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CONCEPTS IN TAXATION

CONCEPTS IN TAXATION

CONCEPTS IN TAXATION (Part 1)

  • Definition: Taxation refers to the process of imposing taxes on individuals and businesses by the government.
  • Details: The Income Tax Act, 1961, governs income tax in India, and the Central Board of Direct Taxes (CBDT) administers it.

Key Concepts

  • Previous Year vs Assessment Year: The previous year refers to the financial year for which tax liability is calculated, while the assessment year is the year following the previous year.
  • Person: As defined in Section 2(31) of the Act, a person includes:
    • Individual
    • Hindu Undivided Family (HUF)
    • Company
    • Partnership Firm, including Limited Liability Partnership (LLP)
    • Association of Person (AOP) or Body of Individual (BOI), whether incorporated or not
    • Local Authority
    • Artificial Juridical Person, not falling within any of the above categories
  • Assessee: As defined in Section 2(7) of the Act, an assessee is a person liable for payment of taxes or any other sum of money under the Act.

Income

  • Definition: As defined in Section 2(24) of the Act, income includes:
    • Profits and Gains from Business or Profession
    • Dividend
    • Capital Gains
    • Gifts received from a non-relative (covered by Section 56)
    • Movable or Immovable Property received at below market price (as per provisions of Section 56)
    • Certain Perquisites arising out of Employment

Residential Status

  • Definition: Residential status is determined as per the provisions of Section 6 of the Act and affects an individual's income tax liability.
  • Types of Residential Status:
    • Resident and Ordinarily Resident (ROR) in India
    • Resident but Not Ordinarily Resident (NOR) in India
    • Non-Resident in India
  • Deemed Resident: An Indian citizen is deemed a resident in India if their total income (excluding income from foreign sources) exceeds Rs. 15 lakhs during the previous year and they are not liable to tax in any other country or territory.

CONCEPTS IN TAXATION (Part 2)

  • Residential Status: The residential status of an individual or a Hindu Undivided Family (HUF) is determined based on their physical presence in India during a financial year.
  • Types of Residential Status:
    • Resident and Ordinarily Resident (ROR): An individual who has been resident in India for at least 2 out of 10 preceding years and has been in India for at least 730 days in the preceding 7 years.
    • Resident but Not Ordinarily Resident (RNOR): An individual who is a resident but does not meet the conditions for ROR.
    • Non-Resident (NR): An individual who is not a resident in India.
  • Tax Implications:
    • ROR: Taxable on worldwide income.
    • RNOR: Taxable on income received or deemed to be received in India, income accrued or arisen in India, and income accrued or arisen outside India from a business controlled from India or a profession set up in India.
    • NR: Taxable on income received or deemed to be received in India and income accrued or arisen in India.
  • Scope of Income:
    • ROR: Worldwide income is taxable in India.
    • RNOR: Only Indian income is taxable in India, except for income from a business controlled from India or a profession set up in India.
    • NR: Only Indian income is taxable in India.
  • Examples:
    • Mr. C is a resident but not ordinarily resident in India for FY 2024-25, as he satisfies the condition of staying 729 days or less in the last seven years.
    • Mr. A, a resident and ordinarily resident, is taxable on his worldwide income in India, including interest income from a USA bank account.
    • Mr. Vilayati, a resident but not ordinarily resident, is not taxable on interest income from a foreign bond in FY 2024-25 and FY 2025-26, but will be taxable from FY 2026-27 when he becomes a resident and ordinarily resident.
  • Five Heads of Income:
    • Salary: Includes wages, annuity, pension, gratuity, and other benefits.
    • House Property: Includes income from rental properties.
    • Business or Profession: Includes income from business or professional activities.
    • Capital Gain: Includes income from the sale of capital assets.
    • Other Sources: Includes income from other sources, such as interest, dividends, and royalties.
  • Income from Salary:
    • Definition: Includes wages, annuity, pension, gratuity, and other benefits.
    • Taxability: Taxable on due basis or receipt basis, whichever is earlier.
    • Deductions and Exemptions: Includes standard deduction, national pension scheme contributions, and other deductions.

CONCEPTS IN TAXATION (Part 3)

  • Employee’s Provident Fund (EPF):
    • Definition: A retirement savings scheme for employees.
    • Details: Employer's contribution above 12% of salary is taxable. Employees' contribution is eligible for Section 80C deduction, but not in the new tax regime.
  • Superannuation:
    • Definition: A retirement benefit scheme for employees.
    • Details: If employer's contribution exceeds Rs. 7,50,000 in aggregate, the excess is taxed as salary income.
  • National Pension Scheme (NPS):
    • Definition: A retirement savings scheme for employees.
    • Details: Employer's contribution is taxable, and employee's contribution is eligible for Section 80C deduction in the old tax regime.
  • Gratuity:
    • Definition: A lump sum payment to an employee on retirement or resignation.
    • Details: The computation of exempted amount of gratuity under Section 10(10) is the same for both tax regimes. The exemption is:
      • For government employees: fully exempt from tax.
      • For employees covered under the Payment of Gratuity Act: exempt up to the least of 15 days' salary for every completed year of service, Rs. 20,00,000, or the gratuity actually received.
      • For other cases: exempt up to the least of half a month's salary for each completed year of service, Rs. 20,00,000, or the gratuity actually received.
  • House Rent Allowance (HRA):
    • Definition: An allowance given to employees to help them pay for housing.
    • Details: Exemption of HRA is available in the old tax regime, but not in the new tax regime. The exemption is the least of the HRA received, excess of rent paid over 10% of salary, or 50% of salary (for certain cities) or 40% of salary (for other cities).
  • Leave Travel Allowance (LTA):
    • Definition: An allowance given to employees to help them pay for travel expenses.
    • Details: LTA is allowed in the old tax regime, but not in the new tax regime.
  • Computation of Salary Income:
    • Definition: The process of calculating an employee's taxable salary income.
    • Details: Salary income is computed by adding basic salary, allowances, perquisites, profit in lieu of salary, and retirement benefits, and then deducting deductions such as entertainment allowance, employment tax, and standard deduction.

CONCEPTS IN TAXATION (Part 4)

  • Definition: Computation of income from house property, which is taxable as income from house property.
  • Details: A house property is classified into three categories: Self-occupied, Let out, and Deemed let-out.

Key Concepts

  • Classification of House Property:
    • Self-occupied: A house property that is occupied by the owner for their own residence.
    • Let out: A house property that is rented out to a tenant.
    • Deemed let-out: A house property that is not actually let out, but is considered as let out for tax purposes.
  • Computation of Income from House Property:
    • Annual Value: The reasonable expected rent from a house property, or the actual rent received, whichever is higher.
    • Municipal Taxes: Taxes levied by the local authority, allowed as a deduction.
    • Net Annual Value: Annual Value minus Municipal Taxes.
    • Standard Deduction: 30% of the Net Annual Value, allowed as a deduction.
    • Interest on Borrowed Capital: Interest on loan taken for purchase, construction, or repair of house property, allowed as a deduction.
  • Deemed Owner:
    • An individual who transfers property to their spouse or minor child without adequate consideration is considered the deemed owner.
  • Deductions Allowed:
    • Municipal Taxes: Allowed as a deduction for let-out and deemed let-out properties.
    • Standard Deduction: 30% of Net Annual Value, allowed as a deduction.
    • Interest on Borrowed Capital: Allowed as a deduction, with limits applicable for self-occupied properties.
  • Tax Regimes:
    • Old Tax Regime: Allows deduction of interest on self-occupied property, up to Rs. 2,00,000.
    • New Tax Regime: Does not allow deduction of interest on self-occupied property.
  • Carry Forward of Losses:
    • Losses from house property can be carried forward and set off against income from house property in subsequent years, under both old and new tax regimes.

CONCEPTS IN TAXATION (Part 5)

  • Definition of Business: The Income Tax Act provides an inclusive definition of a business under Section 2(13) that “Business includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.”
  • Computation of Business Income: Business income is computed according to the method of accounting regularly employed by the assessee, and certain types of assessees can compute income from business or profession on a presumptive basis.
  • Speculative and Non-Speculative Business Income: A business transaction is classified into ‘speculative’ and ‘non-speculative’ while computing the income under the head ‘profits and gains from business or profession’.
  • Income from Capital Gains: Any profit or gain arising from the transfer of a capital asset is taxable under the head ‘capital gains’ in the previous year in which such transfer takes place.
  • Income from Other Sources: Where a particular income cannot be categorised under any of the four heads of income, it will be taxed under this head, provided the said income is otherwise not exempt from tax.
  • Clubbing of Income: The Income Tax Act clubs income of other persons in taxpayer’s income to counteract a generally prevalent and growing tendency on the part of the taxpayers to dispose of their property or income in favour of other persons in such manner that their tax-liability may either be avoided or reduced.

Key Concepts in Business Income

  • Meaning of Business: Business connotes some real, substantial and systematic or organised course of activity or conduct with a set purpose, and it means an activity carried on continuously and systematically by a person by the application of his labour and skill to earn an income.
  • Computation of Business Income: Business income is computed by adding all revenue receipts and capital receipts, and then subtracting revenue expenditures, capital expenditures, depreciation, and expenditures allowed on payment basis or fulfilment of certain conditions.
  • Presumptive Taxation Scheme: Certain types of assessees can compute income from business or profession on a presumptive basis, where the business income is computed as a percentage of turnover or receipts.

Key Concepts in Capital Gains

  • Definition of Capital Gains: Any profit or gain arising from the transfer of a capital asset is taxable under the head ‘capital gains’.
  • Computation of Capital Gains: Capital gains are computed by subtracting the cost of acquisition, cost of improvement, and expenditure incurred wholly and exclusively in connection with the transfer from the full value of consideration.
  • Short-Term and Long-Term Capital Gains: The nature of capital gain, that is, short-term or long-term, is determined on the basis of period of holding of the capital asset.

Key Concepts in Income from Other Sources

  • Definition of Income from Other Sources: Where a particular income cannot be categorised under any of the four heads of income, it will be taxed under this head, provided the said income is otherwise not exempt from tax.
  • Computation of Income from Other Sources: Income from other sources is computed by adding all incomes that are taxable under this head, such as dividend income, winning from lotteries, interest on securities, rental income, and gifts.
  • Allowable Expenses: Attributable expenses are allowed as a deduction while computing income from other sources.

Key Concepts in Clubbing of Income

  • Definition of Clubbing of Income: The Income Tax Act clubs income of other persons in taxpayer’s income to counteract a generally prevalent and growing tendency on the part of the taxpayers to dispose of their property or income in favour of other persons in such manner that their tax-liability may either be avoided or reduced.
  • Provisions Relating to Clubbing of Income: The provisions relating to clubbing of income are contained in Sections 60 to 64 of the Income Tax Act.
  • Income from Assets Transferred to Another Person: If any person transfers the income from any asset without transferring the asset, such income is included in the total income of the transferor.

CONCEPTS IN TAXATION (Part 6)

  • Clubbing of Income: The Income Tax Act contains provisions for clubbing of income of other person with the income of taxpayer. These situations arise when a minor child earns some income or when taxpayer transfers his asset to his spouse, son’s wife, etc.
  • Provisions for Clubbing: The clubbing provisions have been introduced to stop taxpayers from diverting a part of their income to the relatives in order to reduce tax burden. In order to prevent such tax avoidance, clubbing provisions have been incorporated, subject to certain exceptions, in respect of the income of the following persons:
    • Income of Spouse
    • Income of Son’s Wife
    • Minor’s Income
    • Income of any person or Association of persons
    • Income from property gifted to HUF

Key Concepts in Set off and Carry forward of Losses

  • Loss under the head Capital Gains: Capital losses can be of two types – Short-term Capital Loss and Long-term Capital Loss. Both the losses are computed under the same head of income, yet distinct provisions have been prescribed for set-off of these losses.
  • Intra-head Adjustment: If there are several sources of income, falling under any head of income, the loss from one source of income may be set-off against the income from another source, falling under the same head of income.
  • Inter-head Adjustment: If after intra-head adjustment the net result under a head of income is a loss, the same can be set-off against the income from other heads in the same previous year. However, a capital loss, whether short-term or long-term, cannot be set-off against income taxable under any other head.
  • Carry forward of Losses: If capital loss could not be set-off against the eligible capital gains because of the inadequacy of income during the current year, it can be carried forward and set-off against the relevant capital gains of the subsequent year.

Loss under the head profits and gains from business or profession

  • Speculative Loss: Loss from speculative transactions can be set-off only against profit from speculative transactions.
  • Non-Speculative Loss: Normal business loss can be set-off from any income other than salary and income from gambling activities.
  • Carry forward of Losses: Speculative loss and non-speculative loss can be carried forward for 4 years and 8 years respectively.

Losses under the head ‘income from house property’

  • Set off: Loss from one house property can be set off against income from another house property during the same year.
  • Carry forward: The unadjusted loss can be carried forward till next 8 years and can be set off only against income from house property in the subsequent year.

Loss under the head other sources

  • Set off: The loss under the head other sources can be set-off against any income under any head except income from gambling activities.
  • Carry forward: However, if loss under the head other sources cannot be set-off in the current year due to inadequacy of income under other heads then the same shall not be allowed to be carried forward to subsequent years.

Exempt incomes

  • Exempt Incomes: Under Chapter III of the Income Tax Act, there are certain incomes which are exempt and are not to be included in computing the total income of the assessee.

Deductions under Chapter VI-A

  • Deductions: In computing the total income, certain deductions are allowed from the gross total income. These deductions are allowed to encourage saving habits in individuals and pursue institutions to take part in social activities.
  • Available Deductions: These deductions are prescribed in Chapter-VIA of the Income Tax Act, such as:
    • Section 80C: Deduction for investments in insurance policies, repayment of principal portion of housing loan, contribution to certain small saving schemes, taxpayer contribution to pension funds, or fixed deposits.
    • Section 80CCD(1): Employee's or self-employed individual’s contribution towards NPS.
    • Section 80CCD(1B): Contribution towards NPS / NPS Vatsalya Scheme by any individual.
    • Section 80CCD(2): Employer's contribution towards NPS.

CONCEPTS IN TAXATION (Part 7)

  • Tax Deductions: Various sections under the Income Tax Act provide deductions from taxable income, such as:
    • 80C: Deductions for investments in specified instruments, such as Provident Fund, Public Provident Fund, National Savings Certificate, etc.
    • 80D: Deductions for medical insurance premiums and medical expenditures
    • 80DD: Deductions for expenditure on medical treatment of a family member with disability
    • 80DDB: Deductions for medical treatment of specified diseases
    • 80E: Deductions for interest on education loans
    • 80EEB: Deductions for interest on loans for purchase of electric vehicles
    • 80G: Deductions for donations to specified institutions or funds
    • 80GG: Deductions for rent paid by individuals not receiving House Rent Allowance
    • 80QQB: Deductions for royalty income of authors
    • 80RRB: Deductions for royalty income from patents
    • 80TTA: Deductions for interest on deposits in savings accounts
    • 80TTB: Deductions for interest on deposits with banks, post offices, or cooperative societies for senior citizens
    • 80U: Deductions for medical disability
  • Rebate under Section 87A: A tax rebate of up to Rs. 12,500 for resident individuals with total income not exceeding Rs. 5,00,000, and up to Rs. 25,000 for those opting for the new tax regime with total income up to Rs. 7,00,000
  • Gross Total Income: The total income computed before making any deductions under Chapter VI-A, including income from:
    • Salary
    • House Property
    • Profits and Gains from Business or Profession
    • Capital Gains
    • Income from Other Sources
  • Total Income: The income remaining after claiming deductions from Gross Total Income
  • Computation of Tax Payable: Tax calculation based on applicable tax rates, surcharge, Health & Education Cess, and other factors
  • Double Tax Avoidance Agreement (DTAA): An agreement between countries to avoid double taxation of income by allocating taxing rights or giving credit for taxes paid in the source state by the residence state

Concepts in Taxation

  • Resident and Ordinarily Resident: An individual's global income is taxable in India if they are a resident and ordinarily resident in India. They are entitled to a credit of taxes paid in another country.
  • Taxation Regime: The taxation regime in India can be categorized into three types: EEE (Exempt, Exempt, Exempt), EET (Exempt, Exempt, Taxable), and ETE (Exempt, Taxable, Exempt).
  • EEE Investments: Investments that provide tax benefits at all three stages (investment, yield, and transfer/withdrawal), such as Public Provident Fund.
  • EET Investments: Investments that provide tax benefits at the time of investment and transfer/withdrawal, but are taxable at the time of yield, such as Equity Linked Saving Schemes (ELSS).
  • ETE Investments: Investments that provide tax benefits at the time of investment and transfer/withdrawal, but are taxable at the time of yield, such as Tax saving Bank Fixed deposit for 5 years or more.

Tax Rates and Calculations

  • Maximum Marginal Rate (MMR): The highest rate of income tax, including surcharge and health & education cess, applicable to an individual's income.
  • Effective Tax Rate: The rate of tax inclusive of surcharge and health & education cess, leviable on an assessee's income. It can be computed using the formula: Effective tax rate = Applicable tax rate × (1 + Rate of Surcharge) × (1 + Rate of Health & Education Cess).
  • Tax Rate Calculation: The effective tax rate can be calculated using the formula, and examples are provided for partnership firms and individuals.
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