Module 1

Concept and Framework of Taxation

Introduction

Tax is a compulsory levy by the government. It’s a compulsory

contribution made by subject (public) to the state (government). This levy is
based upon income, level of consumption, wealth etc.

Features of Taxes.
1. Tax is a compulsory contribution
2. Imposed by the govt only
3. Element of sacrifice is involved
4. Benefit is not the condition of the payment of tax
5. Not imposed to realize the cost of benefit from tax payer
6. Assessed on income, capital but they are paid out of income.
7. Imposed upon the individuals property or commodity but paid by
individuals.
8. Tax is a legal collection

Adam smith in his classical work ‘wealth of nations’ lists out the various
Conan’s of taxation or principles of taxation, they are.
1. Canon of Equality
2. Canon of Certainty
3. Canon of Convenience
4. Canon of Economy
5. Canon of Productivity
6. Canon of Elasticity
7. Canon of diversification
8. Canon of simplicity
9. Canon of co-ordination
 TAXATION IN INDIA

Article 270 of Indian constitution empowers Central and state govt. to levy Taxes.
It includes

1. Taxes collected and retained by central govt only.

Eg: customs duty.
2. Taxes collected and retained by central government but some portion is
distributed among state govt on the basis of the recommendations of
finance commission
Eg: Income tax, Excise duty
3. Taxes collected and retained by state govt.
Eg: Excise duty on liquor, sales tax, land revenue etc.

KINDS OF TAXES
1. DIRECT TAX & INDIRECT TAX
Direct tax:-
Where the impact & incidence of tax in on the same person. Burden of tax
cannot be shifted.
Eg: Income tax, wealth tax
Indirect tax:-

It’s a tax where the impact & incidence tax is on different persons. Tax is
initially paid by one person & later it will be shifted to someone else.

Eg: Excise duty, customer duty sales tax

SPECIFIC & ADVALOREM DUTY

Specific duty:-

It’s a commodity tax levied on some physical characteristics like weight

length etc.

Advalorem duty:
Tax levied on the value of the commodity
Eg: All commodity taxes in India
PROGRESSIVE, PROPORTIONAL & REGRESSIVE TAXES
Progressive:-
Tax rate increases with the increase in the tax base
Eg: individual Income tax in India
Proportional:
Tax rate remains same irrespective of tax base
Eg: sales tax Excise duty.
Regressive:
Rate of taxes decreases with increase in this tax base
Eg: not available in India

INTRODUCTION TO INCOME TAX

Income Tax is a tax on the income of a person during a previous year.

It is a very important direct tax. It is an important and most significant source of
revenue of the government. The government needs money to maintain law and
order in the country; safeguard the security of the country from foreign powers
and promote the welfare of the people. Since our government is wedded to
socialistic pattern of society it is the foremost duty of the government to bring out
such welfare and development programs which will bridge the gap between the
rich and the poor.

All this requires mobilization of funds from various sources. These

sources may be direct or indirect. Income tax, being the direct tax, is an
important tool to achieve balanced socio-economic growth by providing
concessions and incentives in income tax for various developmental purposes.

BRIEF HISTORY OF INCOME TAX IN INDIA

In India, this tax was introduced for the first time in 1860, by Sir James
Wilson in order to meet the losses sustained by the Government on account of
the Military Mutiny of 1857. Thereafter, several amendments were made in it
from time to time. At last, in 1886, a separate Income Tax Act was passed. This
Act was remained in force upto 1917, with various amendments from time to
time. In 1918, a new Income Tax Act was passed and again it was replaced by
another new Act, which was passed in 1922. This Act remained in force upto the
assessment year 1961-62 with numerous amendments.

The Income Tax Act of 1922 had become very complicated on account of
innumerable amendments. The Government of India referred it to the Law
Commission in 1956 with a view to simplify and prevent the evasion of tax. The
Law Commission submitted its report in September 1958, but in the meantime
the Government of India had appointed the Direct Taxes Administration Enquiry
Committee to suggest measures to minimize inconveniences to assess and to
prevent evasion of tax. This Committee submitted its report in 1959. In
consultation with the Ministry of Law finally the Income Tax Act, 1961 was
passed.
The Income Tax Act, 1961 has been brought into force with effect from 1st
April 1962. It applies to the whole of India and Sikkim (including Jammu and
Kashmir). Since 1962 several amendments of far-reaching nature have made in
the Income Tax Act by the Union Budget every year, which also contains Finance
Bill. After it is passed by both the Houses of Parliament, and receives the assent
of the President of India, it becomes the Finance Act. Besides this, amendments
have also been made by various Amendment Act, for instance, Taxation Laws
Amendment Act, 1984; Direct Taxes Amendment Act, 1987; Direct Taxes Law
(Amendment) Acts of 1988 and 1989, Direct Tax Law (second Amendment) Act,
1989 and at last The Taxation Law (Amendment) Act, 1991. The Amendments in
the Finance Acts, 1992 and 1993, are mostly based on the recommendations of
Chelliah Committee Report.
As a matter of fact, the Income Tax Act, 1961, which came into force on 1st
April 1962, has been amended and re-amended drastically. It has, therefore,
become very complicated for both the administering authorities and the
taxpayers.

Legal Framework of Income Tax in India

Legal framework of Income tax in India is consists of the following.
1. I T act of 1961 with up-to-date amendments.
2. Finance act passed by parliament every year.
3. I T rules by CBDT
4. Circular, notification, orders, and executive instructions given by IT dept.
5. Judgment in court of law relating to matters of IT.

Central Board of Direct Taxes:

The apex body of the Income Tax Department is the Central Board of
Direct Taxes (CBDT) - manned by the officers of the Indian Revenue Service - is
the administrative head of the Income Tax Department and functions as a part of
the Finance Ministry of the Government of India. It performs various statutory
functions. It has the power to assign jurisdiction to the authorities below and to
issue orders, instructions and directions to them for the administration of the tax
laws. It also enjoys certain powers of delegated legislation and is competent to
make rules for carrying out the implementation of the direct tax laws. The CBDT
consists of one Chairman and six members.

Roles and Duties:

India has a well-developed tax structure. The Constitution of India

empowers the legislature to enact and enforce tax laws. The taxes so collected
are required to be divided between the Central Government and the State
Governments. The Central government levies direct taxes such as personal
income tax and corporate tax, and also indirect taxes like customs duties, excise
duties and central sales tax. The states in turn are empowered to levy state sales
tax, entertainment tax etc. apart from various other local taxes like entry tax, etc.
 It has undergone significant changes over the past six years. The tax rates
have been rationalized and now compare favorably with most other countries.
Further, the tax laws have been simplified to ensure better compliance.

At present, the Income Tax Department under the Department of Revenue

in the Ministry of Finance administers the following Tax Laws. (The Gift Tax Act
and the Estate Duty Act, which were also administered by the Income Tax
Department in earlier years, have now been repealed).

Basis of charge of Income tax:

• Income tax is an annual tax on income.

• Income of previous year is taxable in the next following assessment
year at the rate or rates applicable to the assessment year. However
there are certain exceptions to this rule.
• The annual Finance Act fixes tax rates.
• Tax is charged on every person as defined is Section 2(31).
• The Tax is charged on the total income of every person computed
accordance with the provisions of this Act.
• Income tax is to be deducted at the sources or paid in advance as
provided under provisions of the Act.

Heads of Income under the Act:

Under the Act, all income shall, for the purposes of charge of income tax and
computation of total income, be classified under the following heads of income.

• Income from salaries,

• Income from House Property,
• Profits of Business or Profession,
• Capital Gains and
• Income from other sources.
 ASSESSEE

Under 2(7) of the Income-tax Act, ''Assessee'' means a person by whom any tax
or any other sum of money is payable under this Act, and includes-

a. Every person in respect of whom any proceeding under this Act has been
taken for the assessment of his income or of the income of any other
person in respect of which he is assessable, or of the loss sustained by
him or by such other person, or of the amount of refund due to him or to
such other person;
b. Every person, who is deemed to be an assessee under the provision of
this Act;

Every person, who is deemed to be an assessee in default under any

provision of this Act. If the assessment is on a person relating to Income
belonging to others he is called as deemed assessee eg guardian of a minor
legal representitive of a non-resident. If a person fails to fulfill any of his
obligations under IT act he is termed as assessee in default.

Assessment Year:

Under section 2 (9), Assessment Year means the period of twelve months
commencing on the first day of April every year and ending on 31st March of the
next year. It is the year in which the tax is levied on income earned in previous
year.

Previous Year:

Under section 3, Previous year means the year in which income is earned. The
financial year immediately preceding the assessment year is known as
previous year. It is the income earned year.
Uniform previous year:

From the year 1989-90 onwards all the assesses are required to follow the same
previous year irrespective of their book closing year.

Exception to the general rule of previous year.

General rule of previous year says that income of previous year is charged to tax
in the assessment year. But there is certain exception to this rule viz

• Income of non-resident shipping company.

• Person leaving India either permanently or for a longer period of time.
• Bodies formed for short duration.
• Persons likely to transfer property to avoid tax.
• Discontinued business or profession.

Person:Under section 2(31), Person includes the following:

• An individual,
• A Hindu Undivided family,
• A company,
• A firm,
• An association of persons or a body of individuals whether incorporation
or not,
• A local authority,
• Every artificial juridical person, not falling within any of the preceding sub-
clauses.

Income:

Under section2 (24), income includes

• Profits and gains,

• Dividend,
• Any sum received by the assessee from his employees as contributions to
any provident fund or superannuation fund or any fund for the welfare of
the employees;
• Any sum received under a key man insurance policy including the sum
received by way of bonus on such policy,
• The value of any benefits or perquisite arising from business or exercise of
profession;
• Any interest, salary, bonus, commission or remuneration received by a
partner from the firm,
• Any capital gains chargeable under section45;
• The profits and gains of any business of insurance carried on by a mutual
insurance company or by co-operative society,
• Any allowance granted to the assessee either to meet his personal
expenses at the place where he performs his duties or compensate him
for the increased cost of living.

Income given above is inclusive and not exhaustive. Any receipt is

taxable under this act if it comes in general and natural meaning of income. It
is a periodical return from ones work, business, land, investment etc.

The income should have the following characteristics.

• It must be derived from a definite source.

• It must come from outside.
• It may be legal or illegal.
• It may be received voluntarily or under legal compulsion.
• It may be from a temporary or permanent source.
• It may be received in cash or in kind.
 Gross total income

Aggregate of income from all the head before allowing deduction under
sec 80 is known as GTI.

Net Income/ Taxable Income .

Income on which the tax is payable or it is GTI minus deduction u/s 80.

RESIDENTIAL STATUS

Sec ‘6’ Income tax act lays down the test of residential status for the following
taxable entities.

a) An Individual.
b) HUF
c) Firm, association of persons or body of individuals.
d) Company and
e) Every other person.

( A ) Individual (Sec 6)

Depends upon physical presence of individuals in India residential status of

individuals is determined. Here citizenship is immaterial.
 RESIDENTIAL STATUS OF INDIVIDUAL

Resident Non Resident

Ordinary Not ordinary

Basic Conditions 6(1)

1) Stay in India for a period of 182 days or more during the PY

Or
2) Stay of 60 days in PY and 365 days during the last 4 years immediately
preceding the PY

Exception to II nd basic condition

(Second basic condition does not apply to these categories of assesses. They
have to satisfy first basic condition only).

a) Any Indian citizen who leaves India during the previous year for the
purpose of employment outside India or as a member of crew of Indian
ship.
b) Indian citizen or person of Indian origin who lives outside India comes on a
visit to India.

Any assesse who satisfies any one basic condition is said to

be‘resident’ If not he is Non- Resident.
Additional Conditions.
 1) He has been resident of India ( satisfied any one basic condition) in at
least 2 years out of last 10 immediately proceeding the previous year.

2) He has been in India for a period of 730 days or more during 7 years
immediately preceding the relevant previous year.

If any Resident who satisfies both additional conditions then he will be

declared as Resident and ordinary Resident
If fails to fulfill both the additional conditions then he will be declared as
Resident but Not ordinary resident
(satisfying just one additional condition is immaterial)

Residential status of individual at a glance

a) Resident & Ordinary Any one basic & both additional.

b) Resident but not ordinary Any one basic & no additional (even
one additional)
c) Non- resident No basic additional is immaterial.

( B ) HUF Sec 6(2)

RESIDENTIAL STATUS OF HUF

Resident Non Resident

Ordinary Non ordinary

1) Resident

If control & management of HUF is wholly or partly situated in India.

a) Ordinary resident Kartha satisfies both the additional conditions

mentioned u/s 6(6)

b) Not ordinary resident When kartha fails to satisfy both the

additional conditions.

2) Non Resident

If the management and control of HUF is wholly situated out side India.

( C ) Firm and Association of persons

a) Resident Control & management of the affairs are wholly

or partly situated in India.

b) Non resident If control and management of the affairs are

situated outside India.
 ( D ) Company 6(3)

PLACE OF CONTROL INDIAN CO FOREIGN CO

& MGT
Wholly in India Resident Resident
Wholly outside India Resident Non-Resident
Partly in India & Resident Non-Resident
partly out side India

( E ) Any other person

a) Resident ---- control & mgt is wholly or partly situated in India.

c) Non- resident ---- control & mgt is situated outside India.

RESIDENTIAL STATUS & TAX INCIDENCE SEC(5)

In case of Individuals and HUF

OR NOR NR

Indian income

i) Income earned and received in Yes Yes Yes

India
ii) Income Received in India its Yes Yes Yes
immaterial where its earned
iii) Income Earned in India, its Yes Yes Yes
immaterial where its received
Foreign income

i) Business or Profession income Yes Yes No

earned and received outside India
where business is controlled or
profession is setup in India
ii Business of Profession income Yes No No
earned and received outside
but business is not controlled or setup
in India
iii) any other income (other than Yes No No
business or profession)earned and
received outside India
iv) past untaxed foreign income No No No
bought to India during the PY

B ) In case of any other assesses (other than individual and HUF)

Resident Non resident

i)Indian income Yes Yes
ii)foreign income Yes No
 TAX PLANNING

Tax planning can be defined as arrangement of one's financial and

economic affairs by taking complete legitimate benefit of all the deductions,
exemptions, allowances & rebates ,so that the tax liability is reduced to minimum.

Tax Evasion: - Method of avoiding tax liability by dishonest means. eg:- by

reducing sales, increasing expenses etc. It is a dubious method of solving tax
problems by misrepresentation of facts & falsification of accounts.

Tax Avoidance:- It is an exercise where assessee tries to take advantage of

loopholes of tax laws. Here without restoring to illegal ways one try to reduce tax
liability. It is a dodging of tax without breaking the tax laws. Eg:- Depreciation on
Fixed Assets for A.Y. 03-04

Tax Planning:- Avoiding tax using various relief’s and concessions available
within four corners of tax laws.
Corporate Tax Planning:- Considerations, estimates and programmes that
company undertakes to attract minimum tax liability. It includes all those activities
undertaken by the company in order to reduce the tax liability. Without restoring
to illegal means.

NEED FOR TAX PLANNING

1. Increased tax rates and most importantly increase profits/incomes in the hands
of tax payers.
2. Reduced scope for tax evasion and tax avoidance
3. Increase in the importance of corporate social responsibility.
4. Improve organisational profitability in the long run.
5. To help the companies in proper Capital expenditure planning and sales promotion
planning.