ELEMENTS OF DIRECT AND INDIRECT TAXES:

INCOME TAX

The letters I T has different impact on different people. In Electronics and Telecommunication, it is heartily
welcome. In Finance it is a dreaded term everyone wants to avoid.

Taxes are necessary for the administration of any governance. From time immemorial it has been in existence.
Kings levied taxes as revealed by history, where smaller kingdoms used to pay in turn to emperors.

The machinery for taxes are as under.

Norms or principles are laid out in the Act. Act henceforth will refer to Income Tax Act. It came into being in
1961.
Administrative procedures are stipulated in IT Rules, came into being in 1962.
Machinery to implement the rules are CBDT.
Various judgements and case laws serve as guidance to settle disputes. Procedures are laid out for assessment,
appeal, reassessment etc.

Our study will cover roughly less than 1/3rd of the IT Act. Out of 298 sections we’ll cover just 80 sections.
Range of topics to discuss
1. Definition of Income
2. Whose income is taxable
3. Assessment period
4. Computation of income
a. Salaries
b. House Property
c. Business / Profession
d. Capital Gains
e. From other sources
5. Exempted Income
6. Deductions available

Income Tax is applicable to all persons residing in the country and income arising in the country.
Various basic terms will have to be understood clearly. Such as
Assessment Year:
It is the year commencing from 1st April to 31st March, when tax liability is assessed/ computed. In each
Assessment Year the income of the previous year. Assessment year 2008-09 would mean the year
commencing from 1.4.2008 to 31.3.2009.
For all government accounting the Financial Year is the year commencing from 1st April to 31st March.
In each Asst. Year the income of the previous financial Year (known as the previous year) will be assessed.

Previous Year:
Previous year is defined as the Financial Year previous to the Assessment Year. In Assessment Year 2007-08,
the income of the previous Year 2006-07 will be assessed.
Previous year for Assessment Year 2007-08, will be the Financial Year commencing from 1.4.2007 to
31.3.2008.
If a business is set up new in the previous Financial Year, it will be from the date of commencement of
business till the financial year end. i.e 31st March of the year.

Income earned in one Financial year (1.4.07-31.3.08), known as previous year, will be assessed in the
Assessment Year following . i.e 2008-09. i.e the total income earned from 1.4.07 to 31.3.08 will be assessed in
2008-09.

Previous year for IT Assessment purposes will be from 1.4 to 31.3. If a company follows a different
‘accounting year’ say from 1st July ’06 to 30th June ‘07, the assessee will have to divide the accounting year
into two financial years – 1.4.06 to 31.3.07 (Income from July to March) which will be assessed in 2007-08.
The other part (1.4.07 to 30.6.07) will fall in Financial year 2007-08 and will be assessed in 2008-09.

Work out 2 examples – July to June & Jan – Dec. A got an offer of Service contract from Aug.06. His
income from 1.8.06 – 31.3.07 will be assessed in 2007-08 and the income from 1.4.07 will be falling in
Assessment year 2008-09.

Persons:

We learnt that I T is applicable to all persons residing in the country and income arising in the country. How do
you define a person?

A person u/s 2(31) includes,

1. An individual
2. A H U F
3. A Company
4. A Firm
5. An Association of Persons or a Body of Individuals, whether incorporated or not
6. A Local Authority
7. Every Artificial Juridical Person not included in the above.

Need to catagorise:
Difference in treatment of basic exemption
Rates of taxation

Individuals: A person. Male or female, minor or an insane person

Raman, David, Anil
HUF: Self, spouse, children, grand children ( all lineal descendants) their wives and unmarried daughters.
Company:
Any Indian Company – RIL, Infosys, TISCO etc.
Any Body Corporate incorporated under laws of a country outside India
Any Institution,Assn., body assessed/ assessable as company on or before 1.4.70
Any Institution,Assn., body, incorporated or not, whether Indian or not, declared by CBDT as company.
Firm: Firm is assessed distinctly other than by partners. A,B & Co, Architects
A O P: Two or more joining for a common purpose- Anil Snooker Club, Garodia Golf Club

B O I: A team of individuals joining together for earning income. A,B,C forming circus group
Local Authority: Municipality, Corporation, Dist Council, Port Commissioner etc.
Artificial Person: Shirdi Sai Sansthan
 Sidhivinayak foundation, Tirupati Tirumala Devasthanam

U/S 2(24) taxable income will include,

Profits
Dividends
Salary
Perks
Profits in lieu of salary
Profit from sale of permits & license
Refund of customs duty / excise duty NOT IT Refund
Export subsidy
Profits on banking by coop. Society with its members
Winning lotteriesgifts exceeding Rs.50000
Inclusive and not exclusive.

What is an income?
Earning by way of salary, rent profit fees, dividends etc.Income legal or illegal is taxable.
Cash or kind is taxable
Capital receipts not taxable, unless specified to the contrary.
Revenue receipts taxable, unless specified to the contrary.
Income must be real. E.G Appreciation in the value of residential house
Appreciation in the value of shares and stocks held. Etc are not liable to tax as income.
Similarly Goodwill unless realized on sale is not taxable. NOTIONAL Profits are not taxable.

ASSESSMENT:
Assessment is the process of determining the taxable income and the tax payable by a person. Assessment will
also include reassessment.

How is Assessment made?

Every person having a taxable income should file a Tax Return in the prescribed form of the income
earned during the previous year. The person is also required to pay advance tax on self assessment, i.e on the
basis of tax payable as per his calculations.

PROCEDURE OF ASSESSMENT:On receipt of the return the ITO will scrutinize the return filed and take
such steps as are required to verify the return filed and assess the tax due payable. He can call the assessee to
submit any document/s and /or books of accounts. He may seek confirmation of balances as shown in the
books.Then tax is computed.
If the tax calculated is more, assessment order is sent to assessee with demand to pay the difference. If,
however, tax computed is less than what is already paid, ITO will refund excess tax paid.

The ‘assessment’ of income determines the ‘assessed income’ and the tax payable by the ’assessee’ in respect
of the income of that A.Y.
An assessment once made can be reopened for reassessment under certain conditions.

An ASSESSEE is defined U/S 2(7) as a person by whom any tax or any other money is payable under the Act.
(Tax, Interest, Penal Interest, Penalty for default etc.) It includes
 1. Every person in respect of whom proceeding under the Act has been taken for assessment of
His income or income of any other person in respect of whom he is assessable (Minor son, etc.)
2. His loss or loss of any other person in respect of whom he is assessable
(Minor son, etc.)
3. Refund due to him
4. Tax payable by him
5. Every person who is deemed to be an assessee (representative capacity)
6. Every person who is deemed to be an assessee (For non payment of deduction of tax at source etc.
Failure to pay TDS in time )

Levy of Income Tax:

U/S 4 Tax is levied (i) at the rates as per the Finance Act (ii) for the Asst. Year (iii) in accordance with
the provisions of the IT Act (iv) in respect of the Total Income of the previous year (v)of every person.

Computation of Income Tax:

Essential steps for computation of Income Tax:
1. Determination of scope of income. What is to be included and what is to be excluded from ‘Income
assessable to tax’. This will be determined by
1.Status of the person – Resident or Non Resident
2.Previous year- Whether income was earned in the previous Financial Year.
3.Whether the income arises in India or outside India
2. Exempt Income: Certain types of income or totally exempt (;like agricultural income) and some
depending on residential status. Such exclusions from taxable income are made
3. Classification of Income: The taxable income is classified under separate heads such as , Salary
Income, Income from House Property, Income from business or profession, Capital gains and income
from other Sources.
4. Computation of Income: Income is computed under each head. In some cases income of other
persons(Spouse, minor child) are clubbed.
5. Determination of Total Income: Income computed under different heads are combined to reach the
Gross Total Income.
6. Claims for Deduction: Allowable claims are deducted from the total and Net Taxable Income is
arrived at.

7. Net Tax payable is computed on the net taxable income.

Three Ws of Taxation:
I. Who is to be taxed? Who is to be taxed depends upon who earns the income. It depends on the
status of the assessee
II.When is the person to be taxed? In respect of the previous year. i.e the Financial year preceding
the Asst. Year.
III.Where is the income earned? Tax levied would depend on where the income is earned, also
considering the status of the individual.
STATUS OF THE ASSESSEE:
1) Status will be determined each year. It may change depending on number
of days one is in India in the previous year.
2) An assessee can be resident or non resident
3) Resident Individual & HUF can be also Ordinary Resident and Not
ordinarily Resident.
 4) This status is different from Citizenship.
5) Status important in determining taxability of foreign income earned.
RESIDENT:

Residential Status of Individuals:

Conditions Presence in P.Y Presence in Yrs. Prec P.Y
(1) (2)
1.Indian Citizen leaving/visiting 182 Days or more -
India
2.Others 182 Days or more
OR
60 Days or more AND 365 Days in 4Yrs
preceding P.Y

Stay of 182 days or more in previous year or

365 days in previous 4 years AND 60or more days in the previous year.
Exceptions:
A citizen of India or Indian member of the crew of an Indian ship who leaves India for employment, becomes
resident only if he stays in India for 182 days, not 60 days.
Stay of the ship anchored in territorial waters will be included as stay n India.

A PIO coming to India on a visit during the previous year ,staying more than 182 days, not 60 days. POI is one
who, whose parents / grand parents were born in undivided India.

EG: One is a resident if he stays in India for 182 or + days in 2007-08

Or stays for 365 days from 2003 – 2007 AND stays for 60 or + days in 2007-20078

If a citizen or an Indian member of crew on Indian ship, 182 or +days in 2007-2008.

Citizen or PIO visiting India is an R only if he stays for 182or + days in 2007-08.
Residential Status of Other Persons
Management Control & Residence:

Residential status of HUF, Firm or AOP S6(2):

Control & Management are

Persons other than individual Control and Mgt. Of the affairs of Person are
Wholly in India Wholly outside Partly in & out
HUF** Resident Non Resident Resident
Firm Resident Non Resident Resident
AOP Resident Non Resident Resident
Indian Company Resident Resident Resident
Non Indian Company Resident Non Resident Non Resident
Artificial Juridical Person Resident Non Resident Resident
**If the Karta is NOR in any previous year, HUF will also be treated as NOR
NON RESIDENT:
One who is not a resident is a non resident

Ordinary Resident:

If a Person is resident in India for 2 out of previous 10 years immediately preceding the previous year.
If a Person is in India for 730 days or + out of previous 7 years immediately preceding the previous year.

Not Ordinary Resident:

If a Person is Non resident in India for 9 out of previous 10 years immediately preceding the previous year.
If a Person is in India for 729 days or less out of previous 7 years immediately preceding the previous year.

Status for Assessment year 2008-2009 will be determined by days/ years immediately preceding the previous
year 2007-2008. i.e 10 years will be counted from 1.4.1997-to 31.3.2007 and 7 years from 1.4.2000 to
31.3.2007.

Stay need not be in the home place / same place.

Stay can be even for broken periods during the year, not necessarily continuous.
Residential Status & Taxablity of Income:

Nature of Income R&OR R but NOR NR

Income recd. In India Taxable Taxable Taxable
Income accruing/arising in India Taxable Taxable Taxable
Income deemed to be recd. In India Taxable Taxable Taxable
Income deemed to be accrued Taxable Taxable Taxable
In India
Income accruing/arising outside Taxable Taxable Not Taxable
India from business controlled/ Prof
set up in India
Any other Income which accrues Taxable Not Taxable Not Taxable
outside India

PROBLEMS:

Status:
Shirdi Sansthan AJP
Anush – minor child IND
Sharad, his wife, Son Shambav, Daughter Shalini HUF
Ram & Balram, Advocates as partners FIRM
Ganesh tennis Club AOP
RIL Company
Pune Contonment Board Local Authority
Ambani Memorial Trust AOP
Pune University AJP
WADA Panchayat Local Authority

Problems on Status of Persons:

1.Kallis, a South African citizen, but of Indian Origin, came to India on 1st Nov.’02, for the first time. His total
stay in India was as under:
Year Ended No. of Days
31.3.03 24
31.3.04 80
31.3.05 182
31.3.06 100
31.3.07 26
He informs you that he was in India from 1st April 2007 to 30th June 2007.Determinehis residential status for the
Previous Year 2007-08. (March’07)

Solution:
a. Kallis is a P I O.He was in India for (30+31+30)91 days in the previous year 2007-08.
b. He will be a resident if he had stayed for 182 days or more.
c. He does not satisfy the condition. So he is Non Resident in India.

2. Sanjay , an Indian Citizenwent to USA for the first time for employment on 10th May ’07. He came back to
India on 19.11.07. Find out his Residential Status for the Asst. Year 2008-09.

Solution:
a. Sanjay is a citizen of India, leaving for employment.
b. He will be a Resident only if he was in India for 182 days or more from 1.4.07 to 31.3.08.
c. He was in India for 173 days.
So, Sanjay is a Non Resident.
(March’06)
st
3. Mr. X is an U S Citizen. He came to India on Oct.15, 2007 for a visit and was in India till 31 March’08. In
pevious years his stay in India was as under:
Year No. of Days
1997-98 188
1998-99 190
1999-2000 185
2000-2001 200
2001-02 40
2002-03 300
2003-04 195
2004-05 185
2005-06 100
2006-07 200
Find his Residential Status for the Asst. Year 2007-08, assuming he is not a person of Indian Origin.
(March’05)

X is not a Citizen of India

He will be a Resident in India if,
a. He is India from 1.4.06-31.3.07 for 182 + days. OR
b. He is in India from 1.4.06 to 31.3.07 for 60 + days AND for 365 days from
1.4.02 to 31.3.06.
c. He is in India from 1.4.06 to 31.3.07 for 168 days AND for 680 Days from 1.4.06
to 31.3.06.

Mr. X is a Resident.
Further,
He will be an ordinary Resident if he is a resident for at least 2 out of preceding 10 years AND is in India for at
least 730 days between 1.4.99 to 31.3.06.

if he is a resident for at least 9 years AND is in India for at least 730 days between 1.4.99 to 31.3.06.

Year No. of Days R/NR

1996-97 188 R
1997-98 190 R
1998-99 185 R
1999-2000 200 R
2000-01 40 NR
2001-02 300 R
2002-03 195 R
2003-04 185 R
2004-05 100 R
2005-06 200 R

He is a Resident and Ordinary Resident for 9 years as he was in India for 1200 days between 1.4.99 to 31.3.06.

Receipt & Accrual of Income:

Receipt & Remittance: First occasion when money comes under control of receipient is Receipt. Further
transfers are remittance. Illustrate

Cash & Kind: CA receiving Gold chain; Builder receiving Cranes as gift

Receipt by assessee or o his behalf: Income received by his agents, bankers , lawyers

Receipt and accrual: Accrual is right to receive. Receipt is actual receiving of funds. Receipt is after accrual.

Accrued and due: Salary accrues every day, but due on month end.

Method of accounting: Cash or accrual. To be consistent. Change to be notified/ declared in the IT Return.
Income deemed to be received: S(7)
Excess contribution to RPF
Transferred cont to RPF in excess of 12% Employer’s contribution and interest in excess of 9.5%.

Dividend Income:
Unless exempt U/S 10(34) or 10(35) dividend will be included in total income.

Final Dividend: Taxed in the previous year in which declared.

Interim Dividend: Taxed in the previous year in which it is unconditionally made available by the company.
Transfer to Bank a/c. cheque paid.etc.

Deemed Dividend: Loan to a substantial shareholder by the company out of its reserve is taxed as income in
receiver’s hands.

Income deemed to accrue: S(9)

At times though income has not accrued or arisen in India it is deemd to have accrued or arisen in India u/s(9).
This widens the scope of taxing NR’s income
Any income through
1. Any business connection in India
2. Any property in India
3. Any asset or source of income in India
4. Any transfer of capital asset situated in India
If business is partly operated in India: Income from Indian operations
Purchase for export by NR.: No income is deemed to accrue.
NR News agency: No income is deemed to accrue
NR shooting Film in India: No income is deemed to accrue. He should not be Indian citizen.

1. Salary for services rendered in India :Accrues in India

2. Salary for service outside India to Government servant: Accrues in India
3. Dividend by Indian Company: Accrues in India
4. Interest Payable: Accures in India when
 Interest payable by Central Govt / State Govt.
 Resident except int. on debts for a business/ Profession carried out side India for earning
income outside India) and
 Non Resident on debts for business or profession carried out in India for earning income in
India
5. Royalties: Accures in India when
 Royalty payable by Central Govt / State Govt.
 Resident except Royalty for a business/ Profession carried out side India for earning income
outside India) and
 Non Resident for business or profession carried out in India for earning income in India

Exemption:
Lumpsum Royalty payable for patent etc vide agreement made before Apr.’76 and approved by Central
Govt. or deemed to be so made.
 By a Resident for transfer of computer software provided by non res. Manufacturer alongwith the
computer under any scheme approved by Government.
Royaty is defined as
• Patent for an invention, design, model, secret formula etc.
• For technical ,commercial, industrial or scientific knowledge.
• For transfer of license, copyright etc.
• For services for above
6. Technical Fees: Accrues in India if
Payable by Government
By Resident except for business out side India for earning outside India
By NR for business in India for earning in India

NON TAXABLE INCOME U/S 10:

Sec 10 of Income Tax Act lists the income exempt from tax. These items are to be totally excluded and will
not form part of the total income for tax purposes.

A. Agricultural Income U/S10(1)

B. Sums received by a member of H U F U/S 10(2)
C. Share of partner in the income of a Firm U/S 10(2A)
D. Casual / Non Recurring Receipts U/S 10(3)
E. Scholorship U/S10 (16)
F. Minor’s income included in Parent’s income U/S 10(32

A.Agricultural Income U/S10(1)

Agricultural Income under the Constitution of the country is a subject of taxation at State Level. Central
Govt can’t tax this and is therefore exempt under Income Tax.
U/S 2 (1A) Agricultural Income is defined as :
1. Any rent or revenue derived from any land situate in India, and is used for agricultural purposes. This
excludes Capital Gains on transfer of agricultural land.
Any Rent Revenue derived from land is treated as agricultural income.
It has to be situated in India.
It should be used for agricultural purposes.
Rent is payment in cash or kind to the owner for use of the land.
Revenue is any type of yield from such land situated in India and used for agricultural purposes.
Derived from Land means the revenue should arise directly from the land. It excludes Capital Gains from
transfer of such land situate in urban areas.
Situated in India. It must be situated in India. Income derived from agricultural land outside India is not
exempt under this section 10(1).
2. Agricultural Income means any income derived from agricultural operations; from processing
agricultural produce; sale of agricultural produce.
Agricultural Operations: should involve use of skill and labour for cultivation of land. Operations are of 2
types- basic operations and subsequent operations.
Basic Operations involve operations before germination of seeds e.g: tilling the soil, sowing the seeds etc.
subsequent operations mean operations after germination of seeds- weeding, pruning, harvesting etc. that
help in production of final crops.

Basic Operations are essential for income to be treated as agricultural income.

Processing: Income from process which makes raw agricultural produce fit to be taken to the market. E.G
Dryiing, curing Coffee, tea leaves.
The process may be done by the cultivator or receiver of the produce (as rent in kind). Such process could
be manual or mechanical. It should be a process ordinarily employed to make produce fit for markets.

Sale of Produce: Income from sale of agricultural produce, by cultivator or receiver of produce (Rent in
kind). No process other than process mentioned earlier should be done. Such as roasting, grinding coffee
and then selling won’t count as agricultural income.

Income from Farm House: Farm House should be,

1. The building occupied by cultivator, or receiver of rent in kind.
2. The building should be situated on or in the immediate vicinity of the farmland.
3. The building is required as a dwelling house , store house or other out house by such persons due to
his connection with the land.
4. The land is assessed to land revenue or is subject to local rate or the land situated outside an urban
area.

Examples of Agricultural Income:

1. Income from lease of agricultural land
2. Income from land used for agriculture purposes – growing produce for human consumption, animal
consumption (fodder), cash crops, commercial crops etc.
3. Compensation from Insurance Co. for damage to crops, tea garden, coffee estate etc.
4. Income from growing flowers or creepers.
5. Salary or interest on capital received by partner from a firm engaged in agriculture.

Examples of Non Agricultural Income:

Income not received directly from Land:
I. Interest on arrears of rent
II.Interest on loan given to a farmer
III.Dairy farming; poultry farming
IV.Dividends received from a company having only agricultural income
V.Salary of a manager of an agricultural estate
VI.Rent for land for storing agricultural crops
Income without performing basic agricultural operations:
Sale of plants growing spontaneously of their own, without sowing seeds etc (mushroom, wild grass, weeds
etc). sale of standing trees, already there while purchase of land.
Income from products sold by others and not by the cultivator :

Sale of agricultural produce eceived as interest on loan

Received as price for water supplied to agricultural land
Sale of agricultural produce by a broker

B. Sums received by a member of H U F U/S 10(2)

U/S 10(2), Any sum received by a member of a H U F out of the income of the family or any indivisible
estate of the family (Rent received by the family from house belonging to the family) is exempt from tax.

Exemption will not apply U/S64(2) of the Act, where the self earned property is transferred to HUF, by
the member of the family.

Double Taxation : HUF, being a separate taxable entity under the IT Act . Income earned by HUF will be
assessed in its hands. Any such income distributed to its members will be exempt from tax in the
individual’s hands. Even if no tax is paid by the HUF, the income being below taxable level, still the
distributed income will be tax free.

PROBLEM:
ABC is a member of a HUF. His personal income is Rs.140000. HUF has an income of Rs.30000. ABC
receives 50% share of HUF Income. What is his tax position?
SOLUTION:
ABC will be taxed on his income. Share of income Rs.15000 received from HUF will be exempt U/S10(2).
Whether HUF has paid tax since the income is below taxed limit is immaterial.

C. Share of partner in the income of a Firm U/S 10(2A)

1. Share of a partner in the income of a firm which is separately assessed as a firm is exempt from tax.
2. Partnership Firm, being a separate taxable entity under the IT Act . Income earned by the firm will
be assessed in its hands. Any such income distributed to its partners will be exempt from tax in the
individual’s hands. Even if no tax is paid by the firm, the income being below taxable level, still the
distributed income will be tax free.
3. This is not applicable to interest, salary, bonus, commission etc. paid to the partner. It is taxable in
the hands of the partner.
4. Share of income:
5. Partner’s share in income is derived by and division of the taxable income in profit sharing ratio as
specified by the Deed.

Share of Partner in the ratio (as per Deed) X Firm’s taxable Income
Total Profits as per P & L acct.

What is exempt is the share (as per Deed) in the taxable income, not his share as per books.

D. Casual / Non Recurring Receipts U/S 10(3): Omitted from the Act Asst. Year 2003-04
E.Scholorship U/S10 (16)
Scholorship granted to meet cost of education is exempt.
1. Entire Scholorship granted to meet cost of education is exempt regardless of actual cost.
2. Scholorship may be for a course not leading to a degree.
3. ‘Cost of education is not confined to tuition fee; includes other incidental expenses.
4. Scholorship granted for education of children of employees by a company would be
exempt U/S 10(16) and will not be taxed in the employee’s hands.
G.Minor’s income included in Parent’s income U/S 10(32)
1. Income of a minor- other than income earned by his own labour or skill or knowledge is to be
clubbed in the income of the parent.
2. Minor’s parent is liable to pay tax on this income.
3. Such parents can claim exemption upto Rs.1500 or the child’s income, whichever is less.

Questions:

What are the items of income exempt U/S of the Income Tax Act?
Write a note on ‘Agricultural Income under Income Tax Act.

Heads of Income U/S 14

After determining Total Income , income should be classified under different heads. There are rules for
computing income under different heads.

Different Heads of Income:

1. Salaries
2. Income from House Property
3. Profits from Gains & Professions
4. Capital Gains
5. Income from Other Sources
S 4 covers ‘charge of income’, S 14 classifies under different heads & S15 to 59 quantifies amount of total
income.

Different Heads of Income are mutually exclusive.

If income is taxable under one head, It has to be done so, not under any other head.
What is taxable under ‘income from profession’ cant be taxed under ‘income from property’ and so on.

It is the same tax that is calculated under different heads, tax being one. Once the income is computed
under different heads tax is calculated.

Expenses On Exempt Income :

No expenses can be claimed against Income that is not forming part of total income.
E.G: Interest paid on loan given for agricultural purposes cannot be deducted from Income as Agricultural
income is exempted from tax.