Introduction and Basic Concept of Income Tax

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Income Tax

Introduction & Brief History

Tax is the compulsory financial charge levy by the government on income, commodity, services, activities or transaction. The word ‘tax’ derived from the Latin word ‘Taxo’. Taxes are the basic source of revenue for the government, which are utilized for the welfare of the people of the country through government policies, provisions and practices.

In India, Income Tax was first time introduced in the year 1860 by Sir James Wilson in order to meet the loss caused on account of ‘military mutiny’ in 1857.

In the year 1886, a separate Income Tax Act was passed, this act was in force for a long time, subject to the various amendments from time to time. In the year 1918, a new Income Tax Act was passed, but again, it was replaced by another new act of 1992. The Act of 1922 became very complicated due to various amendments. This act remains in force to the assessment year 1961-62. In the year 1956, the Government of India referred to the Law Commission in order to simplify the law and also to prevent the evasion of Tax.

The Law Commission submitted its report in September 1958 in consultation with the Ministry of Law. At present, this law is governed by the Act of 1961 which is commonly known as Income Tax Act, 1961 which came into force on and from 1st April 1962. It applies to the whole of India, including the state of Jammu & Kashmir.

Any law is in itself is not complete unless the gaps are being filled. The law of Income Tax in India governed by the Income Tax Act of 1961 and the gaps are being filled by the Income Tax Rules, Notifications, Circulars and judicial pronouncement including rulings by the Tribunal.

The Income Tax law in India consists of the following components;

  1. Income Tax Act, 1961: The Act contains the major provisions related to Income Tax in India.
  2. Income Tax Rules, 1962: Central Board of Direct Taxes (CBDT) is the body which looks after the administration of Direct Tax. The CBDT is empowered to make rules for carrying out the purpose of this Act.
  3. Finance Act: Every year Finance Minister of Government of India presents the budget to the parliament. Once the finance bill is approved by the parliament and get the clearance from President of India, it became the Finance Act.
  4. Circulars and Notifications: Sometimes the provisions of an act may need clarification and that clarification usually in a form of circulars and notifications which has been issued by the CBDT from time to time. It includes clarifying the doubts regarding the scope and meaning of the provisions.

Constitution and Tax Law

Every statute gains sanction from the law of land, i.e.,the Constitution of India. Similarly, the government is authorised by the Constitution to collect the taxes. According to Article 265 of the Constitution of India, no tax shall be levied or collected except by authority of law.[1] Thus, the tax levied and collected must be within the competency of authority authorised by the legislature.

Entry 82 of List I of Seventh Schedule of the Constitution of India confer power on Parliament to levy taxes on income other than agricultural income. Thus, Income Tax is under the Union list and henceforth Central Government is authorised and responsible for the collection of income tax.

The Central Government enjoys the power to collect taxes on income except for the tax on agricultural income, which is being enjoyed by the State Government. Entry 46 of List II of Seventh Schedule of the Constitution of India provides that the State Government has the power to collect taxes on agricultural income.

Status of Income Tax in Other Countries

Income Tax in Australia

Income Tax is the most significant and prime source of revenue for the government of Australia within the Australian taxation system. It consists of three main pillars i.e., personal earnings, business earnings, and capital gains. The progressive approach of the tax system is being followed up by Australia, which means that the more you earn, the more tax you need to pay. The tax is imposed by the federal government on the taxable income of individuals and corporations.

Income Tax in America

The progressive approach of the tax system is being followed up by the United States of America, which means that the more you earn, the more tax you need to pay. The Internal Revenue Service (IRS) in the USA is responsible for levy and collection of income tax. The United States tax system is set up on both a federal and state level. Both are altogether separate and each has its own authority to charge taxes. The federal government does not possess any right to interfere with the state taxation. Each state has its own tax system and different from the other states. The U.S. tax system is quite complex in nature.

Income Tax in China

All individuals working in China either Chinese or foreigner are required to pay ‘Individual Income Tax (IIT) on their earnings. IIT is a complicated tax framework. It is a residence – based tax. In order to determine that whether a person is liable to individual income tax, and the extent to which he or she is liable, are

a) whether the person is living in China;

b) in case a person is expatriate, in that case, how long that person is living in China;

c) the source of the income; and

d) who bears the salary cost for this person.

Income Tax in the United Kingdom

Taxes are levied according to the payer’s ability to pay- higher income persons are assumed to be able to pay at higher rates. The major taxes include income taxes, property taxes, capital gains, UK inheritance taxes, and Value Added Taxes. Taxes are the main source of revenue for the government.

Types of Taxes

Taxes are levied by the government on the taxpayer. Taxes are broadly divided into two parts namely, Direct Tax and Indirect Tax. Direct Tax is levied directly on the income of the person. Income Tax and Wealth Tax are the part of Direct Tax. Whereas, in indirect taxes, the person who pays the tax, shifts the burden to the person who consumes the goods or services. Before 2017 the Indirect Tax comprises of various taxes and duties like Service Tax, Sales Tax, Value Added Tax, Customs Duty, Excise Duty and etc. From July 1st, 2017 all such Indirect Taxes are submerged in one tax law which was named as ‘The Goods and Services Tax Act, 2017”.

Basic Concept of Income Tax Act

“Income Tax is levied on the total income of the previous year of every person”. To understand the basic concept.It is very important to know the various other concepts.

Concept of Income

In common parlance, Income is known as a regular periodic return to a person from his activities. However, the Income has broader classified in Income Tax law. The Income Tax Act, even take consideration of income which has not arisen regularly and periodically. For instance, winning from lotteries, crossword puzzles, income from winning of shows is also subject to tax as per income tax.

The Income includes income from:

Cash or Kind

Income in terms of Cash is not the only way to receive income, it can also be received in terms of a kind. The calculation of income from kind is subject to different treatments in both Direct and Indirect Tax. When the income is received in kind, its valuation will be made.

Legal or Illegal Income

A man of ordinary prudence may think that the illegal income may not be falling under the concept of income, but income tax does not make any distinction between the income received from a legal or illegal source. In CIT v. Piara Singh[2],the Supreme Court held that the loss of business of smuggling shall be allowed for deduction under Income Tax. The rationale behind the decision was that the smuggling activity is also regarded as a business. Therefore, the confiscation of currency notes employed in smuggling activity is a loss which arises directly from the carrying on of the business.

Temporary or Permanent

As per Income Tax Act, there is no distinction in computing income whether nature is temporary or permanent.

Receipt basis or Accrual basis

Income arises either on receipt basis or accrual basis. It may accrue to a taxpayer without its actual receipt. The income in some cases is deemed to accrue or arise to a person without its actual accrual or receipt. Income accrues where the right to receive arises.[3]

Gifts 

Gifts up to Rs. 50,000 received in Cash do not constitute tax liability. Gifts in kind having the fair value maximum up to Rs. 50,000 is not liable to tax. However, the whole amount will be taxed if the value exceeds the prescribed limit. Moreover, the treatment of valuation of the gift is different in the different situation especially gifts received on occasion of marriage.

Lump sum or Instalments 

Income Tax does not make any distinction in computing income, whether it receive in lump sum or instalment.

Moreover, the income is defined in Section 2(24) of the Act.

Person

Income tax is levied on the total income of the previous year of every person. In general terms, the meaning of a person can be interpreted in a short term. Whereas, as per Section 2 (31), Person includes:

i. an individual,

ii. a Hindu undivided family (HUF),

iii. a company,

iv. a firm,

v. an association of persons (AOP) or a body of individuals (BOI), whether incorporated or not,

vi. a local authority, and

vii. every artificial juridical person (AJP), not falling within any of the preceding sub-clauses.

The definition of Person starts with the word includes, therefore, the list is inclusive, not exhaustive.

 Assessee

An assessee is a taxpayer means a person who under the income tax act is subject to pay taxes or any other sum of money, as defined under section 2 (7) of the Act. The expression ‘any other sum of money’ includes other such obligations payable, for instance fine, interest, penalty and other tax etc.

 Assessment Year

“Assessment Year” means the year in which income of the previous year of an assessee is taxed. The timed lap of assessment year is of twelve months beginning from the 1st April every year. The period starts from 1st April of one year and ending on 31st March of next year. Broadly, assessment year is defined under section 2 (9) of the Act.

 Previous Year

Income earned during the year is taxable in the next year. The definition of “Previous Year” is given under section 3 of the Act. Previous Year is the year in which income is earned. Previous year is the financial year immediately preceding the relevant assessment year. From 1989-90 onwards, every taxpayer is obliged to follow financial year (i.e., April 1st of one year to March 31st of next year) as the previous year.

For a newly set up business or profession, the first previous year will start from the day from which that business or profession has commenced, but the period of ending will remains same (i.e., 31st March).

Illustration 1: X set up business on July 20, 2016. What is the previous year for the assessment year 2017-18?

Solution: Previous year for the assessment year 2017-18 is the period commencing from the date of setting up of business/ profession (i.e., July 20, 2016) and ending on March 31, 2017.

Illustration 2: Mr X joins an Indian company on January 21, 2016. Prior to joining this company, Mr X was not in employment anywhere nor does he have any other source of earning. Determine the previous year of Mr X for the assessment year 2016-17 and 2017-18?

Solution: Previous year for the assessment year 2016-17 and 2017-18 are as follows:

Previous Year Assessment Year
Jan. 20, 2016 to March 31, 2016 2016-17
April 1, 2016, to March 31, 2017 2017-18

 

Heads of Income

As per Income tax, section 14 classifies income under five heads:

i. Income from salaries

ii. Income from House Property

iii. Profits and gains of business and profession

iv. Capital Gains

v. Income from other sources

Tax Rates

The Income is taxed at the rates prescribed by the relevant Finance Act. The tax levied on the basis of a slab system where different tax rates have been directed for the different slab. In India, there are three categories of individual taxpayers:

i. An individual below the age of 60 years,

ii. A senior citizen above the age of 60 years, but below the age of 80 years,

iii. A super senior citizen above 80 years of age.

The tax slab varies according to the different persons.

Surcharge

The Surcharge is commonly known as Tax on Tax. It is an additional tax levied on the taxpayers on a special group of people. It is an additional tax liability levied on the person having more income than prescribed.

 Education Cess and Secondary Higher Education Cess

The amount of income tax shall be increased by an Education Cess on Income Tax by 2% and Secondary and Higher Education Cess by 1% of the tax liability.

Frequently Asked Questions (FAQs) 

  • What are the various tax slab for the assessment year 2018-19?

Rates for Income Tax for Assessment Year 2018-19 an amendment made by the Finance Act, 2017;

A.

I. In the case of the individual below the age of 60 years, or HUF, or AOP/BOI (other than a co-operative society) whether incorporated or not or every AJP.

INCOME CATEGORIES TAX RATES
Upto Rs. 2,50,000 Nil
Rs. 2,50,000 to Rs. 5,00,000 5%
Rs. 5,00,000 to Rs. 10,00,000 20%
Above Rs. 10,00,000 30%

II. In the case of an individual, being a resident in India, who is of 60 years or more but below 80 years (senior citizen) at any time during the previous year.

INCOME CATEGORIES TAX RATES
Upto Rs. 3,00,000 Nil
Rs. 3,00,000 to Rs. 5,00,000 5%
Rs. 5,00,000 to Rs. 10,00,000 20%
Above Rs. 10,00,000 30%

III. In the case of an individual, being an Indian resident, who is of 80 years of age or more (super senior citizen) at any time during the previous year.

INCOME CATEGORIES TAX RATES
Up to Rs. 5,00,000 Nil
Rs. 5,00,000 to Rs. 10,00,000 20%
Above Rs. 10,00,000 30%

 B. In the case of a co-operative society;

INCOME RATES
where the total income does not exceed Rs. 10,000 10% of the total income;
where the total income exceeds Rs. 10,000 but does not exceed Rs. 20,000 Rs. 1000 plus 20% of the amount by which the total income exceeds Rs. 10,000;
where the total income exceeds Rs. 20,000 Rs. 3000 plus 30% of the amount by which the total income exceeds Rs. 20,000;

 

C. In the case of any firm (including Limited Liability Partnership), the tax will be charged at the rate of 30%.

D. In the case of a company;

I. For domestic companies:

a. If the total turnover or the gross receipts of the previous year 2015-16 does not exceed Rs. 50 Cr.: 25%

b. In all other cases: 30%

II. For foreign companies: 40%

Bibliography

[References]

[1]Article 265 of the Constitution of India.

[2](1980) AIR 1271, (1980) SCR (3)1122.

[3]The Institute of Company Secretaries of India, Tax Laws and Practice 6.

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