g. A cash payment of Rs. 15,000 was given to him by one of his patients in appreciation of his services. The same were not accounted for in the books of accounts.

Solution Calculation of taxable income for Dr. Bhale Particulars Profits from Business

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