TAXATION SYSTEM IN INDIA

UNIT I:
Introduction: Indian Taxation system – Over view of Direct Taxes.
Income Tax: Concepts: Income, Person, Assessee, Assessment year,
Previous year, Income, Casual income, PAN, Gross total income,
Agricultural income and its assessment, Capital and Revenue, Residential
status and incidence of tax of an individual (Including problems), Incomes
exempt from tax, Tax evasion Vs. Tax avoidance.
Wealth tax: Concepts: Previous year, Assessment year, Assessee,
Valuation date, Taxable assets, Deemed assets, Exempted assets, Net
wealth (Theory only).

India has a well-developed tax structure with clearly demarcated authority between Central and State
Governments and local bodies. Central Government levies taxes on income (except tax on agricultural income,
which the State Governments can levy), customs duties, central excise and service tax.

Value Added Tax (VAT), (Sales tax in States where VAT is not yet in force), stamp duty, State Excise, land
revenue and tax on professions are levied by the State Governments. Local bodies are empowered to levy tax
on properties, octroi and for utilities like water supply, drainage etc.

In last 10-15 years, Indian taxation system has undergone tremendous reforms. The tax rates have been
rationalized and tax laws have been simplified resulting in better compliance, ease of tax payment and better
enforcement. The process of rationalization of tax administration is ongoing in India.

Since April 01, 2005, most of the State Governments in India have replaced sales tax with VAT.

Taxes Levied by Central Government

Direct Taxes
Tax on Corporate Income
Capital Gains Tax
Personal Income Tax
Tax Incentives
Double Taxation Avoidance Treaty
Indirect Taxes
Excise Duty
Customs Duty
Service Tax
Securities Transaction Tax
Taxes Levied by State Governments and Local Bodies
Sales Tax/VAT
Other Taxes

India has a well-developed tax structure with clearly demarcated authority between Central and
State Governments and local bodies. Central Government levies taxes on income (except tax on
agricultural income, which the State Governments can levy), customs duties, central excise and
service tax.

Value Added Tax (VAT), (Sales tax in States where VAT is not yet in force), stamp duty, State
Excise, land revenue and tax on professions are levied by the State Governments. Local bodies
are empowered to levy tax on properties, octroi and for utilities like water supply, drainage etc.

In last 10-15 years, Indian taxation system has undergone tremendous reforms. The tax rates
have been rationalized and tax laws have been simplified resulting in better compliance, ease of
tax payment and better enforcement. The process of rationalization of tax administration is
ongoing in India.
Since April 01, 2005, most of the State Governments in India have replaced sales tax with VAT.

Direct Taxes
Taxes on Corporate Income

Companies residents in India are taxed on their worldwide income arising from all sources in
accordance with the provisions of the Income Tax Act. Non-resident corporations are essentially
taxed on the income earned from a business connection in India or from other Indian sources. A
corporation is deemed to be resident in India if it is incorporated in India or if it’s control and
management is situated entirely in India.

Domestic corporations are subject to tax at a basic rate of 35% and a 2.5% surcharge. Foreign
corporations have a basic tax rate of 40% and a 2.5% surcharge. In addition, an education cess
at the rate of 2% on the tax payable is also charged. Corporates are subject to wealth tax at the
rate of 1%, if the net wealth exceeds Rs.1.5 mn ( appox. $ 33333).

Domestic corporations have to pay dividend distribution tax at the rate of 12.5%, however, such
dividends received are exempt in the hands of recipients.

Corporations also have to pay for Minimum Alternative Tax at 7.5% (plus surcharge and
education cess) of book profit as tax, if the tax payable as per regular tax provisions is less than
7.5% of its book profits.

Capital Gains Tax

Tax is payable on capital gains on sale of assets.

Long-term Capital Gains Tax is charged if

• Capital assets are held for more than three years and
• In case of shares, securities listed on a recognized stock exchange in India, units of specified
mutual funds, the period for holding is one year.

Long-term capital gains are taxed at a basic rate of 20%. However, long-term capital gain from
sale of equity shares or units of mutual funds are exempt from tax.

Short-term capital gains are taxed at the normal corporate income tax rates. Short-term capital
gains arising on the transfer of equity shares or units of mutual funds are taxed at a rate of 10%.

Long-term and short-term capital losses are allowed to be carried forward for eight consecutive
years. Long-term capital losses may be offset against taxable long-term capital gains and short-
term capital losses may be offset against both long term and short-term taxable capital gains.

Personal Income tax

Personal income tax is levied by Central Government and is administered by Central Board of
Direct taxes under Ministry of Finance in accordance with the provisions of the Income Tax Act.
The rates for personal income tax are as follows:-

Income range (Rupee) Tax Rate (%)

0-100,000 Nil
1,00,000-1,50,000 10
1,50,000-2,50,000 20
2,50,000 and above 30

Surcharges of 10% on total tax is levied if income exceeds Rs. 8,50,000

Rates of Withholding Tax

Current rates for withholding tax for payment to non-residents are:-

(i) Interest 20%

(ii) Dividends Dividends paid by domestic companies: Nil
(iii) Royalties 10%
(iv) Technical Services 10%
(v) Any other services Individuals: 30% of the income
Companies: 40% of the net income

The above rates are general and are applicable in respect of countries with which India does not
have a Double Taxation Avoidance Agreement (DTAA).

Tax Incentives

Government of India provides tax incentives for:-

• Corporate profit
• Accelerated depreciation allowance
• Deductibility of certain expenses subject to certain conditions.

These tax incentives are, subject to specified conditions, available for new investment in
• Infrastructure,
• Power distribution,
• Certain telecom services,
• Undertakings developing or operating industrial parks or special economic zones,
• Production or refining of mineral oil,
• Companies carrying on R&D,
• Developing housing projects,
• Undertakings in certain hill states,
• Handling of food grains,
• Food processing,
• Rural hospitals etc.

Double Tax Avoidance Treaty

India has entered into DTAA with 65 countries including the US. In case of countries with which
India has Double tax Avoidance Agreement, the tax rates are determined by such agreements.
Domestic corporations are granted credit on foreign tax paid by them, while calculating tax
liability in India.

In the case of the US, dividends are taxed at 20%, interest income at 15% and royalties at 15%.
 Income tax

An income tax is a tax levied on the income of individuals or businesses

(corporations or other legal entities). Various income tax systems exist, with
varying degrees of tax incidence. Income taxation can be progressive,
proportional, or regressive. When the tax is levied on the income of
companies, it is often called a corporate tax, corporate income tax, or profit
tax. Individual income taxes often tax the total income of the individual
(with some deductions permitted), while corporate income taxes often tax
net income (the difference between gross receipts, expenses, and additional
write-offs). Various systems define income differently, and often allow
notional reductions of income (such as a reduction based on number of
children supported).

ASSESSMENT YEAR

It is tangible underneath territory 2(9), that states that A.Y is a duration of twelve
months commencing upon a initial day of Apr any year as well as finale upon a final
day of impetus a subsequent year.

For Example : the stream assessement year 2009-2010 commences from Apr 1,
2009 as well as ends upon impetus 31, 2010. Tax is levied in any comment year,
with apply oneself to or upon a sum income warranted by a assesse in a prior year.
It is additionally well well known as Tax Year.

“Assessment year” means the period starting from April 1 and ending on March 31
of the next year.

Example- Assessment year 2006-07 which will commence on April 1, 2006, will end
on March 31, 2007.

Income of previous year of an assessee is taxed during the next following

assessment year at the rates prescribed by the relevant Finance Act
 PREVIOUS YEAR
It is tangible underneath territory 3 of Income Tax Act 1961, whivh equates to it is
a duration of twelve months prior to a derivation of a comment year. Generally it is
a monetary year ( 1st Apr to 31st march) preceding a asessment year as a
assessement year regularly rught away follows a prior year. Income warranted in a
prior year is taxable in a rught away following comment year during a rates
specified by a revelant Finance Act for any such comment year. Hence , a year in
that is warranted is a prior year as well as a year in that such income shall be taxed
is a comment year. For a stream comment year 2009-2010, The prior year 2008-
2009 commences from Apr 1, 2008 as well as ends upon impetus 31st, 2009. It is
additionally well well known as Income Year.

Income earned in a year is taxable in the next year. The year in which income is
earned is known as previous year and the next year in which income is taxable is
known as assessment year. In other words, previous year is the financial year
immediately proceeding the assessment year.

Illustration 1.1 - For the assessment year 2006-07, the immediately preceding
financial year (i.e., 2005-06) is the previous year. Income earned by an individual
during the previous year 2005-06 is taxable in the immediately following
assessment year 2006-07 at the rates applicable for the

assessment year 2006-07. Similarly, income earned during the previous year 2006-
07 by a company will be taxable in the assessment year 2007-08 at the rates
applicable for the assessment year 2007-08. This rule is applicable in all cases [see,
however,

PERSON

The word chairman is a far-reaching term. It includes

         Individual: It refers to a healthy vital tellurian being.

 
         HUF ( Hindu Undivided Family): It equates to a family that consists of all persons,
linearly descendent from a usual forerunner together with their wives as well as unwed
duaghters.
 

         Company: It is an artifical chairman purebred underneath Indian Companies Act 1956 or
any alternative law.
 

         Firm: It is an artifical entity that comes in to life as a outcome of partnership agreement.
The usually condition for a partnership entity to be assessed as organisation is that it
contingency submit, a partnership deed.
 

         AOP ( Association of persons) : A organisation that has not submitted a partnership
help or series of partners is some-more than twenty, afterwards it is treated with colour as an
AOP.

Example: Cooperative societies, Trustees of a certitude etc.

         Local Authorities: Muncipalities, Panchayats, Contonment Boards, Port trusts, etc have
been internal authorities.
 

         Artifical Juridicial Person: Statuory Coorporations similar to LIC, Universities etc have
been called Arificial juridicial Persons.
The term “person” includes:

a. an individual;

b. a Hindu undivided family;

c. a company;

d. a firm;

e. an association of persons or a body of individuals, whether incorporated or not;

f. a local authority; and

g. every artificial juridical person not falling within any of the preceding categories.
These are seven categories of persons chargeable to tax under the Act. The aforesaid definition is
inclusive and not exhaustive. Therefore, any person, not falling in the above-mentioned seven
categories, may still fall in the four corners of the term “person” and accordingly may be liable to tax.

ASSESSEE

Any chairman who is probable to compensate taxation or any alternative sum of income
( interest, penality, etc..) is an Assessee.

It is tangible underneath territory 2(7), that states that a chairman by whom any
yaks or any alternative sum of income is upon credit underneath this action &
includes

         Any chairman opposite whom a little record underneath this action have been starting on.

         Any chairman by whom a little volume of tax, seductiveness or penality is payable.

         Any chairman to whom reinstate is due

         Any chairman who has suffered waste though filled returns

         Any chairman who is obliged upon interest of a minor, goofy or a non-resident is a deemed
assessee.

         Any chairman deducts taxation during source though doesn’t deposition it in supervision
book is assessee upon default.

Like correct if a chairman doesn’t allege tax, he is additionally an assesee in

default..

“Assessee” means a person by whom income tax or any other sum of money is payable under the Act. It
includes every person in respect of whom any proceeding under the Act has been taken for the
assessment of his income or loss or the amount of refund due to him. It also includes a person who is
assessable in respect of income or loss of another person or who is deemed to be an assessee, or an
assessee in default under any provision of the Act.

MEANING OF INCOME
The definition of the term “income” in section 2(24) is inclusive and not exhaustive. Therefore, the term
“income” not only includes those things that are included in section 2(24) but also includes those things
that the term signifies according to its general and natural meaning.

GROSS TOTAL INCOME

As per section 14, the income of a person is computed under the following five heads:

1. Salaries.

2. Income from house property.

3. Profits and gains of business or profession.

4. Capital gains.

5. Income from other sources.

The aggregate income under these heads is termed as “gross total income”. In other words, gross total
income means total income computed in accordance with the provisions of the Act before making any
deduction under sections 80C to 80U.

Casual Income

Income from horse races, winning from lotteries, cranky word puzzles, label gains or
gambling or betting, winning from T.V programmes, propitious dips, conducted by
commercial operation establishments have been couple of examples of casual incomes. This
incomes have been taxable underneath Sec. 56 underneath a conduct Income from alternative
sources.

PAN

Permanent Account Number (PAN) is a ten-digit alphanumeric number, issued in the form of a
laminated card, by the Income Tax Department.

A typical PAN is AABPS1205E.

It is mandatory to quote PAN on return of income, all correspondence with any income tax
authority. From 1 January 2005 it will be mandatory to quote PAN on challans for any payments
due to Income Tax Department.

It is also compulsory to quote PAN in all documents pertaining to financial transactions notified
from time-to-time by the Central Board of Direct Taxes. Some such transactions are sale and
purchase of immovable property or motor vehicle or payments in cash, of amounts exceeding Rs.
25,000/-to hotels and restaurants or in connection with travel to any foreign country. It is also
mandatory to mention PAN for obtaining a telephone or cellular telephone connection. Likewise,
PAN has to be mentioned for making a time deposit exceeding Rs. 50,000/- with a Bank or Post
Office or depositing cash of Rs. 50,000/- or more in a Bank.

What is agricultural income?

To consider an activity as agriculture the basic operation such as tilling, sowing, irrigating & harvesting
should have been carried out. Thereafter what is sold in the market should be the primary product
harvested. Receipt from such sale is considered as agricultural receipt. If however some further
processing or modification were done to the harvested product to enhance its marketable value then such
enhanced value would be considered as business income.

What does the term Agricultural Income mean?

As per Income Tax Act income earned from any of the  under given three sources meant
Agricultural Income;

(i)     Any rent received from land which is used for agricultural purpose.

(ii)   Any income derived from such land by agricultural operations including processing of
agricultural produce, raised or received as rent in kind so as to render it fit for the market, or sale
of such produce.

(iii)   Income attributable to a farm house subject to the condition that building is situated on or
in the immediate vicinity of the land and is used as a dwelling house, store house etc.

Now income earned from carrying nursery operations is also considered as agricultural income
and hence exempt from income tax.

In order to consider an income as agricultural income certain points have to be kept in mind:

(i)  There must me a land.

(ii)  The land is being used for agricultural operations.

(iii)   Agricultural operation means that efforts have been induced for the crop to sprout out of
the land .

(iv)  If any rent is being received from the land then in order to assess that rental income as
agricultural income there must be agricultural activities on the land.

(v)   In order to assess income of farm house as agricultural income the farm house building must
be situated on the land itself only and is used as a store house/dwelling house.

 
Certain income which is treated as Agriculture Income;

(a)    Income from sale of replanted trees.

(b)   Rent received for agricultural land.

(c)    Income from growing flowers and creepers.

(d)   Share of profit of a partner from a firm engaged in agricultural operations.

(e)    Interest on capital received by a partner from a firm engaged in agricultural operations.

(f)    Income derived from sale of seeds.

Certain income which is not treated as Agricultural Income;

(a)    Income from poultery farming.

(b)   Income from bee hiving.

(c)    Income from sale of  spontaneously grown trees.

(d)   Income from dairy farming.

(e)    Purchase of standing crop.

(f)    Dividend paid by a company out of its agriculture income.

(g)   Income of salt produced by flooding the land with sea water.

(h)   Royalty income from mines.

(i)     Income from butter and cheese making.

(j)     Receipts from TV serial shooting in farm house is not agriculture income.

Certain points to be remembered;

(a)    Agricultural income is considered for rate purpose while computing tax of
Individual/HUF/AOP/BOI/Artificial Judicial Person.
(b)   Losses from agricultural operations could be carried forward and set off with agricultural
income of next eight assessment years.

(c)    Agriculture income is computed same as business income.

Revenue
In business, revenue is income that a company receives from its normal business activities,
usually from the sale of goods and services to customers. In many countries, such as the United
Kingdom, revenue is referred to as turnover. Some companies receive revenue from interest,
dividends or royalties paid to them by other companies.[1] Revenue may refer to business income
in general, or it may refer to the amount, in a monetary unit, received during a period of time, as
in "Last year, Company X had revenue of $32 million."

Profits or net income generally imply total revenue minus total expenses in a given period. In
accounting, revenue is often referred to as the "top line" due to its position on the income
statement at the very top. This is to be contrasted with the "bottom line" which denotes net
income.[2]

For non-profit organizations, annual revenue may be referred to as gross receipts.[3] This
revenue includes donations from individuals and corporations, support from government
agencies, income from activities related to the organization's mission, and income from
fundraising activities, membership dues, and financial investments such as stock shares in
companies.[4] For government, revenue includes gross proceeds from income taxes on companies
and individuals, excise duties, customs duties, other taxes, sales of goods and services, dividends
and interest.[5]

In general usage, revenue is income received by an organization in the form of cash or cash
equivalents. Sales revenue or revenues is income received from selling goods or services over a
period of time. Tax revenue is income that a government receives from taxpayers.

In more formal usage, revenue is a calculation or estimation of periodic income based on a

particular standard accounting practice or the rules established by a government or government
agency. Two common accounting methods, cash basis accounting and accrual basis accounting,
do not use the same process for measuring revenue. Corporations that offer shares for sale to the
public are usually required by law to report revenue based on generally accepted accounting
principles or International Financial Reporting Standards.

In a double-entry bookkeeping system, revenue accounts are general ledger accounts that are
summarized periodically under the heading Revenue or Revenues on an income statement.
Revenue account names describe the type of revenue, such as "Repair service revenue", "Rent
revenue earned" or "Sales".[6]

Capital
A capital gains tax (CGT) is a tax charged on capital gains, the profit realized on the sale of a
non-inventory asset that was purchased at a lower price. The most common capital gains are
realized from the sale of stocks, bonds, precious metals and property. Not all countries
implement a capital gains tax and most have different rates of taxation for individuals and
corporations.

For equities, an example of a popular and liquid asset, each national or state legislation, have a
large array of fiscal obligations that must be respected regarding capital gains. Taxes are charged
by the state over the transactions, dividends and capital gains on the stock market. However,
these fiscal obligations may vary from jurisdiction to jurisdiction because, among other reasons,
it could be assumed that taxation is already incorporated into the stock price through the different
taxes companies pay to the state, or that tax free stock market operations are useful to boost
economic growth.

India

As of 2008, equities are considered long term capital if the holding period is one year or more.
Long term capital gains from equities are not taxed if shares are sold through recognised stock
exchange and STT is paid on the sale . However short term capital gain from equities held for
less than one year, is taxed at 15% [5] (w.e.f. 1 April 2009. [6]) (plus surcharge and education
cess). This is applicable only for transactions that attract Securities Transaction Tax (STT).

Many other capital investments (house, buildings, real estate, bank deposits) are considered long
term if the holding period is 3 or more years.[7] Short term capital gains are taxed just as any
other income and they can be negated against short term capital loss from the same business.

RESIDENTIAL STATUS AND TAX INCIDENCE

2.0 Introduction 2.1 Objectives 2.2 Concept of Residential Status 2.3 Residential Status of Individual

2.3.1 Resident and Ordinarily Resident 2.3.2 Resident but not Ordinarily Resident

2.3.3 Non-Resident 2.4 Residential Status of Hindu Undivided Family

2.4.1 HUF – Resident or Non-Resident 2.4.2 HUF – When ordinarily resident in India

2.5 Residential Status of Firm and Association of Persons 2.6 Residential Status of Company

2.7 Residential Status of every other person 2.8 Residential Status and Incidence of tax

2.8.1 Indian and foreign income 2.8.2 Incidence of tax for different tax payers 2.8.3 Conclusions

2.9 Meaning of Receipt of Income 2.9.1 Receipt vs. Remittance 2.9.2 Actual Receipt vs. Deemed Receipt

2.10 Meaning of Accrual of Income 2.11 Meaning of deemed to accrue or arise in India
2.12 Let us sum up 2.13 Glossary 2.14 Self Assessment Exercises 2.15 Further Readings

2.0 INTRODUCTION

Tax incidence on an assessee depends on his residential status. For instance, whether an income,
accrued to an individual outside India, is taxable in India depends upon the residential status of the
individual in India. Similarly, whether an income earned by a foreign national in India (or outside India) is
taxable in India depends on the residential status of the individual, rather than on his citizenship.
Therefore, the determination of the residential status of a person is very significant in order to find out
his tax liability.

2.1 OBJECTIVES

After going through this lesson you should be able to understand:

• The concept of residential status

• Residential status of an Individual

• Residential status of a Hindu Undivided Family

• Residential status of a Firm and an Association of Persons

• Residential status of a Company

• Residential status of every other person

• Residential status and Incidence of Tax

• Meaning of receipt and accrual of India

• Meaning of income deemed to accrue or arise in India

2.2 CONCEPT OF RESIDENTIAL STATUS

The following norms one has to keep in mind while deciding the residential status of an assessee:

1. Different taxable entities - All taxable entities are divided in the following categories for the purpose
of determining residential status:

a. An individual;

b. A Hindu undivided family;

c. A firm or an association of persons;

d. A joint stock company; and

e. Every other person.

2. Different residential status - An assessee is either: (a) resident in India, or (b)non-resident in India.

However, a resident individual or a Hindu undivided family has to be (a) resident and ordinarily resident,
or (b) resident but not ordinarily resident. Therefore, an individual and a Hindu undivided family can
either be:

a. resident and ordinarily resident in India; or

b. resident but not ordinarily resident in India; or

c. non-resident in India

All other assessees (viz., a firm, an association of persons, a joint stock company and every other person)
can either be:

a. resident in India; or

b. non-resident in India.

The table given below highlights these points- Category

Individual/Hindu undivided family Firm, association of persons, joint stock company and every other
person

Category 1

Resident in India

Ordinarily resident

Not-ordinarily resident

Category 2

Non-resident in India

Non-resident in India

3. Residential status for each previous year - Residential status of an assessee is to be determined in
respect of each previous year as it may vary from previous year to previous year.

4. Different residential status for different assessment years - An assessee may enjoy different
residential status for different assessment years. For instance, an individual who has been regularly
assessed as resident and ordinarily resident has to be treated as non-resident in a particular assessment
year if he satisfies none of the conditions of section 6(1).
5. Resident in India and abroad - It is not necessary that a person, who is “resident” in India, cannot
become “resident” in any other country for the same assessment year. A person may be resident in two
(or more) countries at the same time. It is, therefore, not necessary that a person who is resident in
India will be non-resident in all other countries for the same assessment year.

2.3 RESIDENTIAL STATUS OF AN INDIVIDUAL

As per section 6, an individual may be (a) resident and ordinarily resident in India, (b) resident but not
ordinarily resident in India, or (c) non-resident in India.

2.3.1 RESIDENT AND ORDINARILY RESIDENT

As per section 6(1), in order to find out whether an individual is “resident and ordinarily resident” in
India, one has to proceed as follows—

Step 1 First find out whether such individual is “resident” in India.

Step 2 If such individual is “resident” in India, then find out whether he is “ordinarily resident” in India.
However, if such individual is a “non- resident” in India, then no further investigation is necessary.

BASIC CONDITIONS TO TEST AS TO WHEN AN INDIVIDUAL IS

RESIDENT IN INDIA - Under section 6(1) an individual is said to be resident in

India in any previous year, if he satisfies at least one of the following basic conditions—

Basic condition (a)

He is in India in the previous year for a period of 182 days or more

Basic condition (b)

He is in India for a period of 60 days or more during the previous year and 365 days or more during 4
years immediately preceding the previous year

Note: In the following two cases, an individual needs to be present in India for a minimum of 182 days or
more in order to become resident in India:

1. An Indian citizen who leaves India during the previous year for the purpose of taking employment
outside India or an Indian citizen leaving India during the previous year as a member of the crew of an
Indian ship.

2. An Indian citizen or a person of Indian origin who comes on visit to India during the previous year (a
person is said to be of Indian origin if either he or any of his parents or any of his grand parents was born
in undivided India).

ADDITIONAL CONDITIONS TO TEST AS TO WHEN A RESIDENT

INDIVIDUAL IS ORDINARILY RESIDENT IN INDIA - Under section 6(6), a resident individual is treated as
“resident and ordinarily resident” in India if he satisfies the following two additional conditions —

Additional condition (i)

He has been resident in India in at least 2 out of 10 previous years [according to basic condition noted
above] immediately preceding the relevant previous year.

Additional condition (ii)

He has been in India for a period of 730 days or more during 7 years immediately preceeding the
relevant previous year. In brief it can be said that an individual becomes resident and ordinarily resident
in India if he satisfies at least one of the basic conditions [i.e., (a) or (b)] and the two additional
conditions [i.e., (i) and (ii)].

It will be worthwhile to note the following propositions:

1. It is not essential that the stay should be at the same place. It is equally not necessary that the stay
should be continuous. Similarly, the place of stay or the purpose of stay is not material.

2. Where a person is in India only for a part of a day, the calculation of physical presence in India in
respect of such broken period should be made on an hourly basis. A total of 24 hours of stay spread over
a number of days is to be counted as being equivalent to the stay of one day. If, however, data is not
available to calculate the period of stay of an individual in India in terms of hours, then the day on which
he enters India as well as the day on which he leaves India shall be taken into account as stay of the
individual in India.

2.3.2 RESIDENT BUT NOT ORDINARILY RESIDENT

As per section 6(1), an individual who satisfies at least one of the basic conditions [i.e., condition (a) or
(b) mentioned in Para 2.3.1a] but does not satisfy the two additional conditions [i.e., conditions (i) and
(ii) mentioned in Para 2.3.1b], is treated as a resident but not ordinarily resident in India. In other words,
an individual becomes resident but not ordinarily resident in India in any of the following circumstances:

Case 1

If he satisfies at least one of the basic conditions [i.e., condition (a) or (b) of Para 12.1-1] but none of the
additional conditions [i.e., (i) and (ii) of Para 12.1- 2]

Case 2

If he satisfies at least one of the basic conditions [i.e., condition (a) or (b) of Para 12.1-1] and one of the
two additional conditions [i.e., (i) and (ii) of Para 12.1-2]

2.3.3 NON-RESIDENT
An individual is a non-resident in India if he satisfies none of the basic conditions [i.e., condition (a) or (b)
of Para 12.1-1]. In the case of non-resident, additional conditions [i.e., (i) and (ii) of Para 12.1-2] are not
relevant.

Illustration 2.1: X left India for the first time on May 20, 2003. During the financial year 2005-06, he
came to India once on May 27 for a period of 53 days. Determine his residential status for the
assessment year 2006-07. Since X comes to India only for 53 days in the previous year 2005-06, he does
not satisfy any of the basic conditions laid down in section 6(1). He is, therefore, non- resident in India
for the assessment year 2006-07.

Illustration 2.2: X comes to India, for the first time, on April 16, 2003. During his stay in India up to
October 5, 2005, he stays at Delhi up to April 10, 2005 and thereafter remains in Chennai till his
departure from India. Determine his residential status for the assessment year 2006-07.

During the previous year 2005-06, X was in India for 188 days (i.e., April 2005 : 30 days ; May 2005 : 31
days; June 2005 : 30 days ; July 2005 : 31 days ; August 2005 : 31 days ; September 2005 : 30 days and
October 2005 : 5 days). He is in India for more than 182 days during the previous year and, thus, he
satisfies condition (a) mentioned in Para 19.1-1. Consequently, he becomes resident in India. A resident
individual is either ordinarily resident or not ordinarily resident.

To determine whether X is ordinarily resident or not, one has to test the two additional conditions as
laid down by section 6(6) (a) [see conditions (i) and (ii), Para 19.1-2].

Condition (i) of Para 19.1-2 - This condition requires that X should be resident in India in at least 2 years
out of 10 years preceding the relevant previous year. X is resident in India for the previous years 2003-
04 and 2004-05.

Condition (ii) of Para 19.1-2 - This condition requires that X should be in India for at least 730 days
during 7 years immediately preceding the previous year. X is in India from April 16, 2003 to March 31,
2005 (i.e., 716 days).

X satisfies one of the basic conditions and only one of the two additional conditions. X is, therefore,
resident but not ordinarily resident in India for the assessment year 2006-07.

Note: In order to determine the residential status, it is not necessary that a person should continuously
stay in India at the same place. Therefore, the information that X is in Delhi up to April 10, 2005 is
irrelevant. Check Your Progress

Activity A- X, a foreign citizen comes to India, for the first time in the last 30 years on March 20, 2005.
On September 1, 2005, he leaves India for Nepal on a business trip. He comes back on February 26,
2006. Determine the residential status of X for the assessment year 2006-07.

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Activity B- X, an Italian citizen, comes to India for the first time (after 20 years) on May 28, 2005.
Determine his residential status for the assessment year 2006-07.

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2.4 RESIDENTIAL STATUS OF A HINDU UNDIVIDED FAMILY

As per section 6(2), a Hindu undivided family (like an individual) is either resident in India or non-
resident in India. A resident Hindu undivided family is either ordinarily resident or not ordinarily
resident.

2.4.1 HUF- Resident or Non-Resident

A Hindu undivided family is said to be resident in India if control and management of its affairs is wholly
or partly situated in India. A Hindu undivided family is non-resident in India if control and management
of its affairs is wholly situated outside India.

Control and management means de facto control and management and not merely the right to control
or manage. Control and management is situated at a place where the head, the seat and the directing
power are situated.

2.4.2 HUF- When ordinarily resident in India

A resident Hindu undivided family is an ordinarily resident in India if the karta or manager of the family
(including successive kartas) satisfies the following two additional conditions as laid down by section 6(6)
(b):

Additional condition (i)

Karta has been resident in India in at least 2 out of 10 previous years [according to the basic condition
mentioned in Para 12.1-1] immediately preceding the relevant

previous year
Additional condition (ii)

Karta has been present in India for a period of 730 days or more during 7 years immediately preceding
the previous year If the karta or manager of a resident Hindu undivided family does not satisfy the two
additional conditions, the family is treated as resident but not ordinarily resident in India.

2.5 RESIDENTIAL STATUS OF FIRM AND ASSOCIATION OF PERSONS

As per section 6(2), a partnership firm and an association of persons are said to be resident in India if
control and management of their affairs are wholly or partly situated within India during the relevant
previous year. They are, however, treated as non-resident in India if control and management of their
affairs are situated wholly outside India.

2.6 RESIDENTIAL STATUS OF A COMPANY

As per section 6(3), an Indian company is always resident in India. A foreign company is resident in India
only if, during the previous year, control and management of its affairs is situated wholly in India.
However, a foreign company is treated as non-resident if, during the previous year, control and
management of its affairs is either wholly or partly situated out of India.

2.7 RESIDENTIAL STATUS OF EVERY OTHER PERSON

As per section 6(4), every other person is resident in India if control and management of his affairs is,
wholly or partly, situated within India during the relevant previous year. On the other hand, every other
person is non-resident in India if control and management of its affairs is wholly situated outside India.

2.8 RESIDENTIAL STATUS AND INCIDENCE OF TAX

As per section 5, incidence of tax on a taxpayer depends on his residential status and also on the place
and time of accrual or receipt of income.

2.8.1 INDIAN AND FOREIGN INCOME

In order to understand the relationship between residential status and tax liability, one must understand
the meaning of “Indian income” and “foreign income”. “INDIAN INCOME” - Any of the following three is
an Indian income —

1. If income is received (or deemed to be received) in India during the previous year and at the same
time it accrues (or arises or is deemed to accrue or arise) in India during the previous year.

2. If income is received (or deemed to be received) in India during the previous year but it accrues (or
arises) outside India during the previous year.

3. If income is received outside India during the previous year but it accrues (or arises or is deemed to
accrue or arise) in India during the previous year.

FOREIGN INCOME - If the following two conditions are satisfied, then such income is “foreign income” —
a. Income is not received (or not deemed to be received) in India; and

b. Income does not accrue or arise (or does not deemed to accrue or arise) in India.

Illustration 2.3- The above provisions may be explained in brief as follows:

Whether income is received (or Whether income accrues (or Status of the deemed to be received) in
India arises or is deemed to accrue or income during the relevant year arise) in India during the relevant
year Yes

2.8.2 INCIDENCE OF TAX FOR DIFFERENT TAXPAYERS

Tax incidence of different taxpayers is as follows— Individual and Hindu undivided family Resident and
Resident but not Non-resident ordinarily resident Ordinarily in India resident in India

► Indian income Taxable in India

► Foreign income - If it is business income Taxable in India Not taxable in and business is controlled
India wholly or partly from India - If it is income from Taxable in India Taxable in India Not taxable in
profession which is set up India in India - If it is business income Taxable in India Not taxable in Not
taxable in and business is controlled India from outside India - If it is income from Taxable in India Not
taxable in profession which is set up India outside India - Any other foreign Taxable in India Not taxable
in income (like salary, rent, India interest, etc.) Any other taxpayer (like company, firm, co-operative
society, association of persons, body of individual, etc Resident in India Non-resident in India Indian
income

Taxable in India Foreign income Taxable in India Not taxable in India

2.8.3 CONCLUSIONS

The following broad conclusions can be drawn —

1. Indian income - Indian income [see Para 2.8.1a for meaning] is always taxable in India irrespective of
the residential status of the taxpayer.

2. Foreign income - Foreign income [see Para 2.8.1b for meaning] is taxable in the hands of resident (in
case of a firm, an association of persons, a joint stock company and every other person) or resident and
ordinarily resident (in case of an individual and a Hindu undivided family) in India. Foreign income is not
taxable in the hands of non-resident in India.

In the hands of resident but not ordinarily resident taxpayer, foreign income is taxable only if it is (a)
business income and business is controlled from India, or (b) professional income from a profession
which is set up in India. In any other case, foreign income is not taxable in the hands of resident but not
ordinarily resident taxpayers.

Activity C: Determine whether the following is true or false:

1. The business income received by X Ltd. an Indian company in New York is foreign income of X.

2. The dividend received from a foreign company in India is Indian company.

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2.9 MEANING OF RECEIPT OF INCOME

Income received in India is taxable in all cases irrespective of the residential status of an assessee. The
following points are worth mentioning in this respect:

2.9.1 RECEIPT vs. REMITTANCE

The “receipt” of income refers to the first occasion when the recipient gets the money under his control.
Once an amount is received as income, any remittance or transmission of the amount to another place
does not result in “receipt” at the other place.

2.9.2 ACTUAL RECEIPT vs. DEEMED RECEIPT

It is not necessary that an income should be actually received in India in order to attract tax liability. An
income deemed to be received in India in the previous year is also included in the taxable income of the
assessee. The Act enumerates the following as income deemed to be received in India:

► Interest credited to recognized provident fund account of an employee in excess of 9.5 per cent.

► Excess contribution of employer in the case of recognized provident fund (i.e., the amount
contributed in excess of 12 per cent of salary).

► Transfer balance.

► Contribution by the Central Government to the account of an employee under a pension scheme
referred to in section 80CCD.

► Tax deducted at source.

► Deemed profit under section

2.10 MEANING OF ACCRUAL OF INCOME

Income accrued in India is chargeable to tax in all cases irrespective of residential status of an assessee.
The words “accrue” and “arise” are used in contradistinction to the word “receive”. Income is said to be
received when it reaches the assessee; when the right to receive the income becomes vested in the
assessee, it is said to accrue or arise.

2.11 MEANING OF INCOME DEEMED TO ACCRUE OR ARISE IN INDIA

In some cases, income is deemed to accrue or arise in India under section 9 even though it may actually
accrue or arise outside India. Section 9 applies to all assessees irrespective of their residential status and
place of business. The categories of income which are deemed to accrue or arise in India are as under:

Nature of income Whether income is deemed to accrue or arise in India Income from business
connection in India Yes Income from any property, asset or source of income in India Yes Capital gain on
transfer of a capital asset situated in India Yes Income from salary if service is rendered in India Yes
Income from salary (not being perquisite/allowance) if service is Yes rendered outside India (provided
the employer is Government of India and the employee is a citizen of India) Income from salary if service
is rendered outside India (not being a No case stated above) Dividend paid by the Indian company Yes
Nature of From whom Payer’s source of income Yes Income is received Interest Government of Any Yes
India Interest A person Borrowed capital is used by the No resident in payer for carrying on India
business/profession outside India or earning any income outside India Interest A person Borrowed
capital is used by the Yes resident in payer for any other purpose India Interest A person non- Borrowed
capital is used by the Yes resident in payer for carrying on India business/profession in India Interest A
person non- Borrowed capital is used by the No resident in payer for any other purpose India
Royalty/fees for Government of Any Yes Technical India Services Royalty/fees for A person Payment is
relatable to a No Technical resident in business or profession or any services India other source carried
by the payer outside India Royalty/fees for A person Payment is relatable to any other Yes Technical
resident in source of income services India Royalty/fees for A person non- Payment is relatable to a Yes
Technical resident in business or profession or any services India other source carried by the payer in
India Royalty/fees for A person non- Payment is relatable to any other No Technical resident in source of
income services India

Illustration 2.4- For the assessment year 2006-07 (previous year 2005-06), X is employed in India and
receives Rs. 24,000 as salary. His income from other sources includes:

Dividend received in London on June 3, 2005: Rs. 31,000 from a foreign company; share of profit
received in London on December 15, 2005 from a business situated in Sri Lanka But controlled from
India:

Rs. 60,000; remittance from London on January 15, 2006 out of past untaxed profit of 2003-04 earned
and received there: Rs. 30,000 and interest earned and received in India on May 11, 2006: Rs. 76,000.
Find out his gross total income, if he is (a) resident and ordinarily resident, (b) resident but not ordinarily
resident, and (c) non-resident for the assessment year 2006-07.

If X is resident and ordinarily resident, his gross total income will be Rs. 1, 15,000 (i.e., Rs. 24,000 + Rs.
31,000 + Rs. 60,000). If X is resident but not ordinarily resident, his gross total income will work out to be
Rs. 84,000 (i.e., Rs. 24,000 + Rs. 60,000). If X is non-resident, his gross total income will come to Rs.
24,000.

Notes:

1. The remittance from London of Rs. 30,000 is not taxable in the previous year 2005-06 because it does
not amount to “receipt” of income. 2. Although the interest of Rs. 76,000 earned and received in India is
taxable, it is not included in the total income of the assessment year 2006-07, as it is not earned or
received in the previous year 2005-06. It will, therefore, be included in the total income of X for the
assessment year 2007-08.

2.12 LET US SUM UP

The lesson discusses in detail the meaning of the term residential status as incidence of tax depends
upon this status of the assessee. The residential status of individual, Hindu undivided family, firm
association of persons, company and every other person are analysed. In addition the concept of Indian
income and foreign income has also been dealt with so as to give a complete picture to the students of
the income, which is liable to be taxed in India according to the residential status.

2.13 GLOSSARY

Incidence of tax: Tax incidence means the final burden of tax. In other words, incidence of tax is on
person who actually bears/pays the final tax liability. Remittance: Remittance is transmission of income
after its first receipt.

2.14 SELF ASSESSMENT QUESTIONS

1. How is residential status determined?

2. What are the different categories of residential status? Explain how these categories are determined
and affect the tax liability of an assessee?

3. “The incidence of income-tax depends upon the residential status of an assessee”. Discuss fully.

4. Write short notes on the following:

a. Income received in India

b. Income deemed to accrue or arise in India

c. Control and management of a business

5. X, an Indian citizen, leaves India on May 22, 2005 for vacation to Uganda and returns on April 9, 2006.
Determine the residential status of X for the assessment year 2006-07?

6. X, a foreign citizen, visits India since 1985 every year for a period of 100 days. Determine the
residential status of X for the assessment year 2006-07?
2.15 FURTHER READINGS

Income-tax Act, 1961, Taxmann Publications Pvt. Ltd., New Delhi (latest edition). Singhania, Vinod. K.
and Monica Singhania, Students Guide to Income-tax, Taxmann Publications Pvt. Ltd., New Delhi (latest
edition).

INCOME EXEMPT FROM TAX

STRUCTURE

3.0 Introduction 3.1 Objectives 3.2 Income exempt under section 3.3 Agricultural income

3.4 Receipts by a member from a Hindu Undivided Family 3.5 Share of profit from partnership firm

3.6 Casual and Non-recurring income 3.7 Leave travel concession 3.8 Foreign Allowance

3.9 Tax on perquisite paid by employer 3.10 Amount paid on life insurance policies

3.11 Educational, scholarships 3.12 Daily allowances of members of parliament

3.13 Family pension received by members of allowed forces 3.14 Income of minor

3.15 Capital gain on Transfer of US64 3.16 Dividends and Interest on Units

3.17 Capital gain on compulsory acquisition of urban agricultural land

3.18 Long-term capital gains on Transfer of equity shares/units in cases covered by Securities
Transaction Tax

3.19 Let us sum up 3.20 Glossary 3.21 Self Assessment Exercises 3.22 Further Readings

3.0 INTRODUCTION

However, every income is taxable under income tax law, whether it is received in cash or in kind,
whether it is capital or revenue income, but still some incomes are given exemption from tax. In this
lesson we will study those incomes which are exempt from tax.

3.1 OBJECTIVES

After going through this lesson you should be able to understand the various incomes which are exempt
from tax.

3.2 INCOME EXEMPT UNDER SECTION In the following cases, income is absolutely exempt from tax, as it
does not form part of total income. The burden of proving that a particular item of income falls within
this section is on the assessee.

3.3 AGRICULTURAL INCOME

As per section 10(1), agricultural income is exempt from tax if it comes within the definition of
“agricultural income” as given in section 2(1A). In some cases, however, agricultural income is taken into
consideration to find out tax on non- agricultural income.

3.4 RECEIPTS BY A MEMBER FROM A HINDU UNDIVIDED FAMILY

As per section 10(2), any sum received by an individual as a member of a Hindu undivided family either
out of income of the family or out of income of estate belonging to the family is exempt from tax. Such
receipts are not chargeable to tax in the hands of an individual member even if tax is not paid or payable
by the family on its total income.

Illustration 3.1 - X, an individual, has personal income of Rs. 56,000 for the previous year 2005-06. He is
also a member of a Hindu undivided family, which has an income of Rs. 1, 08,000 for the previous year
2005-06. Out of income of the family, X gets Rs. 12,000, being his share of income. Rs. 12,000 will be
exempt in the hands of X by virtue of section 10(2). The position will remain the same whether (or not)
the family is chargeable to tax. X shall pay tax only on his income of Rs. 56,000.

3.5 SHARE OF PROFIT FROM PARTNERSHIP FIRM

As per section 10(2A), share of profit received by partners from a firm is not taxable in the hand of
partners.

3.6 CASUAL AND NON-RECURRING INCOME

This exemption is not available from the assessment year 2003-04.

3.7 LEAVE TRAVEL CONCESSION

As per section 10(5), the amount exempt under section 10(5) is the value of any travel concession or
assistance received or due to the assessee from his employer for himself and his family in connection
with his proceeding on leave to any place in India. The amount exempt can in no case exceed the
expenditure actually incurred for the purposes of such travel. Only two journeys in a block of four years
is exempt. Exemption is available in respect of travel fare only and also with respect to the shortest
route.

3.8 FOREIGN ALLOWANCE

As per section 10(7), any allowance paid or allowed outside India by the Government to an Indian citizen
for rendering service outside India is wholly exempt from tax.

3.9 TAX ON PERQUISITE PAID BY EMPLOYER

As per section 10(10CC), the amount of tax actually paid by an employer, at his option, on non-monetary
perquisites on behalf of an employee, is not taxable in the hands of the employee. Such tax paid by the
employer shall not be treated as an allowable expenditure in the hands of the employer under section

3.10 AMOUNT PAID ON LIFE INSURANCE POLICIES

As per section 10(10D), any sum received on life insurance policy (including bonus) is not chargeable to
tax. Exemption is, however, not available in respect of the amount received on the following policies -

a. any sum received under section 80DD (3) or 80DDA (3);

b. any sum received under a Keyman insurance policy; c. any sum received under an insurance policy
(issued after March 31, 2003) in respect of which the premium payable for any of the years during the
term of policy, exceeds 20 per cent of the actual sum assured.

In respect of (c) (supra) the following points should be noted -

1. Any sum received under such policy on the death of a person shall continue to be exempt.

2. The value of any premiums agreed to be returned or of any benefit by way of bonus or otherwise,
over and above the sum actually assured, which is received under the policy by any person, shall not be
taken into account for the purpose of calculating the actual capital sum assured under this clause.

3.11 EDUCATIONAL SCHOLARSHIPS

As per section 10(16), scholarship granted to meet the cost of education is exempt from tax. In order to
avail the exemption it is not necessary that the Government should finance scholarship.

3.12 DAILY ALLOWANCES OF MEMBERS OF PARLIAMENT

Clause (17) of section 10 provides exemption to Members of Parliament and State

Legislature in respect of the following allowances:

Cases

Nature of allowance How much is exempt

Case 1

Daily allowance Entire amount is exempt

Case 2

Any Other allowance Entire amount is exempt received by a Member of Parliament Under the Members
of Parliament (Constituency Allowance) Rules, 1986

Case 3

All allowances received by Up to Rs. 2,000 per month any person by reason of his in aggregate member-
ship of any State Legislature Or any Committee there of

3.13 FAMILY PENSION RECEIEVED BY MEMBERS OF ARMED FORCES

As per section 10(19), family pension received by the widow (or children or nominated heirs) of a
member of the armed forces (including para-military forces) of the Union is not chargeable to tax from
the assessment year 2005-06, if death is occurred in such circumstances given below—

a. acts of violence or kidnapping or attacks by terrorists or anti-social elements;

b. action against extremists or anti-social elements;

c. enemy action in the international war;

d. action during deployment with a peace keeping mission abroad;

e. border skirmishes;

f. laying or clearance of mines including enemy mines as also mine sweeping operations; g. explosions of
mines while laying operationally oriented mine-fields or lifting or negotiation mine-fields laid by the
enemy or own forces in operational areas near international borders or the line of control; h. in the aid
of civil power in dealing with natural calamities and rescue operations; and i. in the aid of civil power in
quelling agitation or riots or revolts by demonstrators.

3.14 INCOME OF MINOR

As per section 10(32), in case the income of an individual includes the income of his minor child in terms
of section 64(1A), such individual shall be entitled to exemption of Rs. 1,500 in respect of each minor
child if the income of such minor as includible under section 64(1A) exceeds that amount. Where,
however, the income of any minor so includible is less than Rs. 1,500, the aforesaid exemption shall be
restricted to the income so included in the total income of the individual.

3.15 CAPITAL GAIN ON TRANSFER OF US 64

As per section 10(33), any income arising from the transfer of a capital asset being a unit of US 64 is not
chargeable to tax where the transfer of such assets takes place on or after April 1, 2002. This rule is
applicable whether the capital asset (US64) is long-term capital asset or short-term capital asset. If
income from a particular source is exempt from tax, loss from such source cannot be set off against
income from another source under the same head of income. Consequently, loss arising on transfer of
units of US64 cannot be set off against any income in the same year in which it is incurred and the same
cannot be carried forward.

3.16 DIVIDENDS AND INTEREST ON UNITS

As per section 10(34)/ (35), the following income is not chargeable to tax—

a. any income by way of dividend referred to in section 115-O [i.e., dividend, not being covered by
section 2(22) (e), from a domestic company];

b. any income in respect of units of mutual fund;

c. income from units received by a unit holder of UTI [i.e., from the administrator of the specified
undertaking as defined in Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002];

d. income in respect of units from the specified company.

3.17 CAPITAL GAIN ON COMPULSORY ACQUISITION OF URBAN AGRICULTURAL LAND

As per section 10(37), in the case of an individual/Hindu undivided family, capital gain arising on transfer
by way of compulsory acquisition of urban agricultural land is not chargeable to tax from the assessment
year 2005-06 if such compensation is received after March 31, 2004 and the agricultural land was used
by the assessee (or by any of his parents) for agricultural purposes during 2 years immediately prior to
transfer.

3.18 LONG-TERM CAPITAL GAINS ON TRANSFER OF EQUITY SHARES/UNITS IN CASES COVERED BY

SECURITIES TRANSACTION TAX

As per section 10(38), Long-term capital gains arising on transfer of equity shares or units of equity
oriented mutual fund is not chargeable to tax from the assessment year 2005-06 if such a transaction is
covered by securities transaction tax.

The securities transaction tax is applicable if equity shares or units of equity- oriented mutual fund are
transferred on or after October 1, 2004 in a recognized stock exchange in India (or units are transferred
to the mutual fund). If the securities transaction tax is applicable, long-term capital gain is not
chargeable to tax; short-term capital gain is taxable @ 10 per cent (plus SC and EC). If income is shown
as business income, the taxpayer can claim rebate under section 88E.

3.19 LET US SUM UP

The lesson discusses in brief few selected income, which are exempt from income-tax in India. The few
important in today age include agricultural income, income of minor, family pension; leave travel
commission and dividend income.

3.20 GLOSSARY

Deduction: While deduction is available from gross total income, exemptions are not included in gross
total income. Agricultural income from a foreign country: Indian agricultural income is exempt from tax
by virtue of section 10(1). Agricultural income from a foreign country is treated as non-agricultural
income in India.

3.21 SELF ASSESSMENT EXERCISES

1. Name any five incomes which are exempt from tax.

2. Explain briefly the exemption from income-tax available in the case of a minor child.

3. Discuss the exemption with respect to agricultural income from India

4. Explain briefly the exemption from income-tax available in the case of dividend income received from
an Indian company.

3.22 FURTHER READINGS

Income-tax Act, 1961, Taxmann Publications Pvt.Ltd., New Delhi (latest edition). Singhania, Vinod. K. and
Monica Singhania, Students Guide to Income-tax, Taxmann Publications Pvt.Ltd., New Delhi (latest
edition).

Tax avoidance and tax evasion

Tax avoidance is the legitimate minimizing of taxes, using methods approved by the IRS. Businesses avoid taxes
by taking all legitimate deductions and by sheltering income from taxes by setting up employee retirement plans
and other means, all legal and under the Internal Revenue Code or state tax codes.

Tax evasion, on the other hand, is the illegal practice of not paying taxes, by not reporting income,
reporting expenses not legally allowed, or by not paying taxes owed.

Tax evasion is most commonly thought of in relation to income taxes, but tax evasion can be practiced
by businesses on state sales taxes and on employment taxes. In fact, tax evasion can be practiced on
all the taxes a business owes.

Tax avoidance is the legal utilization of the tax regime to one's own advantage, to reduce the
amount of tax that is payable by means that are within the law. By contrast, tax evasion is the
general term for efforts to not pay taxes by illegal means. The term tax mitigation is a synonym
for tax avoidance. Its original use was by tax advisors as an alternative to the pejorative term tax
avoidance. Latterly the term has also been used in the tax regulations of some jurisdictions to
distinguish tax avoidance foreseen by the legislators from tax avoidance which exploits
loopholes in the law.

Some of those attempting not to pay tax believe that they have discovered interpretations of the
law that show that they are not subject to being taxed: these individuals and groups are
sometimes called tax protesters. An unsuccessful tax protestor has been attempting openly to
evade tax, while a successful one avoids tax. Tax resistance is the declared refusal to pay a tax
for conscientious reasons (because the resister does not want to support the government or some
of its activities). Tax resisters typically do not take the position that the tax laws are themselves
illegal or do not apply to them (as tax protesters do) and they are more concerned with not
paying for particular government policies that they oppose.
 Wealth tax

A wealth tax is generally conceived of as a levy based on the aggregate value of all household
holdings actually accumulated as purchasing power stock (rather than flow), including owner-
occupied housing; cash, bank deposits, money funds, and savings in insurance and pension plans;
investment in real estate and unincorporated businesses; and corporate stock, financial securities,
and personal trusts.

17.3.1 ASSESSMENT YEAR [A.Y.] [Sec2 (d)]

Assessment year means a period of 12 months commencing from 1st day of April
every year falling immediately after valuation date
Thus, for the year 2006, A.Y. is from1st April2006 to 31st March 2007.
17.3.2 VALUATION DATE Sec.2 (q)
Valuation date is 31st March immediately preceding the assessment year. Thus, for
assessment year 1st April 2006 to 31st March2007 valuation date is 31st March
2006. Valuation date is very important because:
a) It is the tax base for the charge of wealth tax
b) The residential status of an assessee is determined with reference to the year
ending on valuation date
c) The value of an asset is determined on valuation date.
d) The wealth as on the last moment of the valuation date is taken to be the net
wealth for Taxation purposes

17.3.4 NET WEALTH

Net Wealth represents the amount by which the total value of all assets including
deemed assets but excluding exempt assets, belonging to the assessee on the
valuation date exceeds the value of all debts owed by the assessee on the
valuation date incurred in relation to the taxable assets.

17.3.6 DEEMED ASSETS [sec. 4]

Deemed assets represent those assets, which belong to some other person but for
the purpose of calculation of wealth tax, these are included in the wealth of the
assessee. (transferor), it is because at time an individual may transfer his assets
without adequate consideration to persons in whom he may be interested.
Thus to prevent avoidance of wealth tax in this manner, wealth tax Act provides
that assets transferred by an individual after 31-03-1956 (in case of Dadra Nagar
Havely, Goa, Daman and Diu and Pondicherry on after 01-04-1963) shall be
included in the net wealth of the transferor, provided following conditions are
satisfied.
(i) The individual must be the owner of these assets.
(ii) The assets must be transferred without adequate consideration
in money or money is worth. In case of inadequate
consideration, difference between adequate consideration and
inadequate consideration shall be included in the net wealth of
the transferor.
(iii) The asset must be held by the transferor on the valuation date
whether in the same form or in converted form.
If assets have been lost, destroyed, transferred by the transferee to a third party
211
and it is not held by transferee on the valuation date. Then the value of the assets
shall not be included in the net wealth of the transferor, further the form of asset
has been changed by transfer then value of substituted asset is included in the
wealth of transferor if it is taxable u/s 2 (ea).
If the asset transferred by an individual to the spouse without adequate
consideration was not an asset u/s 2 (ea) but on the valuation date, it has been
substituted by an asset taxable u/s 2 (ea) then value of such asset shall be included
in the net wealth of transferor.
DEEMED ASSETS u/s 4 (i) are as follows.
1) Assets transferred to spouse Sec. 4(1) (a) (ii).
If the assessee has transferred an asset to his/her spouse without adequate
consideration or in connection with in an agreement to live apart, then value of
such asset in included in the wealth of assessee provided their relationship exists
both on the date of transfer and on the date of valuation.
2) Assets held by minor child Sec. 4 (1) (a) (ii)
The value of assets held by minor child including step child and adopted child,
excluding a married daughter, a handicapped child, illegitimate child and grand
child of an individual is included in the wealth of a parent.
If marriage of parents subsists, then in the wealth of that parent whose net wealth
is more.
If marriage of parents does not subsist, then in the wealth of that parent who
maintains the minor child in the previous year.
However there are certain exceptions to it.
(i) Assets acquired by the minor child out of his income arising on
account of his manual work or activities involving application
of his specialized knowledge and experience shall not be
included in the net wealth of a parent.
(ii) Assets held by a disabled minor child shall not be included in
the wealth of the parent.
In these cases, net wealth of the child shall be determined separately and assessed
in his hands.
3) Assets transferred to a person or to AOP’s, Sec. 4 (1) (a) (iii)
If an individual transfers his assets to another person or AOP’s without adequate
consideration, directly or indirectly, for the immediate or deferred benefit of the
individual or his spouse then these assets are included in the wealth of the
individual provided their relationship exists on valuation date.
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4) Revocable transfer of asset Sec. 4(1) (a) (iv)
Revocable transfer means a transfer which can be revoked at any time by the
transferor. Thus, if an individual has transferred any assets to another person or
AOP under revocable transfer then value of such assets is included in the wealth
of the individual.
5) Assets transferred to son’s wife Sec. 4(1) (a) (v)
If an individual transferred an asset to his son’s wife directly or indirectly after
31-05-1973 without adequate consideration then the value of such assets is
included in the net wealth of the individual.
6) Assets transferred to a person/AOP for the benefit of son’s wife Sec. 4(1)
(a) (vi)
If an assessee has transferred his asset to another person or AOP directly or
indirectly after 31-05-1993 without adequate consideration for the immediate or
deferred benefit of his son’s wife then value of such assets shall be included in
wealth of the individual.
7) Interest in a Firm or AOP Sec. 4(1) (b)
If the assessee is a partner in a firm or a member of an AOP (not being a
cooperative
housing society), then value of his interest in the assets of firm or
association shall be included in his net wealth. Where a Karta of H.U.F. is a
partner in a firm, his interest in the firm’s assets is includible in the net wealth of
the H.U.F.
8) Converted Property Sec. 4(1A)
If an individual who is a member of an HUF converts his individual property after
31-12-1969 into Joint family property either by throwing it into the common stock
or by making gifts of separate property or through act of impressing such separate
property with the character of property belonging to family without adequate
consideration, such properly is called converted property. In this case value of the
converted property or any part of it held by the family on valuation date is
included in the net wealth of the individual.
However in case the converted property becomes the subject matter of partition
among the members, then the part of the property received by the individual and
his spouse is includible in his net wealth.
9) Transfer by means of book entry [Sec.4 (5A)]
Where a person makes a gift of money to another person by means of entries in
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the books of account maintained by
the donor or an individual or HUF or firm or AOP or body of individuals with
which the done has business or other relationship.
Then value of such gift is includible in the net wealth of donor unless the donor
satisfies the Assessing officer that the money was actually delivered to the done at
the time of making the entries.
10) Impartible Estate Sec. 4(6)
Impartible estate of an H.U.F. is that estate which by special law or custom
descend to one member of the family though it is a Joint property belonging
equality to all, Value of impartible estate is included in the net wealth of such
holder, so far wealth tax purposes. He is the deemed owner of the impartible
estate.
11) House from a Co-operative Housing society etc. Sec. 4(7)
If the assessee is a member of a co-operative Housing Society, company or AOP’s
and he is allotted a building a part thereof or leased under a house building
scheme of the society, company or association, as the case may be then he is the
deemed owner of that building part thereof and hence value of such building shall
be included in his net wealth.
12) Building in part performance of a contract Sec. 4(8) (a)
If a person is allowed to take or retain possession of any building in part
performance of a contract of the nature referred u/s 53 A of Transfer of Property
Act, 1882 then he is the deemed owner of that building or part thereof and hence
value of such building shall be included in his net wealth.
13) Building on lease Sec. 4(8) (b)
If an assessee acquires any right by way of lease with respect to a building by
virtue of any transaction to a building by virtue of any transaction referred to in
clause (f) of Sec. 269 U A. shall be the deemed owner of the building or part
thereof and its value shall be included in his net wealth, however it excludes any
right by way of a lease from month to month of for a period not exceeding 1 year.
Illustration 17.3: Explain the taxability of the following in the net wealth
computation of Mr. A
a) Gifts of jewellery made to wife Rs 60,000, Market value on valuation date
is Rs 2, 00,000.
b) He gifted cash Rs. 2, 00,000 to his son’s wife without consideration,
which she deposited in bank.
c) Urban land transferred by him to his minor handicapped child
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d) A minor son of Mr. A receives income by acting in films. Out of this
income, he purchased a Car and a residential house; value of these on
valuation date is Rs 50 Lacs.
e) He transferred a house valued at Rs 20 Lacs to his married daughter but he
has reserved the right to live in that house for whole life.
Solution 17.3:
a) Since the gift has been made without adequate consideration, hence the
value of jewellery on valuation date will be included in wealth of Mr. X.
b) Although the gift has been made without any adequate consideration but
as on valuation date it is in form of fixed deposits, which is not an asset
under section 2 (ea), hence it is not an asset.
c) Assets held by minor handicapped child are not taxable in the hands of
parents, hence the value of urban land is not to be included in wealth of
Mr. X, but it is chargeable in hands of the child.
d) The assets acquired by the minor child out of his income arising on
account of any manual work done by him or activity involving application
of his specialized knowledge or skill is not included in the wealth tax of
parents, hence the assets valued at Rs 50 Lacs will be included in the
wealth of the child.
e) Mr. A transferred his house to his married daughter. Hence he does not
remain the owner of the house on the valuation date, but he has reserved
the right to live in that house for whole life, hence it is a revocable transfer
u/s 4 (1) (a) (iv) thus value of the house will be included in wealth of Mr.
A
17.3.7 Exempt Assets [Sec 5]
The following assets are exempt from wealth tax
1) Property held under trust Sec. 5(i)
Any property held under trust or other legal obligations by the assessee for any
public purpose of a charitable or religious nature in India is exempt.
2) Interest in the coparcener property Sec. 5(ii)
if the assessee is a member of H.U.F., he is not liable to pay tax on his share in the
joint property, so long as the property remains joint and he continues as the
member of that family.
3) One building in the occupation of former Ruler Sec. 5(iii)
any one building which is in the occupation of a Ruler and which has been
declared as his official residence by the Central Govt .is totally exempt from tax.
However the exemption available only to the Ruler during his life time.
4) Jewellery in possession of a former Rule Sec. 5(iv)
Jewellery in possession of a former Ruler not being his personal property which
has been recognized by the Central Govt. as his heirloom, before commencement
of Wealth Tax Act or by the board after that shall be exempt. However this
exemption is subject to fulfillment of certain conditions like keeping of jewellery
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in India, in its original shape, allowing authorized person to examine the jewellery
as and when necessary
5) Assets of Indian repatriate Sec. 5 (v)
Indian repatriate means a person of Indian origin or a citizen of India who was
residing in a foreign country and on leaving such country assessee has returned to
India with the intention of permanently residing therein. In this case his following
assets shall be exempt for 7 successive assessment years, commencing with the
assessment year following the date of his return to India.
(i) Money brought by him in India.
(ii) Assets brought by him in India.
(iii) Any balance in Non-Resident External Accounts in India on the date of his
return
(iv) Assets acquired by him out of money in his Non-resident External
Account or by sending money from foreign country within 1 year
immediately preceding the date of his return to India.
(v) Any assets acquired by him out of money brought in by him in India or
out of the balance in NRE account after his arrival in India.
6) House [Sec 5 (vi)]
One house or part of a house or a plot of land belonging to an individual or HUF
is exempt provided size of plot is not bigger than 500 square meters.
Illustration 17.4: How would you treat the following items under the wealth tax act?
i) Mr. Gupta is a managing trustee of an educational society. The society is a public
charitable trust. The value of trust property is Rs 50 Lacs, which is held by Mr.
Gupta in his name as Managing director.
ii) Mr. G, an Indian repatriate came to India on 1st Oct’2005, The balance in his
non resident external account is Rs 10 Lacs on that day, out of which he purchased
a car for Rs 4 Lacs
iii) Mr. X is a former ruler; his jewellery was recognized by Central Govt. as his
heirloom in 1956.
iv) Interest of Mr. Z in the HUF to which he is a member
v) Mr. Shyam owns only one house valued at Rs. 12 Lacs, the house has been build
on a land area of 450 sq. meter.
Solution 17.4:
i) Any property held by assessee under trust for any public purposes of charitable
nature in India is exempt u/s 5 (I, hence value of trust property is neither
includable in the wealth of Mr. Gupta nor the society is liable to pay wealth tax on
it.
ii) Balance on Non-resident external account is exempt u/s 5 (v),further Car
acquired by him out of that balance is also exempt.
iii) Jewellery in procession of a former ruler that has been recognized as an
heirloom by central govt. is exempt u/s 5 (iv).
iv) As Mr. Z is a member of HUF so his interest in family property is totally exempt
from tax u/s 5 (ii)
v) Since the land area does not exceed 500 sq. meters. , Thus the value of house is
exempt from wealth tax as value of one house is exempt u/s 5 (vi)
CHECK YOUR PROGRESS
ACTIVITY B: State True or False:
i) Motor car held as stock-in-trade is a taxable asset. ------
ii) Investment into shares of a company is non-taxable asset. -----
iii) Assets transferred to a minor child are taxable in the hands of the parents. ----
iv) Property transferred to a trust for the benefit of the spouse is exempt. -----
v) All residential buildings of a former ruler are exempt. ------
vi) The only house owned by the assessee built on the area of 600sq. meters is
exempt. ---