Basic Concepts in Income Tax
Among the busiest of professionals, Doctors have little time to learn about the latest tax provisions. Tax planning is often neglected in the crush of other obligations. Being India’s Top 10s income earners, they need to give more attention to their financial planning and taxation.
Income tax is chargeable on the total income of the previous year (Financial Year) during which the Income is earned by a person at the rates prescribed by Finance Act every year. Income Tax can be classified in two parts:
Personal Income Tax and Corporate Tax
Income tax levied on individuals, Hindu Undivided Families (HUFs), Partnership Firms, Association of Persons (AOPs), Body of individuals (BOIs), Local Authorities and Artificial Juridical persons is called Personal Income Tax, whereas, Income tax levied on companies is called Corporate Tax. Companies would include LLPs, Private Limited Companies, Public Limited Companies and Large Partnership Firms engaged in Business & Profession.
Distinction between Capital vs. Revenue (As Per Income Tax ACT. 1961)
Income Tax is levied on income of assessee and not an every receipt which he receives. The method of charging tax on different types of receipt is different. Income tax Act, 1961 provides a separate head “CAPITAL GAINS” for levying tax on capital receipts. Similarly, while calculating net taxable income of an assessee only revenue expenses are allowed to be deducted out of revenue receipts. Particularly while calculating business profit or professional gain only revenue receipts and revenue expenses are considered. This makes the distinction between capital and revenue of vital importance. For this distinguish capital and revenue items can be divided in to 3 sub-parts:
1. Capital Receipts vs. Revenue Receipts
2. Capital Expenses vs. Revenue Expenses
3. Revenue Losses vs. Capital Losses
CAPITAL RECEIPT VS REVENUE RECEIPTS
Capital receipts are to be charged to tax under “Capital Gains” and revenue receipts are taxable under respective heads of Income. Hence it is important to understand which receipt is a Capital Receipt and which one is a Revenue Receipt. Some tests, however, can be applied in particular cases.
On the basis of nature of Assets : If a receipt is with reference to Fixed Asset, it is capital receipt and if it is with reference to circulating asset (current assets) it is revenue receipt. Fixed assets is that with the help of which owner earns profit by keeping it in this possession, e.g. Plant, Machinery, Building or factory etc. Circulating Asset is that with help of which owner earns profits by parting with it and letting others to become its owner, e.g. Stock-in Trade.
CAPITAL EXPENSES VS REVENUE EXPENSES
To distinguish a Revenue Expenditure from a Capital Expenditure, the following tests can be applied for this purpose :
i. Nature of the Assets
ii. Nature of Liability
iii. Nature of Transaction: if an expenditure is incurred to acquire a source of income, it is Capital Expenditure
iv. Nature of Payment in the hands of payer: If expenditure is incurred by an assessee as a Capital Expenditure, it will remain a capital expenditure even if the amount may be revenue receipt in the hands of receiver.
CAPITAL LOSSES VS REVENUE LOSSES
Distinction has to be made between revenue losses and capital losses of the business because under the provisions of this Act, Capital Losses are dealt with under the Chapter “Capital Gain” whereas Revenue Looses are treated as Business Losses and as such are treated under the head “Profit and Gains of Business or Profession”. Capital Losses can be set off against the Income from Capital Gain only, whereas the Revenue Losses are business losses and as such can be set off against any other income of the assessee. It is very difficult to distinguish between a Capital Loss and a Revenue Loss on the basis of certain principles
SALIENT FEATURES OF “INCOME’
The following features of income can help a person to understand the concept of income.
· Definite Source
· Income must come from Outside
· Tainted Income: Income earned legally or illegally remains income and it will be taxed according to the provisions of the Act.
· Temporary or Permanent
· Voluntary Receipt: The receipts which do not arise from the exercise of a profession or business or do not amount to remuneration and are made for reasons purely of personal nature are not included in the scope of total income.
· Dispute regarding the Title: In case a person is receiving some income but his title to such receipts is disputed, it will not free him from tax liability. The recipient of such income has to pay tax.
· Income in Money or Money’s worth: The income may be in Cash or in kind. It is taxable in both cases.
TAX TREATMENT OF “INCOME’
For the purposes of treatment of income for tax purposes it can be divided into 3 categories :
· Taxable Income
· Exempted Incomes
· Rebateable (Tax Free) Incomes
GROSS TOTAL INCOME (GTI) & TOTAL INCOME
U/s 14 the term “Gross Total Income” [ GTI ] means aggregate of incomes computed under the following 5 heads :
1. Income under the head “Salaries”
2. Income under the head “ House Property”
3. Income under the head “Profit and Gains of Business or Profession”.
4. Income under the head “Capital Gain”.
5. Income under the head “Other Sources”.
After aggregating income under various heads, losses are adjusted and the resultant figure is called as “Gross Total Income” [GTI. From Gross Total Income, Deductions u/s 80 is allowed. The resultant figure is called “Total Income “on which Rates of Taxes are applied to work out Taxes Payable.
ASSESSMENT YEAR [ Section 2 (9) ]
“Assessment Year” means the period of 12 months commencing on the 1st day of April every year. In India, the Govt. maintains its accounts for a period of 12 months i.e. 1st April to 31st March every year. As such it is known as Financial Year (Previous Year). The Income Tax department has also selected same year for its Assessment procedure.
The Assessment Year is the Financial Year of the Govt. of India during which income of a person relating to the relevant previous year (financial year) is assessed to tax. Tax is calculated and compared with the amount paid and assessment order is issued. The year in which whole of this process is under taken is called Assessment Year.
During the Assessment Year 2019-2020 (1-4-2019 to 31-3-2020) Income earned during Previous Year (Financial Year ending on 31-03-2019) will be assessed and hence called “Assessment Year”
Income of Previous Year (Financial Year) of an assessee is taxed during the next following Assessment Year at the rates prescribed by the relevant Finance Act.
PREVIOUS YEAR [Section 3]
As the word ‘Previous’ means ‘coming before’ , hence it can be simply said that the Previous Year is the Financial Year preceding the Assessment Year e.g. for Assessment Year 2019-2020 the Previous Year should be the Financial Year ending 31st March 2019. Effectively it means the year in which income is earned.
Who All Have To Pay Income-Tax?
There are 3 categories of individual taxpayers: 1.Individuals (below the age of 60 years) which includes residents as well as non-residents-Income in excess of Rs.2.5 lakhs 2.Resident Senior citizens (60 years and above but below 80 years of age)- Income in excess of Rs.3.0 lakhs 3.Resident Super senior citizens (above 80 years of age)- Income in excess of Rs.5.0 lakhs
HUF-Income in excess of Rs.2.5 lakhs. HUF is also considered tax paying entity (besides it`s Manager (Karta) and gets same Basic Exemption like Individual i.e. Rs.2, 50,000/-.
How Income-Tax Will Be Charged By The Income Tax Department?
Income Tax is charged on 5 different heads. Aggregate of taxable income under each head of income is known as Gross Total Income and so, Taxable Income = Gross Total Income - Allowance Deductions.
Deduction of Expenditure: In computing income under various heads, deduction is allowed towards expenditure incurred in relation to earning the income. However, no deduction shall be allowed in respect of expenditure incurred in relation to incomes exempt from tax.
Computation of Gross Total Income: It is the aggregate of incomes under various heads of income calculated after set-off of unabsorbed depreciation/loss, carried forward from earlier years.
Set-off and Carry Forward: Set-off means adjustment of certain losses against the income under other sources / heads. Carry forward implies carrying forward of certain losses for set-off from earlier year/s in to subsequent years.
Total / Taxable Income: Total / Taxable Income are computed after deducting permissible deductions under section 80A to 80U, from the Gross Total Income.
Where the Gross Total Income of the Assesses includes Short-Term Capital Gains from transfer of equity shares / units of an equity oriented mutual fund subject to Securities Transaction Tax or any Long-Term Capital Gains, then no deduction shall be allowed against such Capital Gains. On this Taxable Income, Income Tax will be calculated as per the applicable rates.
RESIDENTIAL STATUS OF AN ‘INDIVIDUAL’
What is chargeable to tax is only Income, shall be taxed as per the applicable tax rates. A key tangent to decide whether the income earned is taxable in India is the residential status of the person who is receiving the income. The act follows a residence based rule of taxation, a principle imbibed by many tax laws across the world, which taxes income based on the residential status of a person. As per this rule, a resident ends up paying taxes on income regardless of where the income is sourced from.
For the purpose of income tax in India, the income tax laws in India classifies taxable persons as:
· A resident
· A resident not ordinarily resident (RNOR)
· A non-resident (NR)
The taxability differs for each of the above categories of taxpayers. Before we get into taxability, let us first understand how a taxpayer becomes a resident, an RNOR or an NR.
Section 6 of the income tax act guides us on how to calculate the residential status. The primary conditions are as follows:
· Has stayed in India for a period of 182 days (applicable only if Income from Indian sources is below Rs.15 lakhs) or more in the previous year (120 days applicable if Indian Income is above Rs.15 lakhs) , or
· Has stayed in India for 60 days or more in the previous year, and 365 days or more in the four previous years immediately preceding the previous year in question.
Additionally to qualify as a Resident and ordinarily resident, a person has to satisfy BOTH the following conditions:
1. A resident for at least 2 previous years out of the last 10 previous years immediately preceding the previous year in question, AND
2. Has stayed in India for 730 days or more in seven previous years immediately preceding the previous year in question.
For Citizens / Persons of Indian origin, who leave India for seeking employment opportunities outside India or those who come to India for a vacation, or temporarily, point (b) above in the primary conditions will apply as if 60 days is substituted with 182 days.
However, from the financial year 2020-21, the period is reduced to 120 days or more for such an individual whose total income (other than foreign sources) exceeds Rs 15 lakh). In another significant amendment from FY 2020-21, an individual who is a citizen of India who is not liable to tax in any other country will be deemed to be a resident in India. The condition for deemed residential status applies only if the total income (other than foreign sources) exceeds Rs 15 lakh and nil tax liability in other countries or territories by reason of his domicile or residence or any other criteria of similar nature.
Residential Status OF ‘H.U.F.’ , ‘FIRM’ , ‘ A.O.P.’
Section 6(2) of the Act provides that status of these persons shall be determined as per Tests given below :
1. Resident [Section 6(2)] It means that if a H.U.F., FIRM, AOP is controlled from India even partially it will be Resident assessee.
2. Non- Resident [Section 2(30)] H.U.F., FIRM, AOP shall be Non-Resident if the control and management affairs is situated wholly outside India.
3. Not Ordinarily Resident [ Section 6(6)b ] H.U.F. will be ‘Not Ordinarily Resident’ if :
(i) its manager (Karta) has not been resident in India in 9 out of 10 previous year preceding the relevant accounting year ; or
(ii) the manage had not , during the 7 previous year preceding the relevant accounting year been present in India for a period or periods amounting in all to 730 days.